Evidence of Crowding on Russell 3000 Reconstitution Events

TL;DR

This paper presents a highly accurate methodology for replicating Russell 3000 index reconstitutions using publicly available data, enabling analysis of crowding effects and transaction costs related to index rebalancing and IPO additions.

Contribution

The authors develop and validate a novel index reconstruction method that accurately replicates Russell indexes using CRSP data, and analyze crowding and trading impacts during reconstitution events.

Findings

Quarterly rebalancing leads to less crowding than annual rebalancing.

Index crowding increases during IPO additions and deletions.

Transaction costs could be reduced by timing trades around rebalancing dates.

Abstract

We develop a methodology which replicates in great accuracy the FTSE Russell indexes reconstitutions, including the quarterly rebalancings due to new initial public offerings (IPOs). While using only data available in the CRSP US Stock database for our index reconstruction, we demonstrate the accuracy of this methodology by comparing it to the original Russell US indexes for the time period between 1989 to 2019. A python package that generates the replicated indexes is also provided. As an application, we use our index reconstruction protocol to compute the permanent and temporary price impact on the Russell 3000 annual additions and deletions, and on the quarterly additions of new IPOs . We find that the index portfolios following the Russell 3000 index and rebalanced on an annual basis are overall more crowded than those following the index on a quarterly basis. This phenomenon implies that transaction costs of indexing strategies could be significantly reduced by buying new IPOs additions in proximity to quarterly rebalance dates.