LSEG FTSE Russell Transcript Ep 1
Paul: Welcome to index ideas from FTSE Russell. I am Paul Amery, your podcast host. Index ideas is your front row seat for the fast-changing landscape of index investing. In this podcast, we explore how cutting-edge indices and benchmarks are built to solve real world investment challenges. We help you to manage risk and capture new opportunities, and we help you stay ahead of market shifts and understand the ideas shaping tomorrow's passive strategies. In this episode, I'm joined by Catherine Yoshimoto, who's director of product management at FTSE Russell. Catherine looks after some of the best-known equity index families at our firm, and today she's joined me to talk about the Russell US indexes, which measure the performance of the world's largest stock market, the US. The Russell US indexes include the Russell 1000 index for US large-cap stocks and the Russell 2000 for US small caps, plus a number of size and style variants. Catherine, welcome to Index Ideas. Let me start with a question of terminology. Last year, the Russell US indexes celebrated their 40th anniversary and we published a special report to commemorate it. That report is available on the FTSE Russell website, and it's called “How We Built a Better US Equity Benchmark”. So why do we call the Russell 1000 and Russell 2000 benchmarks?
Catherine: The Russell 1000 and Russell 2000 indexes are used as benchmarks, so as a measure of investment fund performance. Initially they were used as measures of relative success for active managers, active funds. These days they are increasingly being used as the basis of passive or index fund investments.
Paul: So why do we say that they're better benchmarks?
Catherine: We call them better benchmarks because at the time that the Russell US indexes were launched in 1984, there really was not a broad representative benchmark, which ultimately led to the design of the Russell 3000 index, covering the entire investable US equity market at the time, segmented into the US large-cap Russell 1000 and small-cap Russell 2000 indexes. So they're better benchmarks because they are representative and more accurately allow investment managers to distinguish the different segments of the market based on size. In 1987, we also launched the growth and value indexes that allowed further segmentation of the investable opportunity set.
Paul: So what dollar volume of assets are tied in one way or another to the Russell Index family?
Catherine: In terms of assets benchmarked, the total assets benchmarked, the Russell U.S. indexes have more than $10 trillion following the indexes. Now of that, about $2 trillion is in these passively managed index funds that are more closely replicating the indexes.
Paul: Before the recording, I looked up the size of the US stock market. It was just over $50 trillion at the end of May, according to the FTSE All World Index. Does that mean that about 20% of the market looks at the US equity market through a Russell lens.
Catherine: You could potentially look at it that way. That's right. And with this year's Russell recon, for example, the Russell 3000 measures about $58 trillion in market cap.
Paul: Right. So you mentioned recon. We're coming up to that event. It's every June. It's the annual reconstitution of the Russell. We call it in short the “Russell recon”. Let's start with the basics. Why do we need to reconstitute the Russell?
Catherine: The Russell US indexes are reconstituted regularly to ensure that they are capturing changes that have occurred in the US equity markets since the previous rebalance or reconstitution. Today, we rebalance the Russell US indexes annually to make sure we have a regular cadence of updating the Russell US indexes to make sure we're capturing changes like a small-cap stock becoming a large cap stock, or a growth company becoming a value company. Right. So it's changes like that that we're ensuring we're capturing with the rebalancing, the reconstitution of the indexes. I will mention that originally when the Russell US indexes were launched, the indexes were rebalanced quarterly. Then they moved to a semi-annual cadence in 1987. And since 1989, it's been an annual cadence. Because of the turnover, the additional turnover you would incur from a more frequent rebalance. But, we did announce earlier in the year that we will be moving back to a semi-annual rebalance beginning next year in 2026, in order to ensure that we're continuing to capture and represent the underlying US equity markets accurately.
Paul: Okay, so how significant is this recon? Let's talk about the annual reconstitution for now. How significant has that day been in the overall US equity market calendar?
Catherine: It tends to be one of the busiest trading days of the US equity markets. And by that definition, as you mentioned earlier, the US is the largest equity market globally. And so some people say it is one of the busiest trading days globally. Last year, at the close of Russell reconstitution on the fourth Friday of June, almost $220 billion traded at the close of reconstitution, which was a record for us.
Paul: And it was about double the level of five years earlier. So the volumes have been. And part of that is reflecting the rise in value of US stocks. But even so, it's a big it's a big number.
Catherine: [00:05:21] Yes. The dollar traded value at the close of recon has continued to appreciate since about 2019. It's been above $100 billion at the close and continuing to rise. And that was actually one of the reasons why index users came to FTSE Russell, to ask for us to consult on whether to move back to a semi-annual reconstitution because of, you know, the volume of trades, increasing trades. And so it in one sense, to reduce the risk of that one-day trading event, as well as more accurately continuing to reflect the underlying market.
Paul: So at what point on the recon date does the index switch out of the old stocks and into new ones if there is a change of membership?
Catherine: Yeah. So the way that the index reconstitution works is that you think about it as trading into the close, but the effective date is at the open of the Monday. So this year the effective date for Russell Recon is after the close of June 27th. Close of US equity markets. Passive index funds tend to trade into the close. So you see a lot of stats about the closing trade right. I mentioned that $220 billion. So Nasdaq you know has its closing auction to make sure that stocks are trading at a single price. The same price, in the last few seconds of the trade, NYSE has its closing auction. So most passive funds do choose to trade into the close in order to minimise the tracking error or difference they see in their fund versus the benchmark, against the index that they're tracking. But the effective date is technically over the weekend into the open of Monday. So what clients see is in their open files for Monday, June 30th, they will see what the opening weights for the stocks.
Paul: So how far in advance of that end June recon date do market participants know who's going into, let's say, the Russell 1000? Who's going out, who's going into and out of the Russell 2000? When do people become aware of the changes?
