Russell Microcap Index Adds 252 Stocks in Largest Rebalance in Years

The Russell Indexes' first semi-annual reconstitution took effect at the end of June, and the changes to the small-cap and microcap benchmarks were unusually large.

The Russell Microcap Index added 252 new stocks, the biggest cohort of new entrants in nearly five years and roughly 50% more than last summer's influx. The Index also removed 154 securities, for a net increase of nearly 100 constituents. The Russell 2000 moved back toward its standard 2,000-stock target with 244 new entrants, roughly one-third of which came from the Microcap Index moving up.

The shift comes as small-cap and microcap stocks have led all U.S. equity. The Russell 2000 returned 41% over the year ending June 30, nearly doubling the 22% return of the large-cap Russell 1000. The Russell Microcap Index returned 59% over the same period.

Those strong returns changed the composition of the benchmarks themselves. The Russell Microcap Index's weighted average market cap peaked at $2.5 billion in June, larger than where the Russell 2000 was just a decade ago. The Russell 2000 hit an all-time high of $8.6 billion weighted average market cap in June, which is larger than several stocks in the S&P 500.

Matt Nieman, a portfolio manager at Acuitas Investments who manages U.S. microcap portfolios, said the fast growth of some small-cap stocks created distortive impacts on their indexes. The move to semi-annual reconstitutions, rather than the traditional annual schedule, helps combat that. Fast-growing stocks now graduate into the proper index more quickly, resulting in a more accurate representation of the stock universe, he said.

Nieman also noted that the underlying quality of the new microcap entrants improved. A larger proportion of newcomers boast positive earnings compared to those leaving the Index. The Microcap Index experienced a roughly 4% increase in both return on equity and operating margins, with reduced leverage across the Index.

Most Microcap Index constituents will once again be profitable companies, while valuations are declining across the board. Better companies and cheaper multiples create an environment that should bode well for active managers who specialize in small and microcap stocks, Nieman said.

The semi-annual reconstitution schedule also allows new entrants into the indexes at a faster pace. Companies that go public via a SPAC, for example, can now be included half a year earlier than they previously would have been, Nieman said.

For advisors and their clients, the changes mean the microcap and small-cap universes are fundamentally different from a decade ago, Nieman said. The Russell Microcap Index's weighted average market cap of $2.5 billion is larger than where the Russell 2000 stood a decade ago, a sign of how much the segment has grown.

The next reconstitution is scheduled for December.