New Russell Index Procedures Ease Annual Tune-Up for Stock Market Benchmarks (Russell.com)

New Russell Index Procedures Ease Annual Tune-Up for Stock Market Benchmarks
Industry Input Helps Smooth Mid-Year Reconstitution

TACOMA, Wash. — July 21, 2004 — Millions of shares may be affected by the annual reconstitution of Russell stock indexes, but three changes to Russell's process this year helped ensure an orderly transition for index fund investors and other followers of Russell indexes. The mid-year reconstitution event, a market-driven adjustment procedure that takes on more significance each year with the growing use of Russell indexes, resulted in a particularly smooth transition this year.

The three new procedural changes included a guaranteed weekend for enactment of index adjustments, new provisional indexes to allow early anticipation of index adjustments and use of the NASDAQ Closing Cross for clear pricing of securities.

"As we update and maintain the Russell indexes, part of our responsibility is to listen to those who depend on them as market benchmarks and portfolio models," said Lori Richards, senior product manager for the Russell indexes. "We want to provide investors with an operational process that gives them an orderly and secure trading environment."

The procedural changes stemmed primarily from Russell's Index Client Advisory Board—comprised of independent industry leaders including plan sponsors, investment managers and prime brokers. Board members advised that these changes would help offer a larger window of time for trading, higher service standards for investors and a fairer environment for closing trades.

First, Russell shifted the final day of its index reconstitution process to the last Friday in June instead of the last day in June. This new schedule gave passive managers and brokers a buffer over the weekend to manage any increase in stock trading volumes that occurred as funds and investors adjusted in response to the newly reconstituted membership of the indexes.

Richards said a representative of one large index fund, for example, told her the additional time was useful to assure accuracy, particularly since they traded 43 percent more assets in 2004 than the previous year.

Another member of the advisory board, Sandy Rattray, managing director, Goldman, Sachs & Co., said, "The Russell index reconstitution day is one of the busiest trading days in the U.S. equity market, particularly because passive managers are rebalancing small cap portfolios. Occasionally closing prices can be difficult to immediately determine on the rebalance day. Moving the date to the last Friday in June allows exchanges, asset managers and brokers plenty of time to be ready for the next trading day if operational issues arise."

Second, Russell posted "provisional" returns on its website for two weeks prior to the reconstitution's effective date in order to give passive fund managers more flexibility in determining when to make their portfolio transitions. This made available performance figures for the emerging reconstituted indexes each weekday in addition to performance data for the existing indexes. As a result, index fund managers were able to align their portfolio to the new index membership during a two-week window, instead of waiting until the close of markets June 25.

Richards said feedback from asset managers suggested this year's provisional indexes were a hit and some managers said they'd like to see an even earlier window of opportunity.

"Asset managers are telling us that a longer period of provisional index returns and values on a total return basis would be helpful and diminish opportunities of arbitrage traders," said Richards. "We'll definitely work to lengthen the time we use provisional returns next year."

Third, Russell used the NASDAQ Closing Cross to price NASDAQ-listed securities for reconstitution. This decision brought together the buy and sell interest in these stocks and led to the execution of all shares for each stock at a single price reflecting the true supply and demand for the security.

"The NASDAQ Closing Cross provided Russell with a vital means of determining their index valuations during one of the securities industry's most critically important liquidity events," said Adena Friedman, executive vice president of NASDAQ Corporate Strategy and Data Products. "Index providers, mutual funds and the broader investing public received a highly transparent and accurate closing price that provided them even greater certainty in pricing major transactions. Some 333 million shares were traded on NASDAQ at the close, far exceeding the earlier record of 24 million, set the prior Friday. And the average price change across NASDAQ stocks was less than 1.5 percent."

The advisory board's recommendation were based in large part on the fact that Russell indexes have emerged as the index family of choice for a growing number of money managers and plan sponsors. According to a new study based on data compiled by Thompson Nelson Information, Russell indexes are used as benchmarks for more institutional products than any other index family. Additionally, the amount of passively managed assets benchmarked to Russell indexes surpassed $360 billion in 2003, more than tripling from $116 billion at the beginning of 2000.

"Growing use of Russell indexes means that we have to recognize that the reconstitution process has become a significant industry event," said Richards. "These new steps this year were implemented to alleviate trading pressure and help the industry absorb the effects of reconstitution."

Richards added that, as part of the ongoing decision-making process on possible enhancements to the reconstitution process, Russell researches whether to increase the frequency of its index reconstitution process. "The research continues to show us that more frequent changes would involve substantial increases in transactional costs, but does not provide an offsetting benefit to investors in terms of market or segment representation," she said. "Our goal has always been to offer a family of indexes that accurately reflects the market without undue trading costs for investors."

Richards also noted the results this year also dispelled a common notion that companies being added to an index always have a positive return. "Larger economic variables had much more effect on stocks than index reconstitution," she said. "For example, small cap stocks tend to underperform in rising interest rate markets, which held true in June. So despite being added to the Russell 2000 index, many small company stocks actually underperformed during June primarily due to broader economic factors."

Additional details of Russell's annual index reconstitution process are available in the "U.S. indexes" area on russell.com.

About Russell
Russell Investment Group, a global leader in multi-manager investment services, provides investment products and services in more than 35 countries. Russell manages more than $110 billion in assets and advises clients worldwide representing more than $1.8 trillion. Founded in 1936, Russell is a subsidiary of Northwestern Mutual and is headquartered in Tacoma, Wash., with additional offices in New York, Toronto, London, Paris, Singapore, Sydney, Auckland and Tokyo.

Contact: Steve Claiborne 253.594.1858

Russell Investment Group is a registered trade name of Frank Russell Company, a Washington, USA corporation, which operates through subsidiaries worldwide. Frank Russell Company is a subsidiary of The Northwestern Mutual Life Insurance Company.

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