FTSE Russell provides a series of U.S. equity indexes that are commonly used benchmarks for both active and passive investors. These indexes are intended to provide a proxy for the investible U.S. public equity market. Russell provides U.S. as well as non-U.S. indexes, but they're primarily known for the U.S. index suite. As of Dec. 31, 2017, Russell reported that approximately $9 trillion of assets or 67% of actively managed U.S. equity institutional assets are benchmarked to one of their U.S. indexes. Russell indexes are commonly used by our clients for benchmarking their retirement plan’s active U.S. equity managers (e.g., large cap value, large cap growth, small cap value, etc.).
To provide an overall view of the U.S. equity market performance an investor can use the Russell 3000 Index. This index covers the investible U.S. public equity. From there, Russell will divide the U.S, equity market by capitalization (e.g., large, mid, small) and style (e.g., value and growth). The first factor, market capitalization, is fairly straightforward. Stocks are segmented by their market capitalization (total value of a company’s stock traded in the market) and style. Russell uses a relative valuation approach (book-to-price ratios, forecasted earnings growth rates, and historical sales-per-share ratios) to segment stocks into the appropriate growth or value style index.
Russell’s construction methodology relies on relative measures (size and style). Given that these measures change daily with price movements, a key feature of Russell’s process is its annual reconstitution. Each year, during May and June, Russell conducts the index reconstitution exercise. This is a notable event for investors, whether they are an active or a passive investor. Moving a stock into or out of an index has implications for a stock’s demand due to investor mandates. For example, a passive manager will need to purchase stocks that are moving into their designated index and sell stocks that are moving out of the index. This movement creates shifts in supply and demand for different investor groups that may impact a stock’s price. In order to minimize the impact on investors, Russell follows a clearly defined process for announcing index constituent changes with preliminary and updates lists during the month of June. This year, the index reconstitution day was on June 22. Active managers will also note the changes in index composition as this will impact their ‘active positioning’ (amount of over- or underweight relative to index). At a high level, these active positions will ultimately determine the amount of value the manager is able to add relative to the index, assuming their positions are correct.
So how does this activity impact our retirement plan clients and their participants? The reconstitution activity is an important annual event that effectively rebalances indexes to reflect current valuations. This provides active managers with appropriate style benchmarks for U.S. equity mandates reflecting the current market and allows passive investors to hold stock portfolios that are rebalanced to reflect their selected equity style.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.
Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s clients.