Russell Reconstitution And Derivatives

February 12, 2004

Russell Reconstitution As A Transition Trade

The Russell reconstitution can be viewed as a large transition trade. Transition trades now often involve the use of futures in managing the market risk level of the trade as it progresses. Many of the trading strategies discussed above are viewed in this way. Hedging one's market risk during a transition trade is growing more and more sophisticated and requires the use of more precise instruments than in the past. Using S&P 500 futures to hedge small-cap portfolio transitions introduces a level of basis risk that makes more sophisticated investors uncomfortable. The brokerage firms discussed above are engaged in a long-term transition trade and may want to use more precise instruments in their process of conducting that trade.

Conclusion

The growing acceptance of the Russell indexes as investment vehicles has caused market participants to improve their techniques for managing the transition from the 'old' index to the 'new' index. The growing number of derivative instruments based on the Russell indexes has provided market participants with more and more tools with which to control their risks and lower their costs. These improvements will lead to better results for investors and more efficient capital markets.

Frank Russell Company, a Washington, USA corporation, operates through subsidiaries worldwide, and is a subsidiary of The Northwestern Mutual Life Insurance Company. Frank Russell Company is the owner of the trademarks, service marks, and copyrights related to its indexes. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Russell 1000® Index: Measures the performance of the 1,000 largest companies in the Russell 3000® Index, representative of the U.S. large capitalization securities market. Russell 1000® Growth Index: Measures the performance of those Russell 1000® Index securities with higher price-to-book ratios and higher forecasted growth values, representative of U.S. securities exhibiting growth characteristics. Russell 1000® Value Index: Measures the performance of those Russell 1000® Index securities with lower price-tobook ratios and lower forecasted growth values, representative of U.S. securities exhibiting value characteristics.

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