Russell 2000 Reconstitution Preview
posted by The Traveller on Saturday, May 01, 2010

IMPORTANT: This post has been updated (click here)

The Russell 2000 Index's annual reconstitution is an event every small cap investor should be prepared for and watch closely. Inclusion in the world's leading small cap index has enormous benefits for the growth stocks I am covering here on this blog, including much enhanced liquidity, gaining a larger investor base and especially much broader exposure amongst institutional investors and independent analysts.

For those of you who are not familiar with the Russell methodology, here is how it works. Russell will rank the US common stocks from largest to smallest market capitalization on the last trading day in May. The largest 1,000 stocks become the Russell 1000 Index and the next 2,000 stocks become the Russell 2000 Index. Excluded are stocks trading below $1.00, pink sheet and bulletin board stocks, foreign stocks and American Depositary Receipts (ADRs), and closed-end mutual funds, limited partnerships, royalty trusts, SPAC's etc.

For 2010 the relevant dates are the following:
  • May 31: Stocks will be ranked by market capitalization
  • June 11: Preliminary additions and deletions to the Russell Indexes published after 3:00 pm PST
  • June 18: Updates to the list of additions and deletions
  • June 25: More updates and final reconstitution after the close of the US markets
There is a potentially enormous addition/deletion effect on the stock price of the added or dropped companies. Asset managers whose portfolios reflect the composition of the Russell 2000 will need to buy or sell stocks in proportion to their new weighting. That will make June 25 most likely the busiest trading day of the year with record turnover and huge volatility especially into the close. For 2009 NASDAQ reported a new record with 1.002 billion shares representing $9.2 billion executed in the Closing Cross in 2.9 seconds.

Now, in theory, new additions to the index should appreciate in price in anticipation of the June 25 action while deletions should see some selling pressure as soon as their preliminary deletion is announced. Thinly traded stocks should on average see the highest volatility and biggest price jumps. If we can identify likely candidates for both additions and deletions early, we can possibly make good returns with taking positions in those stocks before preliminary index changes are announced.

Let's have a look at potential candidates in the China small caps space and - most importantly - what could the market cap threshold for entry into the 2010 Russell 2000 Index be.

Last year the market cap threshold was just $78 million, a record low since 1993 and down from $167 million in 2008. The reason for this big drop was that at the end of the financial crisis downturn, when mid- and larg-cap companies held up relatively well, small caps were still underperforming the general market. As we all know this has changed dramatically over the last twelve months.

From May 31, 2009 until today (April 30, 2010), the Russell 2000 gained 42.86%, which is a far better performance than the general market as measured by the S&P 500 which gained "just" 29.11% in that period. Year-to-date the Russell 2000 outperformed the large cap Russell 1000 as well with a return of 15.01% compared to 7.65%.

We can safely assume that this year's market cap threshold will be much higher than 2009's $78 million and many of last year's addition will be deleted again if they haven't at least doubled in price. I will go with a threshold of $150 million for now, treating companies with a market cap between $120 million and $180 million as uncertain candidates.

Current Russell 2000 Members Market Cap
CAASChina Automotive Systems$703 million
HRBNHarbin Electric$680 million
HOGSZhongpin$437 million
CHBTChina-Biotics$429 million
CSRChina Security & Surveillance$411 million
WATGWonder Auto Technology$393 million
CFSGChina Fire & Security$378 million
ADYAmerican Dairy$373 million
SDTHShengdaTech$372 million
AOBAmerican Oriental Bioengineering$363 million
FSINFushi Copperweld$331 million
CASTChinaCast Education$304 million
CPBYChina Information Security$299 million
CGAChina Green Agriculture$295 million
FUQIFuqi International$270 million
DYPDuoyuan Printing$253 million
COGOCogo Group$252 million
ABATAdvanced Battery Technology$240 million
CSKIChina Sky One Medical$237 million
GSIGeneral Steel Holdings$193 million
FEEDAgfeed Industries$193 million
CTFOChina TransInfo Technology$158 million
UTAUniversal Travel Group$152 million
NIVNIVS IntelliMedia Technology$131 million
CBAKChina BAK Battery$126 million
CHLNChina Housing & Land Development$110 million
SUTRSutor Technology$104 million
HQSHQ Sustainable Maritime$84 million

Based on Friday's close I would expect only China Housing, Sutor and HQS to be deleted from the Russell 2000, and four more stocks being at risk. Of course there is still a full month to go and things could change dramatically from here on. Now let's have a look at possible additions from the China small cap space.

Possible Russell 2000 Addition Market Cap
CCMEChina MediaExpress$535 million
RINORINO International$493 million
SCOKSinoCoking Coal$474 million
CBEHChina Integrated Energy$426 million
GFREGulf Resources$371 million
CVVTChina Valves Technology$347 million
YONGYongye International$340 million
CXDCChina XD Plastics$301 million
LLENL&L International$297 million
CAGCChina Agritech$281 million
CBPOChina Biologic Products$281 million
SHEShengkai Innovations$262 million
LIWALihua International$256 million
DEERDeer Consumer Products$240 million
CNYDChina Yida Holding$237 million
NEPChina North East Petroleum$212 million
CELMChina Electric Motors$196 million
SORLSORL Auto Parts$194 million
CHNGChina Natural Gas$193 million
QKLSQKL Stores$170 million
PUDAPuda Coal$165 million
TBVTiens Biotech$163 million
ONPOrient Paper$155 million
CMFOChina Marine Food$150 million
CREGChina Recycling Energy$146 million
CPHIChina Pharma Holdings$146 million
CEUChina Education Alliance$146 million
TSTCTelestone Technologies$144 million
WWINWinner Medical Group$140 million
YUIIYuhe International$140 million
CNGLChina Nutrifruit$138 million
BSPMBiostar Pharmaceuticals$129 million
SPUSkyPeople Fruit Juice$123 million
CWSChina Wind Systems$113 million
KNDIKandi Technologies$107 million
TPITianyin Pharmaceutical$107 million
AXNAoxing Pharmaceuticals$100 million
ALNAmerican Lorain$96 million
CRTPChina Ritar Power$94 million
GRPCGuanwei Recycling$88 million

Our screen identifies a large number of Chinese stocks that will probably make the cut. Many of the names on this list are companies which uplisted from the bulletin boards since March 31, 2009 and this year's reconstitution will be their first chance to get added (Russell is only adding regular IPO's like DYP on a quarterly basis). Some of those names like CAGC, RINO or the coal stocks are already trader's favourites and the announcement of their addition will likely get a lot of buzz because of the stocks' popularity. Other names on this screen do currently have a small investor base and trade on very thin volume. I would expect the addition effect for stocks like CNYD or SHE to be greater than average.

I will make adjustments to the China Model Portfolio shortly, based on the results of this screen: Russell 2000 - Reconstitution Screen for China Small Caps.

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At July 14, 2010 11:45 am , Anonymous Research Paper said...

Many institutions limit access to their online information. Making this information available will be an asset to all.


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