By Chuck Mikolajczak
NEW YORK (Reuters) -Meta Platforms will return to its former status as a full growth stock after financial data provider FTSE Russell finishes its annual shakeup of its stock index components on Friday.
The so-called Russell Reconstitution is important because it causes portfolio managers to scramble to readjust their holdings to better align with their benchmarks – and it often results in one of the heaviest stock trading days of the year.
Every year, FTSE Russell reconstitutes, or refreshes, the components across its indexes, such as the Russell 2000 index of small cap stocks and Russell 1000 index of large-cap names. Together they make up the Russell 3000 index.
There are also style indexes such as the Russell 1000 Growth and Russell 2000 Value. FTSE Russell says about $12.1 trillion is currently benchmarked to the Russell US equity indexes.
This refresh forces many fund managers to adjust their portfolios to reflect the new weightings and components. The methodical nature of the reconstitution process, which began in late April this year, also creates additional demand for buying and selling stocks. Some investors may use the additional liquidity to take advantage of price dislocations that may result, especially before the reconstitution is completed at week’s end.
Goldman Sachs estimates 23 stocks will be added to the Russell 1000, another 287 will be included in the Russell 2000 and 163 will be removed from the Russell 3000.
One of the bigger changes this year will be Facebook owner Meta Platforms, which has surged nearly 70% since last year’s reconstitution. It will once again be considered 100% growth after a brief detour last year with a heavy value shift.
FTSE Russell discloses ahead of time its rules for inclusion and any changes from prior years, enabling the investment community to project, for instance, that Meta will be deemed a growth stock even though the annual Russell Reconstitution has yet to be finalized. FTSE Russell is owned by the London Stock Exchange Group.
Growth stocks are those that are seen as expensive by valuation metrics but are expected to grow faster than most companies, while value stocks are considered cheap compared with their peers.
Stocks can be partially in both growth and value indexes based on Russell’s criteria on characteristics including earnings growth and valuation. Meta is currently 84% value and 16% growth, according to Goldman.
“It puts challenges on the portfolio managers because it essentially locks in that benchmark’s return,” said Bryant VanCronkhite, senior portfolio manager at Allspring Global Investments in Menomonee Falls, Wisconsin.
VanCronkhite said this can present a problem for managers who did not own Meta because their benchmark will now reflect the strong gains posted by the stock over the past 12 months. “So from a relative performance standpoint, it becomes quite a challenge when you have moves of that magnitude in individual stocks,” he said.
Other companies expected to attain a greater growth weighting include Google parent Alphabet and Salesforce. Between Meta and Alphabet, the communication services sector is expected to receive the biggest weighting increase in the large-cap growth index.
A large part of the reason for the shifts in Meta and Alphabet were their “relatively high past sales growth and medium-term growth forecast,” according to a post from Catherine Yoshimoto, director of product management at FTSE Russell.
On the other end of the spectrum, Walmart is likely to stay at 100% value while industrials, consumer staples and energy are expected to represent some of the biggest moves out of growth into value.
“The growth indexes look more like growth benchmarks and the value indexes look more like cyclical value indices,” said Steven DeSanctis, equity analyst at Jefferies in New York.
“You’ve gone back full circle, with some of the rotation.”
Given the amount benchmarked to Russell indexes and the number of stocks involved, the trading session of reconstitution often results in very heavy volume, with much of it coming in the minutes before the closing bell. During the 2022 reconstitution, Nasdaq said a record 3.31 billion shares representing $63.8 billion across Nasdaq-listed stocks were traded in 2.04 seconds during the exchange’s “Closing Cross.”
As such, both the Nasdaq and New York Stock Exchange put contingency measures in place in the event of unusual market conditions.
But some managers prefer to sit out the last-minute frenzy before the reconstitution is finalized, due to the potential for price dislocations.
“It’s a move that’s not based on the underlying fundamentals of the company and so … as an active manager, you’re changing your point of view,” said Thomas Martin, senior portfolio manager at Globalt Investments in Atlanta.
“You want to keep your relative weight the same,” he said, adding that this is more easily said than done.
(Reporting by Chuck Mikolajczak in New YorkEditing by Alden Bentley and Matthew Lewis)