Russell 2000 Rebalancing Trading Strategy (Backtest and Analysis)

Russell 2000 rebalancing at the end of June is an important event. It’s important because it leads to potential imbalances, but more importantly, the Russell 2000 has shown abnormal outperformance over these few days. The seasonality and effect are so strong it seems to be a tradeable Russell 2000 rebalancing trading strategy.

In this article, we test how the Russell 2000 rebalancing at the end of June leads to a rally in the last few days of June. It turns out the seasonality is for real. Our result suggests the Russell 2000 performs much better at the end of June than any other period of the year. We present a Russell 2000 rebalancing strategy based on the imbalances and effects.

What is the Russell 2000 Index?

As the name implies the index has 2 000 stocks included. It’s regarded as a small-cap index. The reason for that is that Russell 2000 is a subset of the smallest companies in the Russell 3000 Index which tracks the largest 3000 public companies. Russell 2000 is a market-weighted index. The ticker for the index is RUT, the ETF has the ticker IWM, and the futures contract is RTY.

The name Russell is a result of the Frank Russell Company that established the Russell indices back in 1984. It’s now owned by FTSE Russell, a UK company.

Despite having 2000 companies included, the index has just 10% of the overall US market capitalization. Thus it’s being used as a small-cap gauge of the market.

Russell 2000 components

The ten biggest holdings are currently these: OVV, AR, CHK, SWN, BJ, RRC, PDCE, BHVN, WSC, and MTDR.

When does the Russell 2000 rebalance?

Every year on the fourth Friday of June, the Russell 1000, Russell 2000, Russell 3000 and other Russell indexes are reconstituted. (FTSE Russell gives investors a heads up about what moves they should expect.)

Russell 2000 rebalances their holdings once per year on the fourth Friday of June. The date of the fourth Friday varies, obviously, so traders are advised to look at Russell’s website to find out when.

What does Russell 2000 rebalancing mean?

Russell 2000 rebalances their holdings at the end of June every year. Here is what they said about rebalancing some years ago:

June is the month that the preliminary reconstitution portfolio is communicated to the marketplace. Beginning on June 9, preliminary lists are communicated to the marketplace and updates are provided on June 16 and 23. The newly reconstituted indexes take effect after the close on Friday, June 23.

The Russell 2000 needs to rebalance its holdings in order to reflect the universe it’s supposed to cover. The Russell 2000 is a highly anticipated event and captures the changes over the last year in the mid and small-cap universe.

Why does Russell 2000 rebalance?

The purpose of an index is to mirror the returns of a market or asset class. Each index has a stated methodology, and obviously, from time to time the index needs to reflect the methodology.

This means some securities need to be bought and others sold – no matter if the index is market-weighted or equal-weighted. Over the course of time, some stocks rise in value and others decrease in value.

For example, The Russell 2000 measures the performance of the small-cap universe. The index is market-weighted and rebalanced annually to reflect the changed market capitalization of the underlying stocks since the previous rebalancing last year. The Russell 2000 rebalances only once per year – in June. In 2021 it was done on Friday the 25th of June.

A rebalancing might lead to imbalances. For example, as of writing, Gamestop is one of the stocks that has risen a lot during the last year and the managers need to buy more shares in Gamestop. This might lead to a buying imbalance where there are not enough sellers, or the price need to go up to attract more sellers. Thus, we have an imbalance.

Vice versa for those stocks that need to be reduced.

Overall, this means many buys and sells in June for many small caps. But interestingly, the Russell 2000 rebalancing has led to an overall rally for the index in the last days up until the close of the first trading day of July.

How often do indices rebalance?

How often an index rebalances is started in the methodology. The S&P 500 is rebalanced four times per year, while the Russell 2000 rebalances only once a year.

How does Russell 2000 rebalance the index?

To rebalance is, in principle, very easy. If the methodology says Gamestop should be five percent of the index but is currently only four percent, the managers need to add one percent.

Even though it’s easy, the managers need to buy and sell in the market. And this is why we might experience imbalances.

We test the following Russell 2000 rebalancing trading strategy:

In order to test the Russell 2000 rebalancing trading strategy we backtest the idea below to check the outperformance of the Russell 2000 at the end of June.

We make the following trading rules: