Bill, it looks like a multi-step process, The Journal says the heaviest day will be June 30th but, I suspect their is incentive to front run this process, especially for closet indexers. CNBC is making a big deal that the rebalancing will commence after the close today.
June 11, 1999
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Russell 2000 Index Will
Trim Hot Net Stocks
By TERZAH EWING
Staff Reporter of THE WALL STREET JOURNAL
Goodbye, sexy Internet stocks. Hello, widgets.
The Russell 2000, the benchmark index for small stocks, gets its annual overhaul after the close of trading Friday night, in which stocks that have grown too big to still be "small" are cut away and replaced with smaller issues.
This year's Russell reshuffle is more important than most, because it will cause the loss of a bunch of glamorous Internet-related stocks that had boosted the index's performance for much of the year. Those Web stars -- including E*Trade Group, CMGI and Lycos -- are expected to be replaced by dowdier industrial stocks like pipelines (the oil kind, not Internet portals) and food companies.
About 26 large Net issues in all will leave the Russell 2000. A handful of small-cap Internet stocks will replace them, but there is no guarantee the newcomers will perform like their predecessors.
Some small-cap managers see the reshuffling as good news, particularly those who have a hard-and-fast rule against holding large stocks in their funds. They have suffered when analysts compared their performance to that of a Russell 2000 pumped up on Internet steroids.
For most of the year, the Russell 2000 enjoyed a sizable boost as many of its component Internet stocks caught fire. It finished at 442.27, up 4.8% since Dec. 31. Without Internet issues, it would have risen only 1.6%, according to Prudential Securities. And that is even given that volatile Internet stocks were a drag on the index in May and have been again this month.
"More managers have underperformed the index than I have seen in a long time," says Christine Benz, associate editor at Chicago-based fund tracker Morningstar. The Russell 2000 "used to be kind of a slam dunk; unless you were doing something weird, you could outperform that index. This year, as the [Internet] stocks skyrocketed, they took up a greater percentage of the index and it became harder to beat."
Internet stocks' weighting in the new Russell 2000 will drop to around 1.3%, down from about 7.7% as of May 31, says Maria Tsu, vice president of equity-derivatives research at Goldman Sachs, who wrote a recent report on the index rebalancing. (May 31 is when the Russell indexes' publisher puts together its internal list of the stocks that will likely make up the new index.)
Separate estimates by Prudential put the overall technology sector in the new Russell 2000 at 17.8% -- still the largest group in the index but down from its current weighting of nearly 20%. Consumer services and basic industry both should enjoy increased weightings, according to Prudential.
The first step in the index's reshuffling occurs Friday at around 9 p.m. EDT when Frank Russell Co., which publishes both the small-capitalization Russell 2000 and its large-cap counterpart, the Russell 1000, will announce the preliminary list of the companies that will make up the indexes for the next year. A second preliminary list will be put out on June 18 and a third on June 25. The final list, which allows for any new developments among the companies through the last day of June, will be published July 7.
Because there are typically few changes between June 25 and the publication of the final list, most managers do their heaviest rebalancing trading on June 30.
Any stock with a market capitalization of $1.5 billion or less is considered small-cap by this newspaper; Prudential estimates the largest stock in the reshuffled Russell 2000 will have a market cap of about $1.3 billion.
"A lot of investors have been spending a lot of time looking at indexes and have been forced to own Internet stocks as a phenomenon, as opposed to investing in them company by company," says Elizabeth Dater, co-manager of Warburg Pincus Small Company Growth Fund and Warburg Pincus Emerging Growth Fund. "I think we've been careful about owning only those companies that we think have growth potential."
For those small-stock managers who run index funds designed to mimic the Russell 2000's performance, the reconstitution has different implications. They must readjust their holdings to reflect the index's new breakdown, and that means selling Net issues and buying stocks that may not deliver as much of a pop.
Knowing the June Russell deadline loomed, and given recent shakiness in the Internet sector, many active fund managers began selling Internet issues a long time ago. Joseph Keating, chief investment officer at Kent Funds in Grand Rapids, Mich., says his firm's Kent Small Company Growth Fund has been steadily paring back on Internet stocks since the end of the first quarter.
"What we've been doing is trimming back" on holdings of stocks like E*Trade and Ameritrade Holding, Mr. Keating says. "We'll continue to do that right through to the rebalance date. We don't want to be part of the rush to get out of them." Mr. Keating estimates the fund has already shed 60% of what it will need to sell in the Internet sector to bring his fund in line with the new Russell 2000.
Though some managers have been selling ahead of the deadline, others speculate that June 30 could be a volatile day. Gus Sauter, manager of the Vanguard SmallCapitalization Stock Index Fund, says he also has had healthy holdings of Internet stocks but doesn't think he will have any trouble selling them as the end of the month approaches. He notes that while Russell 2000 index funds will need to sell the stocks, they will find ready buyers among funds that track the Russell 1000.
But, Mr. Sauter adds, "Internet stocks present their own unique problems" because "they trade more on a retail basis. You can't sell 50,000 shares at a whack. You might have to do it in smaller chunks."
No one knows for certain whether June 30 will be a bad day for Internet stocks. But Keith Mullins, a growth-stock analyst at Salomon Smith Barney, notes in a recent report on the Russell reconstitution that of $12 billion of institutional assets indexed to the Russell 2000, $1.1 billion would have been tied up in Net stocks at one point. With only "an insignificant amount" of money indexed to the Russell 1000, small-cap managers indexed to the Russell 2000 will need to sell around $720 million worth to get down to the projected new weighting. There is no telling how much of that chunk still remains to be sold.
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