One key reason why so many investors follow the Dow Jones Industrials (DJINDICES: ^DJI ) is for their stability. The index typically goes years without making changes to its 30 component stocks, usually doing so only when a specific event requires the Dow's overseers to take action. Yet other indexes make much more regular shifts in their stock selections, and one major set of moves is slated to take effect after the market closes today. Let's look at how the annual rebalancing of the Russell family of indexes could affect not only key measures like the Russell 2000 (RUSSELLINDICES: ^RUT ) small-cap benchmark but also the Dow and other large-cap measures.
How Russell's reconstitution works
Russell goes through the same general process every year to update its indexes. Throughout May, Russell looked at stocks in its various universes, ranking them in line with the methodologies of its respective indexes. Earlier this month, Russell identified an initial list of additions and deletions from its key indexes, including large-cap, small-cap, and global benchmarks. Last Friday, Russell gave updates to that list based on market fluctuations, and today, the final revisions will be made and then instituted at the market close. Next Monday, investors will get final lists of the stocks in Russell's main indexes, including the Russell 2000.
This expanded schedule has major advantages for market participants over a process with a shorter time frame. Because many of the tiny stocks that make up the Russell 2000 and Russell Microcap indexes have relatively little liquidity compared to the stocks in the Dow Jones Industrials, it can take time to buy or sell those stocks without creating huge inefficiencies. Indeed, many professional traders start looking at prospective Russell additions and deletions months before the reconstitution process begins, seeking to capitalize on the stocks most likely to make it into key indexes and buy shares before index-tracking funds and ETFs jump on board.
What will the impact be?
For the most part, the Russell reconstitution hasn't made a lot of headlines this year. Perhaps the most interesting news has come from the way Russell has dealt with companies moving abroad, as both Delphi Automotive (NYSE: DLPH ) and Liberty Global (NASDAQ: LBTYA ) will be deleted from the indexes after the companies abandoned their U.S. domiciles in favor of the U.K., while Tyco International (NYSE: TYC ) will be added back despite its having its headquarters in Switzerland.
For the most part, the biggest impact of the Russell reconstitution in recent years has been a jump in volume rather than extreme price movements. Barring something truly unexpected, it's unlikely that investors in the Dow Jones Industrials will have much to see from Russell's index moves this afternoon.
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