Catherine: So Russell tends to be known as one of the index providers that provide a very long notice period. So this year the preliminary announcements were made on May 23rd for the June 27th close changes. Now that being said, there is a two-week query period to make sure that you know if there are any clarifications. For example, some changes might come because of nationality differences potentially, or shares or float. So, there is a two-week query period. But since June 6th, you know, we've entered the lockdown period. So index trackers have, you know, ample time, several weeks of notice to prepare for that trade. And that's also one of the reasons why, actually, June tends to be viewed as a relatively low volatility month in terms of trading activity, because many Russell index trackers are preparing for that trade going into the close on the fourth Friday of June.
Paul: Right. So, if we could give an example, what percentage by weight of the index, let's say the Russell 1000, is affected by recon? What percentage of the index is subject to change at the end of June in a typical year?
Catherine: In a typical year, let's say about 30 stocks, 30 to 40 stocks enter and exit the Russell 1000. About 200 stocks enter and exit the Russell 2000. In terms of market cap, you know we calculate a turnover figure based on the market cap. It's relatively low for the Russell 1000. It's like you know a couple, single digits, like 2 or 3%, let's say, of turnover. It is higher for the smaller cap index and it will get higher as you further segment the market. So the growth and value style indexes will see higher turnover relative to the large-cap Russell 1000 index.
Paul: So starting next year we're making a big change to the recon calendar. What is that change and why are we doing it.
Catherine: Yeah. So beginning next year in 2026 we will add a second reconstitution effective on the second Friday of November. I mentioned earlier some of the higher increased trading volumes we're seeing at the close of the June reconstitution. It's a culmination of several different factors. There is a paper published to our website that discusses the increase in assets tracking benchmarks. Especially, we're seeing, you know, an increase on the passive side. So as well as the changing dynamics of the market, the market seems to be at least the last five years or so compared to the previous 15 years, more volatile, relatively speaking, and more dynamic in nature. So, we want to make sure we're accurately capturing those changes on a more frequent basis. And therefore, beginning next year, we will add a second reconstitution, primarily for the Russell 1000 and Russell 2000 and the size indexes. Now, because the style index, as I mentioned earlier, contribute to higher turnover, the style growth and value index changes, they will only be applied for any additions, or stocks that are moving between the Russell 1000 and Russell 2000. The full rebalance has been considered, based on our consultation with clients in the market, too big to implement twice a year.
Paul: For the style indexes.
Catherine: For the style indexes.
Paul: So they'll be reconstituted annually like now.
Catherine: Fully annually, continuing to be fully annually rebalanced in June. And then with just addressing the changes of the membership at the November reconstitution.
Paul: So does the semi-annual reconstitution cover all the Russell indexes.
Catherine: So the Russell semi-annual reconstitution will be a complete rebalancing for the size indexes, the Russell 1000, Russell 2000, etc.. Now for the style indexes, because of the size, the higher size of the turnover for growth and value index membership changes, and we've consulted the market on this. The feedback has been that generally speaking, you know, in order to reduce turnover at that second event, it would be preferable to completely rebalance the Russell US style indexes in June. However, for the November semi-annual reconstitution, only additions to the Russell US indexes or migrations from Russell 1000 to 2000 and vice versa, they would be assigned new growth and value probabilities and style memberships.
Paul: The style indexes are probably a good topic for a separate podcast, Catherine. So, I'm going to ask you back to talk about those. But could you just explain how the consultation process works with clients. You mentioned before that some clients asked for this this switch from annual to semi-annual reconstitution for the main Russell indexes. You know, how did that process happen? And you know, what did we do?
Catherine: Yes, absolutely. Happy to address that. So we do regularly receive feedback from clients in the market on index construction and methodology. We do have a published approach to any changes that need to be made to a benchmark methodology, especially for a widely used index series like the Russell US indexes. We must consult the market and give ample notice. So we did actually, you know, we did start to receive feedback on the frequency of rebalance from the broad market and clients. And then, you know, it goes then through the FTSE Russell Equity Committee process: first through the internal Index Governance Board, then through the equity committees where we consult practitioners who are experts in investments and index usage. And they provide feedback in terms of, you know, what could be included in a consultation. And then we consult publicly. We have a public index consultations page on the FTSE Russell website. We receive feedback that way from a broader cross-section of index users. And then we take that back through our index governance board, equity committees and then announce our decision in terms of making changes to the index methodology.
Paul: Right. So there's quite a lengthy and quite involved process in doing that.
Catherine: Yes, absolutely. And because of the magnitude of this change of moving Russell US indexes back to a semi-annual reconstitution, the decision was also to give almost two years’ notice, enough notice for the markets to prepare for this event.
Paul: Right. Because this is a big change for everybody. A final question for you. You mentioned that the Russell 1000 is the largest 1000 US stocks. The Russell 2000 is the next 2000 by size, measured by market cap. Are there any other kind of key qualifications to get into the Russell. What do you need? How does a stock get in?
Catherine: Yeah, we do have a blog published through our website. Now obviously the most complete rules are going to be published in the ground rules. But the blog is a good primer on, you know, what are the basic rules like nationality, minimum stock price, liquidity and float and voting rights and so on. So I encourage you to take a look at that blog to get an initial understanding. And then if you would like a deeper dive, you can refer to our ground rules.
Paul: Catherine, thank you very much for joining me.
Catherine: Thank you so much.
Paul: That's it for this episode. If you've enjoyed the conversation, then please do follow us and give us a positive rating or review on your podcast app of choice. And if you'd like to get in touch with the show, you can do that via the email
[email protected]. But for now from me, Paul Amery. Goodbye.
