Chip - Here is a copy of a Money Magazine article about the Russell 'reshuffle':
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Wednesday, June 10, 1998
How to play the Russell reshuffle
Rebalancing the popular Russell indexes usually means
price swings for the stocks involved - here's what you
should know before it happens
By Michael Brush
Over the next three weeks, the prices of many small-
cap stocks may start bouncing around as they get added
to or deleted from popular indexes managed by Frank
Russell Company -- presenting what seems like a good
investment play.
Like clockwork each year, Frank Russell reconfigures
its well-known indexes - including the Russell 1000
and Russell 2000 - as stocks get too small to remain
or big enough to join them. Then, as index funds
adjust their portfolios to match the new Russell
indexes, the prices of stocks being added generally
rise, while those being taken out fall.
If only you knew ahead of time which stocks were going
in and out of the indexes, you could make a lot of
money, right? Well, you can find out ahead of time --
but that doesn't mean you're going to be successful
playing the Russell reshuffle.
A preliminary list of comers and goers will be
available on June 12 at Frank Russell's Website
(http://www.russell.com/). (You can find the current
indexes there now). This first draft will be pretty
accurate, since typically about 95% of these stocks
will be on the final version released at the end of
the month.
As if that doesn't seem to make things easy enough for
speculators, consider this. Studies show that most of
the movement in stock prices caused by changes to the
Russell 2000 list occur in the two weeks after the
rough draft is published in the middle of June, notes
Steve Kim, the manager of U.S. equities derivative
research at Merrill Lynch.
And the bulk of the change, he says, happens in the
second week -- the last week of June. This is because
mutual funds that match the Russell indexes can't make
the adjustments too far in advance, even though
companies like Merrill Lynch and ITG Research are
adept at predicting who will be on the list weeks in
advance.
Speculators have yet another factor working in their
favor. After the lists are finalized at the end of
June and the stocks have finished moving, those price
changes typically reverse themselves completely over
the following ten trading days, or the first two weeks
in July, notes David Cushing, of ITG Research
(http://www.itginc.com/). While last year was a
notable exception to that rule, this trend offers the
promise of another good investment play.
All in all, seems like a slam-dunk: Just go long
stocks being added and go short those being deleted
now. Then reverse those positions at the end of June.
Naturally, it is not so easy.
For one thing, estimates Merrill Lynch, upwards of 500
stocks are being added this year while about 300 are
being taken off. So it would be impossible to play
them all. Second, Frank Russell does not list the
weightings of each of the stocks in its indexes in
advance, so it is hard to tell how much of each new
company the index funds have to go after.
And suppose you take a big position in some of the
stocks being added, and their sector or the whole
market tanks. Your speculative bet is likely to get
hit worse. Why? First, the chances are good you will
have made your Russell index play in smaller-cap
stocks -- since many of the changes are made at the
bottom end of the index list. You were probably also
attracted to smaller stocks because they are less
liquid, exaggerating the Russell effect.
But precisely because those stocks are less liquid,
they will probably get hammered more than most stocks
if problems in their sector or the market crop up,
leaving your short-term speculative play way under
water. Even if problems don't arise, trading in and
out of many of the stocks in the reshuffle can be
costly, because the bid-ask spreads for many of the
smaller-cap stocks tend to be high.
What's more, who can really predict what effect the
Russell reshuffle will have this year, asks Cushing,
given that small-caps are in a slump.
Even though making money on the Russell reshuffle is
not as easy as it may seem, there are plenty of ways
you can make the changes work in your favor. Consider
these tips.
* If you were already thinking about buying a stock
and it turns up on the "add" list on June 12, you
might want to buy it as soon as possible -- because
the price is likely to go up. And it is more likely to
have good support over the long term, since being part
of an index draws more attention to the stock.
* If you hold a stock that turns up on the delete list
and you still believe in the company, leave it alone.
The chances are the stock will rebound (although this
is not always the case). But trying to sell around the
dip that may occur as index funds bail out may not
make sense for tax reasons, points out Merrill's Kim.
And you will also probably face high trading costs in
the form of the huge bid-ask spread that often comes
along with the smaller stocks. Being aware that your
stock is on the delete list, however, is important
because it will help you understand why the price is
bouncing around so much.
* If you were considering buying a stock on the delete
list, you might want to wait for the last week of
June, when it may go on sale. Presumably, you already
know why the stock took the plunge that brought down
the market cap and led to its removal from the Russell
index. And you are also reasonably sure the stock is
only suffering from temporary problems.
* The extent of the Russell index impact can depend a
lot on the liquidity for the stock. As a general rule
of thumb, the effect can be greater on smaller-cap
stocks with low trading volume. But Prudential
Securities small-cap analyst Claudia Mott thinks
additions at the higher end of the market cap range
make better plays because they are more likely to be
bought by an index fund trying to match the Russell
universe. Small cap index funds don't necessarily have
to buy all the stocks in the Russell indexes.
Remember, though, it is probably better to resist
attempting to make a pure play on the Russell index
changes. For the reasons noted above, this can be a
big gamble. "It is inherently risky, and it is
definitely not easy to make money off of this," says
ITG's Cushing. "There are a lot of moving parts. So
you really have to devote a lot of time and research
to getting it right. It is not for the average
investor."
###
Special event: Tuesday, June 9, 9pmET/6 pmPT Inside an
Internet brokerage, with Ameritrade president Michael
Anderson at:
chat.yahoo.com
###
Marketwatch for Tuesday, June 9, 1998
Dow Jones Industrial Average: down 19.68 (0.22%) to
9049.92
The Money 30 Index: up 13.15 (0.8%) to 1651.17
New York Stock Exchange
Advances: 1290
Declines: 1639
Volume: 565 million shares
NASDAQ Composite: up 12.99 (0.73%) to 1800.76
S&P 500 Index: up 2.69 (0.24%) to 1118.41
Russell 2000: up 0.40 (0.09%) to 456.74
30-year Treasury bond yield: unchanged at 5.78%
London gold (afternoon fix): up $5.90 to $297.60
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