Russell 3000 Sheds Nearly $2 Trillion in Cap Value

By Murray Coleman

Last June, gas prices at the pump were well below $3 a gallon and a rampaging mortgage meltdown wasn't even a reality yet.

Fast-forward to this June. On Friday, the next-to-last work day of the month, Russell Investments concluded its massive annual rebalancing. How big was it in the indexing world? To put it into perspective, consider that assets benchmarked to the Russell family of indexes reached a record high of around $4.4 trillion in 2007. In addition, some $593 billion in exchange-traded funds assets were tied to Russell benchmarks—both actively and passively.

"As a result, the annual Russell index reconstitution, a major market event that takes place every June, typically results in significant changes to both the capitalization and style indexes," Northern Trust Global Investments analysts noted in a recent report previewing the 2008 reconstitution.

This year was no exception. Add in the drama that began last July when credit markets started swooning as subprime lending collapsed along with the steadily rising costs of energy and other commodities and the 2008 process was chock-full of drama (see charts below).

"It was Sept. 10 last year when the Fed actually cut interest rates as a response to the credit crunch. Even in late August, everyone was debating the extent of what was going on. So we've really only been experiencing this phenomenon for the last three quarters," said Stephen Wood, Russell's senior portfolio strategist.

In terms of names, the actual amount of companies moving up and down weren't all that unusual, he says. "The names coming in and out were almost identical to last year in terms of total movement," Wood said.

Some 45 companies moved up from the small-cap Russell 2000 Index to the large- and mid-cap Russell 1000 Index this year. Meanwhile, another 34 moved down from the Russell 1000 to the Russell 2000—including seven stocks from the financial services sector.

Substantial Drop In Short Time

"But if you look at the Russell 3000 [a total stock market index], there was nearly a $2 trillion drop in market cap valuations that have been lost since the October 2007 highs," said Wood. "So we're looking at a rather significant loss in market capitalization in barely seven months. That's very remarkable."

The poster story for such a picture could be Chevron's move up into the top 10 in the Russell 1000 Index, Wood notes. At the same time, Citigroup fell out of the top 10 in the large-cap-dominated benchmark. "A 60% drop in Citi's share price since this subprime credit crunch will do that," he added.

Much has been made of front-running issues with an annual rebalancing schedule. But according to preliminary reports, Russell says it hasn't seen any definite patterns evolving. Early returns showed a mixed bag, with those moving down generally slipping in line with the broader market. Incomplete data for trading tracked by Russell showed a slight gain for those moving up from smaller indexes.

"Russell has made a number of changes over the past few years to lower turnover and avoid front-running," said Stefanie Hest, an investment strategist at Northern Trust Global Investments.

One of those was to allow non-headquartered companies that trade in the U.S. to be included in some popular benchmarks. This year also was the second reconstitution using so-called banding methodologies. Those create a sort of cushion that lets companies flirting along the border of being kicked out of an index or automatically being moved up more time to be reviewed.

"Normally, Russell has very strict cutoff points between the Russell 1000 and Russell 2000. But now, they've created more flexible bands to lower turnover between the two indexes," said Hest. "As a result, the Russell 1000 for example doesn't have to hold exactly 1,000 names."

Russell this year also removed special purpose acquisition companies. Those are holding companies without any transparency. That eliminated a number of companies. About eight such SPAC firms were dropped from the Russell 2000 alone.

"It's not necessarily front-running that's an issue anymore. But due to the increased number of index-based assets, this is a very closely monitored event in both the active and passive asset management space. So it's typically a higher-volume period just due to managers adjusting their portfolios and the larger amount of indexing assets involved these days," said Hest.

Neck-And-Neck 

But since those moves were slight in the first place, the real story is probably the rise of Tech names across the board. For example, in the Russell 3000 Index, tech jumped 1.1 percentage points to 13.6% of the total. That left it virtually tied with energy as the benchmark's second-biggest sector.

Russell figures energy in two groups. Integrated oils, consisting of large and diversified energy producers such as Chevron, gained 1.2 percentage points in the latest reconstitution. Also, the broader "other energy" category jumped by 2.2 points. Combined, that left oil and energy with a 13.5% weighting in the Russell 3000 Index.

In the Russell 1000, those shifts were even more pronounced. Oil and energy gained a total of 3.5 points to 14% of the index. That pushed it past Tech, which jumped 1.1 percentage points to a 13.5% weighting.

But financial services remained the top sector across the board.

In the Russell 3000 Index, the group lost 4.5 percentage points in market capitalization. But it still captures 17.4% of the market—better than Tech, Oil and Energy, Health care and Consumer Discretionary.

In the Russell 2000 Index, Tech's rise was less—about 0.8 percentage points. But that was enough to keep it in third place at 14% of the total. Energy and Oil rose 2 percentage points to 7% of the index. The big losers in the small-cap-focused benchmark were Consumer Discretionary (-3.1 points to 16.1%) and Financial Services (-1.8 points to 20.8%).

In fact, Financial Services actually gained the most in weighting terms in the Russell 3000. While many such firms dropped in size, those losses were countered by a general rise in market-cap sizes of many regional banks. The addition of Visa after its initial public offering also boosted the sector's position in the overall index.

Some other interesting tidbits from the latest rebalancing:

• Total turnover for the Russell 3000 came in less than 2% and a relatively low 12% for the Russell 2000.

• Besides Visa, several other firms were added: Calpine, Potash, American Water Works and Key Energy Services.

• The biggest additions to the Russell 2000 were: Cheesecake Factory, Chico's, Riverbed Technology, Tractor Supply and Dillard's.

• The smallest company in the reconstituted Russell 2000 is now around $166.7 million (down from $261.8 million in 2007).

• The median market cap for companies in the Russell 2000 slipped to $515 million.

• In Russell's global benchmarks, top-weighted countries with the most additions were: the U.S., India, Canada, Taiwan and Australia.

• Some smaller Middle Eastern countries were also very active. Those included new stocks from Qatar, Kuwait and Egypt.

Changes In Key Sector Weightings Of Newly Reconstructed Russell Indexes

(in percentage points)

Index	Tech	Health	Cons Disc	Cons Staps	Oil	Energy	Materials	Financials
3000	+1.1	-0.1	-1.4	+0.7	+1.2	+2.2	+1.0	-4.5
1000	+1.1	-0.1	-1.2	+0.8	+1.2	+2.3	+1.1	-4.6
2000	+0.8	+0.7	-3.1	+0.5	+0.1	+1.9	-0.1	-1.8

Source: Russell Investments

 

Final Key Sector Weightings In Russell Indexes After 2008 Reconstitution

(in percents)

Index	Tech	Health	Cons Disc	Cons Staps	Oil	Energy	Materials	Financials
3000	13.6	11.5	12.0	7.0	6.5	7.0	6.0	17.4
1000	13.5	11.5	11.7	7.4	7.0	7.0	5.7	17.2
2000	14.0	12.4	16.1	2.7	0.2	6.8	9.6	20.8

Source: Russell Investments

Comments

[Mike Stathis]

"It was Sept. 10 last year when the Fed actually cut interest rates as a response to the credit crunch. Even in late August, everyone was debating the extent of what was going on..." said Stephen Wood, Russell's senior portfolio strategist.

This is precisely why the Russell is in shambles. Those who did not see the full extent of what was going on by August were lost. Unfortunately, the follow-the-leader mentality so widespread on Wall Street led to 99.99% of the "experts" missing everything.

[fatcat]

right on Mike,Ive never seen such denial in my 57yrs...

[iThinkBig]

You probably would have to go back to 1928 Fatcat to see that level of deniability.