Russell Index Rebalancing Brings Meme Stocks Into the Mainstream

(Bloomberg Businessweek) -- Later this month, FTSE Russell, the global index provider, will rebalance its family of U.S. stock indexes, which serve as benchmarks for about $10.6 trillion in assets. The reshuffling opens the door to the slew of meme stocks that Reddit traders have driven skyward. The can of memes is open.

In general, stocks that had a market value greater than the 1,000th-ranked company—about $5.2 billion as of the May 7 cutoff—will be added to the large-cap Russell 1000 Index. According to Goldman Sachs Group Inc., there probably will be 57 new entrants. Among them are likely to be hot unicorns that went public in the recent SPAC frenzy, such as QuantumScape Corp., an EV battery maker. Reddit sensation GameStop Corp. will probably enter the list, though AMC Entertainment Holdings Inc., which had a $4.3 billion market value on May 7, may not.

At first glance, this looks a bit ridiculous. Reddit traders may love their meme stocks, but professional money managers frown upon their random volatility. For instance, Clover Health Investments Corp., which went public in January via one of Chamath Palihapitiya’s special purpose acquisition companies, may join the smaller-cap Russell 2000 Index. On June 8 the stock almost doubled in market value when Reddit traders decided to bid it up to squeeze short sellers.

But markets change, and good indexes need to reflect that. Retail investors are no longer passive players who put money in via mutual funds and exchange-traded funds—they account for about a quarter of stock trading in the U.S., up from 10% a decade earlier, according to Bloomberg Intelligence. Their stock market presence is roughly as big as that of hedge funds and mutual funds combined. Shouldn’t their viewpoints be reflected in broader indexes that aim to capture major characteristics of the marketplace?

Moreover, some meme stocks are due for an upgrade. Plug Power Inc., featured on Reddit’s speculative discussion platform WallStreetBets, became the largest contributor to the performance of the widely followed Russell small-cap growth index in January, thanks to its 88% monthly gain. Plug Power is likely to enter Russell’s large-cap category this month.

Similarly, GameStop and AMC have become the two largest components of the Russell small-cap value index, even though few people would consider either a value stock, often defined as one with a low price-to-book ratio. Those who bought the $69 billion iShares Russell 2000 Value ETF, thinking that value stocks would play catch-up as part of the post-pandemic reflation trade, might be buying something else altogether. Once GameStop enters Russell’s large-cap indexes, it will be tiny compared with, say, Tesla Inc. Its price swings won’t sway an entire index.

When meme stocks enter the major leagues, it’s a validation for the Reddit traders. But it also helps to keep market indexes true to their labels.
 
Ren is a columnist for Bloomberg Opinion.
 

©2021 Bloomberg L.P.