come on I know that was you slinging aroung those calls -g-
here's a great article on the upcoming Russell rebalance and the net stock role in it. :
May 17, 1999
I've never seen anything like it before. The current frenzy
surrounding the Internet companies makes the biotech party
of 1991 look like a wake. Forget about looking back at
other life-changing events like the birth of the semicon-ductor,
cable, and networking. Compared to the universal
adulation afforded today's newly minted billionaire.coms,
such industries can only be considered investment hors
d'oeuvres.
However, if you put aside the day traders, caffeine-laced
students, and those who simply need to get a life, you still
find a considerable number of serious institutional inves-tors
putting real money into the Internet space. Classic
growth stock investors have gotten religion. Certainly,
this stands in stark contrast to a year-ago when only a few
brave fund managers were huddled into AOL and
Amazon.com. Today, by my unofficial tally, roughly half
of the institutional emerging growth funds have a healthy
or growing Internet exposure.
Curiously, a year ago, the valuations afforded most Internet
companies intimidated this usually high-octane capital base.
The business models remained elusive and the market capi-talizations
looked scary. While most professional inves-tors
agreed that the world was quickly moving to a 24 x 7
model (24 hours, seven days a week) with untold opportu-nities
for those who could grasp the new paradigm, most
companies' valuations suggested a visibility of success
which was difficult to understand. Many investors chose
simply to sit out a party which looked well into its cups
rather than trying to play catch-up.
However, over the past year, many serious investors have
shifted billions in assets into the Internet stocks at mar-ket
caps which are multiples above where they had previ-ously
rejected the opportunity. From dozens of conversa-tion
with these recently converted investors, the key driver
appears less of an investment epiphany into the true pros-pects
on individual Internet companies. In fact, over an ex-tended
series of meetings with traditional emerging growth
investors, I recently discovered not a single investor willing
to defend the valuations of their Internet holdings. For a
group which generally employs razor-sharp valuation skills,
such behavior was wildly out of character.
I think a lot of portfolio managers with capital in the
Internet stocks have simply decided to commit intellec-tual
suicide regarding the group's valuations. Repeatedly,
their investment rationale centers around the fact that their
investment benchmark contains a healthy Internet com-ponent.
Those who have held to historical valuation meth-ods
have simply watched their competitors and bench-marks
surge while their portfolios stalled. For many, it's a
case of career survival and asset protection.
Bottom line: many portfolio managers have
made a portfolio decision rather than an in-vestment
decision regarding their Internet
holdings.
What makes such a capital capitulation into the Internet
space dangerous is the fact that the benchmark driving
the decision will be radically adjusted at the end of June.
Through the annual re-balancing, the
Russell 2000 will find its Internet weighting
fall from 9.3% to 3.2% overnight on June
30.<?b>
Given the universal application of the Russell 2000 as a per-formance
benchmark for small-stock investors, such an ad-justment
entails significant consequences.
First, while the rebalancing of the Russell 2000 historically
can be viewed as a non-event, the surge in the Internet stocks
over the past year has dramatically raised the stakes. In the
past, a particular stock or two might have dramatically risen
and assumed an inflated influence on this market-cap index.
However, we have never witnessed such an inflation of influ-ence
for a whole industry as that which has occurred over the
past year with the Internet companies. As the first table shows,
the Internet stocks currently comprise approximately 9.3% of
the total market capitalization for the Russell 2000. Put an-other
way, Internet stocks account for close to $103 billion in
the $1.1 trillion Russell 2000 at the end of April. However, as
this index rebalances in June, this weighting will decline to
roughly 3.19%, or $35 billion. Collectively, the Internet weight-ing
within the Russell 2000 small-stock index will fall by 66%
or $68 billion. Virtually overnight.
Two of our derivatives experts, Peter Forienza and Omar Saeed,
estimate that approximately $12 billion of institutional assets
currently sits indexed to the Russell 2000. No one can even
hazard a guess at the amount of capital closet-indexed by con-sultant-
whipped investors. According to their analysis, this
$1.1 billion of indexed assets sitting in Internet stocks will fall
to $380 million at June's end. Furthermore, they indicate that
only an insignificant amount of capital indexes the Russell 1000.
Essentially, according to this analysis, when the Russell 2000
rebalances at the end of June, $720 million of net selling in the
Internet space will automatically be executed. The impact of
closet indexers may dwarf this figure.
The second consequence on the inevitable rebalancing of the
Russell 2000 will be that the key driver for capital into the
Internet space for most institutional investors will be elimi-nated.
Of course, if the stocks continue to rally, money will
chase the performance. However, I sincerely believe most in-stitutional
investors cannot articulate a compelling valuation
argument for most Internet stocks. They justify their partici-pation
as an attempt to maintain a sector weighting consistent
with their performance benchmark. Such a portfolio decision
will be virtually eliminated on June 30, and the investment
decision process will be pushed to center stage.
I'm particularly curious about investor behavior during the
unavoidable correction in the Internet sector. When it occurs
can be anyone's guess. However, come it will. Previous de-clines
have been met with resistance as uninvested institutional
capital attempts to raise its weightings on weakness. How-ever,
given the loss of the performance benchmark as a cata-lyst,
money will need to fall back on its traditional tools. What's
to cause capital to dig in and buy on a sell-off in the Internet
space? Fifty times sales? The net result could be dramatic as
greed turns to fear with a comforting valuation metric.
A third consequence of the approaching rebalancing of the
Russell 2000 is that a new batch of untested Internet compa-nies
will replace last year's roster. As the tables describe, while
the total decline in Internet weighting within the small-stock
index will approach $67 billion, actually slightly over $91 bil-lion
of current Internet positions will be removed from the
Russell 2000. A newly minted group, approximating $24 bil-lion
in capital, will be added. |
