What Is a Reconstitution?
Today, FTSE Russell will perform its annual reconstitution. Over 3,000 tickers are expected to be impacted by the event this year. A reconstitution means that Russell will add new companies to its indexes and will remove other firms that no longer meet its guidelines.
For example, some of Russell’s changes relate to market capitalization or the value of a company’s outstanding shares of stock. Over the course of a year, some companies grow and others shrink based on performance, guidance, and a multitude of other factors. Some index funds and ETFs track benchmarks related to market capitalization, therefore Russell’s benchmark calibration is extremely important. For context, small cap stocks are typically companies whose market capitalization is roughly between $300 million and $2 billion. Large cap stocks represent the market value of bigger companies.
The reconstitution will also change which stocks are considered value stocks and which are growth. Value stocks are those that are thought to be undervalued and are trading at a lower price relative to fundamentals such as sales, earnings, and dividends. Growth stocks are those that are expected to grow and outperform the rest of the market based on future expectations.
Annual and Quarterly Reconstitutions
Most other indexes make changes every quarter. Proponents of frequent reconstitution say it helps provide a more accurate snapshot of what the overarching index or ETF is meant to track throughout the year. On the flip side, the fact that Russell only makes changes one time per year means it has less turnover.
However, with an annual reconstruction, changes build up over the course of a year, creating a lot of movement on the one reconstitution day. In fact, this closely followed day often ends up being the year’s highest volume trading session.
The Impact of Market Volatility This Year
Since the market has been volatile recently, some analysts expect there will be more changes than usual during this year’s reconstitution.
Bank of America Merrill Lynch (BAC) predicts that 42 Russell 2000 stocks will be bumped up to the Russell 1000, made up of large cap stocks, and 47 Russell 1000 stocks will shift to the Russell 2000, which is made of mostly small cap stocks. Investors will be carefully watching to see how this highly-anticipated day will impact the index and ETF positions in their portfolios and the broader market as a whole.
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