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The fastest billion: Russell reconstitution redefines small caps – yet again

By: Mat Lystra, Senior Research Analyst

The Russell 1000 Index of large cap companies and the Russell 2000 index of small cap companies are re-assessed annually with Russell Indexes’ Reconstitution. This year, the dividing line in market capitalization between large and small cap reached $3.2 billion. Although in a broad sense that number might start to redefine what constitutes a small cap company, it is perhaps unremarkable considering last year’s threshold was $3.1 billion. The speed with which we reached these heights, however, is something worth looking at more carefully. 

Consider that after the Russell 2000 Index launched in 1984, it took 12 years for the dividing line to reach $1 billion. It took only 10 years to reach the next billion, establishing a mark of $2 billion in 2006. The worst financial crisis since The Great Depression dragged the boundary all the way down to $1.2B in 2009. But despite this, it took only eight years to reach the next billion in 2014. 

Notice the pattern?  If this trend was to continue (which no one can predict, of course) it would take only six years to hit the mark of $4 billion, in 2020. As illustrated below, a simulation modeling the historical growth of the dividing line between the Russell 1000 and Russell 2000 indexes suggests the potential for even faster growth. 

Speed of the next billion in market cap threshold between the Russell 1000 and Russell 2000 has accelerated historically

 Source: FTSE Russell, data as at May 30, 2015. Past performance is no guarantee of future results. Please see the final page for important legal disclosures.

The Reconstitution of Russell indexes revaluates changes in the market on an annual basis to maintain the integrity of our benchmarks without introducing unnecessary turnover costs. The indexes’ dividing line between U.S. large and small companies is closely watched as a gauge of market growth.

Such a rapid climb in the large/small dividing line in the next few years, as illustrated in the chart above, seems unlikely but surely the same could have been said in the dark days of early 2009.  For now all we can do is wait and see. However, if in 2020 we do reach a $4 billion boundary, then conventional wisdom—both with respect to valuations and how to define a small cap company—will need to be redefined. 

 

 

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