IWO - The Story Behind 2023 Russell Recon Style Shifts

2023-06-15 02:45:00 ET

Summary

• The Russell annual reconstitution process reflects evolving market dynamics, resulting in shifts in style classifications for constituent companies and industries.
• The methodology behind it ensures that the Russell Indexes continue to accurately reflect the evolving market landscape.
• Style valuations have changed for two tech giants since the last reconstitution - Alphabet (Google) and Meta (Facebook) - moving them to pure growth.
• Their relatively high past sales growth and medium-term growth forecast are principally responsible for this move. They therefore represent the Russell 1000 Value Index's largest deletions by both size and weight.
• Energy industry undergoes style change: The Energy industry is experiencing a notable shift toward small cap value.

By Catherine Yoshimoto, director, product management

Of the many stories that emerge from our annual Russell Reconstitution , constituent shifts between our growth and value indexes often garner the most headlines. Last year, Meta’s ( META ) shift from pure growth to primarily value was among the Russell recon’s biggest stories.

On May 19, we released preliminary index additions and deletions in advance of this year’s recon day , and a summary of this year’s changes, giving market participants a peek into what Russell US Style Index reshuffle story could be taking shape this year.

Assigning style weights with an objective methodology

Each year, our Russell recon process involves reevaluating companies in our Russell US Indexes to determine where they lie along the investment styles spectrum. We calculate Russell 1000® and Russell 2000® Growth and Value Index constituent weights and apply banding to limit turnover during the reconstitution.

Constructing the Russell 1000 Growth and Value Indexes

As shown, we use three main variables in our methodology - one value and two growth metrics - to calculate a composite value score ((CVS)) for each Russell 1000 Index constituent.

We then rank the stocks and apply a probability algorithm to determine style index membership weights, where half of the market value of the Russell 1000 Index is allocated to growth, and the other half to value. If constituent data is missing or the book-to-price value is negative, we substitute the company’s score with the average for its Industry Classification Benchmark ((ICB)) group.

It’s also important to note that some stock characteristics don’t allow for absolute style distinction, and in these cases - which typically represent about 30% of the index market value - we allocate portions of the company’s market cap to both growth and value.

Since the Russell 1000 Index is the sum of the Russell 1000 Value and Russell 1000 Growth indexes - and the same is true for the Russell 2000 and its style indexes - constituent market cap is never double counted.

Technology would see the biggest style shift for large caps

Based on the preliminary list of recon additions and deletions for our large cap style indexes, the Technology industry would see the most notable shift in style.

As shown, Technology’s weight in the Russell 1000 Growth Index would increase by 3.68 percentage points, while it would decrease by 1.87 percentage points in the Russell 1000 Value Index.

A closer look at potential constituent membership changes sheds light on the Technology companies behind this shift. Meta (Facebook) and Alphabet (Google) ( GOOG ) ( GOOGL ) represented the largest deletions by weight in the Russell 1000 Value Index, as both tech giants shifted the value portion of their market values to 100% growth, primarily due to strong historical sales growth and forecast medium-term growth attributes.

Energy would change its style for small caps

While the preliminary additions and deletions for our small cap style indexes would also increase Technology’s weight in the growth index, the most significant shift would be in the Energy industry.

Energy company membership changes would result in a 3.14 percentage point increase for the industry in the Russell 2000 Value Index, and a 2.21 decrease in the Russell 2000 Growth Index.

Industries would stay in their lanes

While industry weights could shift between styles as a result of this year’s Russell recon, preliminary 2023 weights suggest industries that are typically growth-oriented will remain heavily weighted in growth indexes, and value-oriented industries will continue to dominate value indexes.

For example, Technology and Consumer Discretionary are traditionally considered growth industries and together are expected to comprise nearly 70% of the Russell 1000 Growth Index.

And value-oriented industries such as Financials, Health Care and Industrials could be among the most heavily weighted industries in the value indexes. However, Health Care has the largest weight in the Russell 2000 Growth Index due to the significant weight of small cap pharmaceutical companies.

An evolving reflection of Style

Every year, the constituent style classification shifts that result from our Russell recon can amount to broader shifts across industries. It’s an annual reminder that as markets change and go through cycles, so too do constituent companies and industries - and our methodology is designed to ensure our style indexes continue to reflect the evolution.

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