The Russell 2000 Rebalancing Strategy (End Of June Rally/Effect)

Last Updated on April 19, 2022 by Quantified Trading

The 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.

When does the Russell 2000 rebalance?

Russell 2000 rebalances their holdings once per year at the end of June. The date varies from year to year, 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 do Russell 2000 rebalance the index?

To rebalance is, in principle, very easy. If the methodology says Gamestop should be five percent of the fund 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 test the following idea to check the outperformance of the Russell 2000 at the end of June:

  1. Buy on the close on the first trading day after the 21st of June.
  2. Sell on the close on the first trading day of July.

The test is pretty simple. We test on free data from Yahoo/finance by using the tickercode ^RUT which is the cash index of the Russell 2000 and doesn’t include dividends.

We compare the result to the cash index of the S&P 500 (^gspc). The test period is from 1988 until the end of 2020, ie. 33 years of data.

Is there any end of June rally/effect in the Russell 2000 index due to the rebalancing?

Our trading strategy says the average gain for the Russell 2000 in late June is 0.95%. That is well above any random period of the year for the index. The average holding time is 7.5 trading days.

The equity chart looks like this:

Here are the dry facts:

Worth noting is that Russell 2000 shows no positive performance up until the 21st day of June. June is a poor month for the stock market, thus making the end of June rally/effect the more powerful. Thus, the Russell 2000 rebalancing plays a major role in June.

This table summarizes all the trades:

July is included in the performance because we exit at the close on the first trading day of July.

For comparison, the S&P 500 has only gained on average 0.46% during the same period.

The Russell 2000 rebalancing effect when hedged with the S&P 500

How does the Russell 2000 rebalancing strategy look like if we go long the Russell 2000 but hedge with a short position in the S&P 500?

Here’s how it looks:

A hedged position didn’t perform well the first 12 years.

Here are the annual hedged returns:

Amibroker code:

If you would like the Amibroker code (Tradestation code is added gradually) for this strategy plus the code and logic for 70 other free trading strategies, please click on this link:

Russell 2000 rebalancing conclusion:

The Russell 2000 rebalancing has led to an end-of-June rally/effect that is significant and could be a valuable tool for any trader. The Russell 2000 rebalancing strategy seems to work pretty well. Even though it happens just once per year, it’s easy to implement in your trading arsenal.

 

Similar Posts