In spite of Nasdaq OMX Group’s botched initial public offering of Facebook, Russell Investments is confident that this year’s rebalance will be smooth and orderly on the exchange.
Rolf Agather, managing director of research and innovation at Russell Indexes, said that the top executive at Russell paid a visit to Nasdaq after the Facebook fiasco, reminding the exchange of the importance of the upcoming rebalance event. A technical glitch on Nasdaq during Facebook’s IPO on May 18 caused numerous trading problems for investors, who were in the dark on the status of their orders.
“Nasdaq has successfully crossed record volumes at reconstitution for the past several years–last year over 750 million shares crossed in 1.1 seconds,” Agather told Traders Magazine. “We have the utmost confidence in them.”
Russell’s indexes will be officially reconstituted at the close of trading next week on Friday, June 22. Rebalance day always sees huge volumes as money managers tracking the indexes all adjust their portfolios at the same time to reflect the new indexes.
Though the rebalance has been relatively orderly in the past couple of years, there have occasionally been problems. In 2001, a network outage interrupted trading on the Nasdaq during rebalance day, causing the exchange to extend its regular trading session until 5 p.m.
Nasdaq is under a cloud this year due to the trading problems that marred the Facebook IPO. However, the company said in a statement it is confident its systems will provide the capacity necessary to ensure an orderly rebalance.
Russell’s Agather said that since the firm officially adopted Nasdaq’s closing cross in 2004, there have not been any serious technical problems.
That does not mean, however, that the rebalance has gone as planned every year. In anticipation of the annual event, certain traders always build up inventories ahead of time. They buy stocks being added to the indexes and short those being dropped, so that on rebalance day, they can provide the other side of the trade for index-tracking managers.
In 2006 and 2007, speculators went overboard, causing a “wrong way” rebalance, because the supply being built up ahead of time outstripped the demand from managers trying to track the indexes. In 2008 and 2009, those same speculative players largely avoided the rebalance, leading to a “right way” rebalance in which demand by indexers drove up the price of certain stocks.
By comparison, the last two years have been relatively orderly, but boutique investment bank Keefe Bruyette & Woods believes several of the stocks moving in and out of Russell indexes have already received significant arbitrage interest. That could be an indication that the Russell trade will reverse itself again.
Agather said the fact that the tide shifts from year to year is probably a good sign.
“In some years the trade works the way people expect it to, and companies being added go up while companies being deleted go down,” Agather said. “However, there are also years where reconstitution behaves just the opposite. It isn’t so cut and dried. At the end of the day, what that’s telling you is there is liquidity in the market.”
However, Russell is by no means standing pat. In addition to publishing preliminary and final indexes ahead of recon day, Russell has to prepare for how it might have to adjust to a major macroeconomic event right before the rebalance. This year, all eyes are on Greece.
“As part of our transparency, we want to make sure that we highlight for people, ‘Here is what you can expect should something happen with Greece or another country in the Eurozone,’” Agather said. “We don’t want people to have to speculate or guess what Russell’s going to do.”
Though no one can anticipate everything, Russell is working to reassure investors it will be able to handle unexpected events in an orderly way. Agather stressed that if something completely unanticipated happens ahead of the rebalance, Russell will provide information about its plans in a transparent manner.
