In this section

• 2008 Report on Russell Reconstitution
• Projection of Adds and Deletes & Full Report
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• Summary by Sector of Projected Russell Index Changes
• Current R2000 Spread Return Chart
• Timeline of the Russell Reconstitution Process
• Print version of ITG 2008 Russell Recon Report

Year 2007 Russell Reconstitution Preview¹

The road to the 2007 Russell Reconstitution passes though some jittery market times in the spring, when investors are nervous about emerging markets (end of February fall-off), increasing mortgage delinquency rates (stock market volatility in March) and the Fed’s signal about possible monetary tightening (April 11). Perhaps, it would not be an exaggeration to suggest that most money managers would gladly separate market-wide uncertainty from reconstitution-related worries.

Unlike market volatility, predicted index changes due to the Russell Reconstitution do not seem large: BDI eligibility is canceled out by introducing 5% bands, and the sector breakdown does not seem to undergo any significant changes.

ITG offers detailed analysis of the impending changes the 2007 Russell Recon brings to index sector composition and risk profile while highlighting the significance of controlling the turnover-related trading costs. Powerful pre-trade tools, such as ITG Logic® could be utilized by portfolio managers seeking to smoothly transition their portfolios.

Highlights

• In order to minimize unnecessary turnover Russell implements 5% band around market capitalization breakpoint for R1000. It means that in order to be moved from R1000 to R2000 or from R2000 to R1000 the existing index member’s market cap should fall outside the 5% of cumulative market cap breakpoint. Cumulative market cap percentages are based on the Russell 3000E Index. According to our calculations, R1000 and R2000 stocks ranked between 832 and 1227 will not be moved between these two indexes.
• On the other hand, Benefit Driven Corporations (BDIs) that were not eligible for inclusion into Russell indexes prior to this year can be included now. BDIs are companies incorporated in the following countries/regions: Bahamas, Belize, Bermuda, British Virgin Islands, Cayman Islands, Channel Islands, Cook Islands, Gibraltar, Isle of Man, Liberia, Marshall Islands, & Netherlands Antilles and Panama. The company must also either have a US headquarters or have US-based primary exchange in order to be eligible. We expect around 26 BDIs to become members of R1000 and 22 to become members of R2000.
• As before, IPOs have been added to Russell indexes on a quarterly basis (20 in Q3 2006, 36 in Q4 2006 and 35 in Q1 2007).
• The chart below shows the historical numbers of companies that were added to and deleted from the R2000 since 1995, combined with this year’s projection. The projected 187 additions and 145 deletions for 2007 would constitute the new historical lows.

• The newly introduced 5% bands play the key role in dramatically decreased number of additions/deletions. We expect that 4.07% of the R2000 index weight will be deleted and that additions will make up 5.30% of the new R2000 index weight.
• Very Few Changes in Sector Composition
  The sector composition of the R3000 is projected not to change significantly post-reconstitution, nor should the reconstituted R1000 and R2000 look much different in sector composition from their June 2006 editions. The biggest deviation from 2006 weights is predicted for Energy sector in R1000 (+0.73%).
• More Indexed Funds, Less Liquidity Pressure
  As of the end of 2006, there were about $408 billion in assets indexed to the R1000, R2000, and R3000 combined. This does not include assets benchmarked to the Russell value and growth indices, and represents a 10% increase over the dollar amount of assets indexed one year before. This increase falls short of a mere appreciation of the weighted average of R1000, R2000 and R3000 in 2006 (15.46%, 18.37% and 15.71%, respectively). More detailed analysis shows that only R1000 had a positive net cash inflow (+8%). R3000 and R2000 experienced net cash outflows of -11% and -24 %, respectively.
• Higher Cutoffs
  The projected market capitalization cutoffs for the new Russell indices are $2.34 billion for membership in the R1000 and $237 million for membership in the R2000, which represent 17% and 5% incremental cutoffs for R1000 and R2000, respectively.

The information set forth herein was obtained from sources ITG Inc. believes to be reliable, but have not been independently verified. Therefore, the accuracy is not guaranteed. Additional and supporting information is available upon request. This is not an offer or solicitation of an offer to buy or sell any security or derivative instrument, or a recommendation to make any investment. Any opinion or estimate constitutes the preparer's best judgment as of the date of preparation, and is subject to change without notice. ITG Inc., its associates or affiliates, and their respective officers, directors, and employees may have long or short positions in, or may buy or sell any of the securities, derivative instruments or other investments mentioned or described herein, either as agent or as principal for their own account. The information contained herein is directed for the use by professional and/or institutional investors only, and is not designed for the general investing public. All projections and analysis are for the use of ITG clients and may not be copied or redistributed without written consent.

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