Tag Archives: Russell 1000

The Russell Reconstitution And Your ETFs

The biggest event on the indexing calendar is the annual reconstitution of Russell Investments’ flagship Russell 3000E Index, of which the Russell 3000, Russell 2000, Russell 1000 and Russell MicroCap Index are subsets.

While changes to the Dow Jones Industrial Average and S&P 500 make big news, they’re few and far between, largely at the subjective discretion of the indexes’ custodians. You can’t plan for or truly predict the changes. Russell’s change can be seen from a mile away.

And it’s a big deal. With $3.9 trillion in managed assets benchmarked to its U.S. indexes, according to Russell (around $542 billion of that in indexed assets), the activity surrounding the annual reconstitution makes June 30—switchover day—one of the U.S. equity market’s largest trading days of the year. The rebalancing forces the movements of many stocks in and out of indexed portfolios as managers try to get the best price for their shareholders amid a huge amount of trading volume.

Negotiating The Transition

“We do a lot of work, months ahead of time, to anticipate the movement from the small-cap index to the large-cap index and vice versa,” said Greg Savage, managing director of iShares’ portfolio management.

According to BlackRock, iShares’ parent, at the end of March there was $83.9 billion in ETF assets following Russell indexes. And while iShares only sponsors 16 of the 70 ETFs tracking Russell’s U.S. indexes, it holds the lion’s shares of the money, with $74.4 billion in assets under management.

The biggest issue affecting passive funds replicating these indexes is the idea of a “free lunch” for traders and active funds that front-run the reconstitution.

You might assume that graduating from the small-cap Russell 2000 to the large-cap Russell 1000 is a good thing for a company. But from a flows perspective, it’s quite the opposite.

When a stock falls from the large-cap Russell 1000 Index to the small-cap Russell 2000, there can be buying pressure. As the smallest stocks in the large-cap index, they may be excluded from both optimized index and actively managed funds. However, when they move to the small-cap index, they tend to be the largest stocks in the new pool, granting them some of the largest weights in that index. Managers of the small-cap fund could potentially buy a lot more shares than the large-cap fund managers will sell.

Meanwhile, opposing high selling pressure occurs when a stock graduates from the Russell 2000 to the Russell 1000.

Consider Capitol Federal Financial (CFFN), a company with a market cap of $1.9 billion. It currently has a weight of 0.000036 percent in the Russell 1000, after falling more than 35 percent over the past 12 months. Given its low ranking, it will likely drop into the Russell 2000 during the rebalance. But what will be the impact?

Estimates say that $135 billion is benchmarked to Russell 1000-linked index trackers. Given CFFN’s weight, that means these funds own about $4.9 million of the stock. If and when it moves to the Russell 2000, it will become a bigger fish.

Based on current levels, it would represent about 0.15% of the index. With $44.2 billion tied to Russell 2000 trackers, those funds would have to buy $6.6 million of the stock. Much of that can slide over from Russell 1000 funds exiting the position, but given the current numbers, there would be a net $1.7 million purchase taking place at the close on the day of the rebalance. That’s the equivalent to 11% of the stock’s average daily volume—a significant, but not overwhelming buy order. However, mutliply that out over hundreds of stocks, and you get some major market-moving activity.

“Some fund managers want to offset the price movements that they think are part of the front- running,” said Joel Dickson, senior ETF strategist at Vanguard. The Valley Forge, Pa., fund company runs seven ETFs tracking Russell indexes. “However, passive managers don’t want to beat the index. They want to minimize the tracking error with respect to the underlying stocks. So, if the goal of the ETF is to provide exposure to the Russell index with low tracking error, then that is attained by doing all your trades on the day of the reconstitution. That way, the front-running doesn’t matter.”

For the full story to go IndexUniverse.com.


New ETFs Leverage Natural Gas, Retail Sectors

If you want to leverage a bet on natural gas or the retail sector, Direxion’s new ETFs will help you achieve that goal. On Wednesday, the Boston firm launched four new new leveraged ETFs, bringing its total to 38.

The Direxion Daily Natural Gas Related Bull 2X Shares (FCGL) seeks to produce 200% of the daily performance of the ISE-REVERE Natural Gas Index. The index tracks companies that derive a substantial portion of their revenues from the exploration and production of natural gas. Oil and gas exploration and production make up 72.1% of the index, while integrated oil and gas comprise 24.3%, with 3.5% in gas utilities. The Direxion Daily Natural Gas Related Bear 2X Shares (FCGS) seeks to produce twice the inverse return of the index.

The Direxion Daily Retail Bull 2X Shares (RETL) seeks to double the returns of the Russell 1000 RGS Retail Index, while the Direxion Daily Retail Bear 2X Shares (RETS) gives negative 200% return of the same index. The Russell 1000 RGS Retail Index contains constituents of the Russell 1000 Index that are classified within the Retail subsector of the Russell Global Sector Scheme.

The funds all have an expense ratio of 0.95%.

Net Cash Inflows Double; Large-Caps Lose, Emerging Markets Win

Net cash inflows into all exchange-traded funds (ETF) and exchange-traded notes (ETN) grew to approximately $17.1 billion in May, doubling April’s total, according to the National Stock Exchange (NSX). Despite the huge inflow overall, ETFs holding large-capitalization indexes such as the S&P 500, Dow Jones Industrial Average and the Russell 1000 posted significant cash outflows. Meanwhile, emerging-market ETFs recorded huge net inflows.

iShares remained the top ETF firm with $290 billion in assets under management. State Street Global Advisors came in second with half that, $142 billion. Vanguard took third at $54 billion. PowerShares’ $31 billion came in fourth and ProShares $26 billion claimed fifth.

The SPDR Trust (SPY) remained the king with $63 billion in assets. SPDR Gold Shares (GLD) came in second with a distant $35 billion.

I noticed a trend of heavy net cash outflows from the large-cap U.S. equity funds. So, even as the market rose in May, the SPDR saw $146 million flow out in May. The PowerShares QQQ (QQQQ), which tracks the Nasdaq 100 and is the sixth-largest ETF, had outflows of $435 million. Meanwhile, $639 million was pulled out of the Dow Diamonds (DIA), which tracks the Dow industrials. Surprisingly, the iShares S&P 500, (IVV) which also tracks the S&P 500 and is the fifth-largest ETF, saw net cash inflows of $441 million. However, all the iShares ETFs that track the Russell 1000 or an offshoot also saw outflows. Does this mean that traders think the U.S. stock market has peaked and have taken profits? I wouldn’t be surprised.

That money appears to be moving into emerging markets. The iShares MSCO-Emerging Markets (EEM) took honors as the third-largest ETF upon receipt of $1 billion in cash inflows in May. The only ETF with more net inflows was the iShares MSCI Brazil (EWZ) with $1.5 billion.

Year-to-date net cash inflows totaled approximately $29.8 billion, led by fixed income, commodity, and short U.S. equity based ETF products, says the NSX. Assets in U.S. listed ETF/ETNs grew 10% sequentially to approximately $594.3 billion at the end of May. The number of listed products totaled 829, compared with 767 listed products a year ago. This data and more can be found in the NSX May 2009 Month-End ETF/ETN Data Report.