- Index-rebalance trading soared has in popularity at funds like Millennium, ExodusPoint, and Point72.
- The overcrowded strategy got torched this month after trades anticipating the Russell 3000 recomposition went awry.
- Traders that wager on changes to passive indexes have suffered substantial losses.
June is supposed to be the mecca for index-rebalance traders, the Wall Street investors who make bets based on stocks that get added or deleted to popular indexes like the S&P 500 and Russell 3000.
Instead, the uber-popular index-arbitrage strategy has turned into a bloodbath, and portfolio managers that crowded into the trade are staring down steep losses, according to industry sources.
Traders wagering on the planned June 27 recalibration of the FTSE Russell indexes, including the Russell 3000 that tracks the 3,000 largest US stocks by market capitalization, have been especially hard-hit, people involved in the strategy said.
“All of index rebal is down,” an index-rebalance portfolio manager said.
“Most people were wrong the same the way,” a hedge fund manager told Insider. “We know people who’ve gotten smashed in it.”
The crux of the strategy involves buying up shares in companies slated for inclusion in an index and selling short the companies about to get booted. Trillions of dollars in passive investment funds like ETFs are dedicated to tracking these indexes as closely as possible, meaning the changes — telegraphed weeks in advance — result in significant, and usually reliable, price moves: The added stocks rise and the deleted stocks fall.
The trend often reverses after the index recomposition is completed.
This arbitrage strategy has been around since the 1990s, but it has exploded over the past five years with hedge funds from Ken Griffin’s Citadel to Steven Cohen’s Point72 piling into the periodic rebalance trades alongside traditional indexers.
But the dynamic flipped this month in advance of the Russell rebalance, which often produces one of the most frenzied trading days of the year.
The macroeconomic factors driving the broader market swoon, including knock-on effects from inflation and rising interest rates, have contributed to the index-rebalance woes.
But the swings have been exacerbated by how crowded the strategy has gotten, as have the effects of traders forced to unwind positions, people involved in the trade said.
The nearly 300 stocks scheduled to join the index on June 27 — including names like Airbnb, Clover Health, Lucid Motors, SoFi, WeWork, and Ziprecruiter — have tanked a combined 58% over the first two weeks of June, according to data analysis compiled by Insider. The S&P 500 and Russell 3000 are each down 9% during that span.
And, confounding matters, the corresponding 300 stocks scheduled to be subtracted — few of them household names — have outperformed, the PM explained.
“The names that were deleted, you would expect them to go down, but instead they’re going up,” the portfolio manager said. “It’s the entire Russell trade going the wrong way.”
The ongoing bust of companies that have gone public via special purpose acquisition companies added to the pain, industry sources said.
These so-called de-
An ETF tracking these companies, a number of them included for addition in the Russell, is down 30% in June.
The bubble is popping
People involved in the index-rebalance strategy said its struggles date back to last fall, though the recent pain has been especially intense.
One word comes up repeatedly in conversations with experts in the strategy: “overcrowded.”
Hedge funds in recent years have scrambled to bite off a piece of the index-rebalance pie, raiding each other’s rosters as well as program trading desks at investment banks.
While tourists have flocked to index rebalance, as one PM previously told Insider, many of the industry’s heaviest hitters dominate the space, including ExodusPoint, Balyasny, Citadel, Schonfeld, and Point72.
But the most prominent player by far is Millennium Management, the $55 billion multi-strategy giant, which has racked up billions in profits from the trade in recent years and helped spark a wave of copycats.
The most prolific portfolio manager at the fund — and across the entire strategy — is Glen Scheinberg, whose index-rebalance profits helped make him Millennium’s top performer in 2020 and among the top last year as well. His pod, known as SRBL for the initials of its four key PMs, is known for putting on enormous, multi-billion dollar trades in the index-rebalance space.
Few in the industry have come away unscathed, and Millennium hasn’t been immune either. SRBL has sustained losses as well, and another Millennium index-rebalance PM, John Yi, has wound down his book, according to people familiar with the matter.
A Millennium spokesman declined to comment.
It’s not the first time the index-rebalance trade has blown up. In 2020, specialists in the strategy started off in disarray as fallout from COVID-19 that March nixed planned rebalances that hedge funds had been anticipating. But as with the market overall, the strategy rebounded and had a stellar year.
This time around, with no warm embrace from the
forthcoming, industry players aren’t expecting such a swift recovery.
“The strategy has been extremely difficult,” a recruiter who works with index-rebalance PMs said. “But it compounds when you have books that unwind.”
“It was a bubble — a big bubble. And it’s popping,” the recruiter said.
Joe Ciolli contributed reporting.
If you have more information about the index-rebalance trade or hedge fund performance, contact Alex Morrell via email at firstname.lastname@example.org, and on encrypted apps Signal or Telegram at (262) 573-1023.