A little-known indexing event on Friday will likely result in the year’s biggest volume day, with large trading and potential price swings in well-known names like Apple, Microsoft, J.P. Morgan, and Grubhub.
One of the world’s largest index providers, FTSE Russell, is rebalancing the large-cap Russell 1000 and the small-cap Russell 2000 indexes. This is a significant annual market event because a lot of money tracks these indexes. Roughly $8 trillion is benchmarked to the Russell indexes, and $1 trillion is passively invested in funds that just attempt to track them. Nearly 10 percent of the money invested in the Russell 2000 is controlled by passive index funds, according to investment banking firm KBW, and when they make large-scale changes piles of money move around.
“It’s a sign that indexers are becoming more important in global investment calculations,” Alec Young, managing director, of global markets research for FTSE Russell, told me. “With more passive indexers the stakes are going up to make sure we get it right.”
All that makes the reconstitution what traders call a “major liquidity event,” meaning a lot of shares are going to change hands Friday. How many shares? The 2016 Russell reconstitution on June 24 of that year saw 6.7 billion shares change hands at the NYSE, three times normal volume and the largest volume day of the last three years. Last year’s reconstitution on June 23 saw nearly 5 billion shares change hands, the second largest volume day of 2017.
Here’s how it works:
Each year, Russell ranks the top 3,000 stocks (virtually the entire stock market universe) by market capitalization, then puts the top 1,000 in the Russell 1000 and the bottom 2,000 in the Russell 2000. Due to share buybacks and other events, many companies have either increased or decreased their market capitalization and so indexers will have to buy or sell shares in direct proportion to the increase or decrease in the index.
That means when you have a single day when all the stocks change their weighting in the index, heavy trading volume is going to occur.
Take Apple, which has been a buyback monster in the last few years. It will reduce its weighting in the Russell 2000 index, and there will be an estimated 2.7 million shares for sale at the close. Fortunately, that is only about 10 percent of the daily volume Apple trades, so the hope is that the price impact will be minimal.
J.P. Morgan has also been buying back stock and will see its share count reduced.