Bloomberg Professional Services
This article was written by Sean Murphy, Equity Index Product Manager at Bloomberg.
With the recent news pertaining to FTSE Russell’s US equity indices, investors are suddenly taking note of reconstitution frequency. During an index reconstitution, securities are selected for inclusion or removal based on rules set out in the index methodology. While client feedback certainly played a role in FTSE Russell’s decision to move to a semi-annual schedule (starting in November 2026), it was surely driven by other factors as well, including to some extent, factors. The impact of reconstitution schedules can be seen when evaluating indices through a factor lens. There are indeed benefits to more frequent reconstitution, but there are tradeoffs as well.
Securities that have moved in market capitalization will get reassigned to a size index based on those movements during a reconstitution. In addition, for style investors, reconstitution will take a fresh snapshot of what companies are growing earnings and which ones are becoming cheaper. The Bloomberg U.S. size and style equity indices have always conducted semi-annual reconstitutions, whereby eligible securities are ranked by market capitalization and assigned to a respective index based on that rank. By performing reconstitutions semi-annually, Bloomberg’s indices strike an effective balance of keeping indices well represented as markets change, while limiting unnecessary turnover.
Reconstitution frequency can especially impact smaller cap indices. A small cap stock that appreciates in price can quickly move to a mid-cap classification, but perhaps not into a mid-cap index. As a result, assuming all else is equal, a small cap index that reconstitutes less frequently may have a higher allocation to larger companies. From a factor perspective, this means less frequent reconstitution could lead to less exposure to the low size factor. But the factor impact goes beyond small size.
Momentum is a factor that measures the price movement of a stock relative to others in its universe. A stock that exhibits high momentum exposure is typically increasing in market capitalization at a faster rate than peers. As a result, small cap names that are getting larger will often have high momentum exposure. Should these names remain in an index longer due to low reconstitution frequency, they may increase an index’s exposure to the momentum factor. In addition, the momentum factor is often associated with the growth style and has a negative correlation to the value factor. Take the price-to-earnings ratio for example. If a stock’s price is moving up without a similar move in earnings, then it is becoming more expensive from a fundamental’s perspective. Because of this, a risk model like Bloomberg’s MAC3 will show that stock as having lower exposure to the value factor.
A recent case study that illustrates this was the rise of Super Micro (SMCI). Super Micro saw its market capitalization appreciate rapidly during 2023, yet remained in some small cap indices for a long period of time due to the frequency of reconstitutions. The Russell 2000 index, the most popular benchmark for small cap managers, did not promote the company to the larger Russell 1000 until their June reconstitution of the following year. At that point, the stock had surpassed $40 billion in market cap and was ranked within the top 600 stocks in the US by market capitalization.
Using the TLTS function in Bloomberg, we can see the factor impact of reconstitution frequency by comparing similar indices around this time. The Bloomberg 2000 takes a similar approach to the Russell small cap equivalent in terms of security selection, however, the B2000 has always reconstituted semi-annually in March and September. The below analysis compares that index to an ETF tracking the Russell 2000 for the six months prior to SMCI’s promotion in the Russell universe. By that point, SMCI had already been moved out of the small cap Bloomberg 2000 into the larger Bloomberg 1000. During the range shown, the Russell 2000 fund had higher exposure to larger size, momentum, and growth factors. The exposure to those factors was at its highest in March 2024, which coincided with SMCI’s price peak.
While the factor exposures above may be too small to qualify as a true “tilt” and would be deemed as noise by some quantitative analysts, the active exposure is persistent when looking over a multi-year period. When we run a similar analysis over the 5 year period through year-end, this and other active exposures, albeit small, can still be observed.
Naturally some might ask “Why not reconstitute even more frequently, perhaps quarterly or monthly?”. While indices themselves are not investable, funds and ETFs that use indices are and must account for costs that result from index turnover due to a reconstitution. While the days of equities trading in “eighths” is long gone, bid-offer spreads do still exist and can be wide, especially for smaller cap stocks. “Paying the spread” can eat into returns, and the weighted average bid offer spread of the constituents in the Bloomberg 2000 (small cap) is four times that of the Bloomberg 1000 (Large/Mid). This is just one aspect of transaction costs, as commissions and taxes are also considerations for investors.
Indices serve a vital role for investors of all types, and as such, should be diligently constructed to meet varying needs. Their construction should demonstrate both data and investment expertise, conscious of identifiable pitfalls and overly simplistic shortcomings. Active managers focused on a particular market capitalization should have their relative performance compared to a benchmark that is responsive, as that relative performance may be skewed by a stock that would otherwise be removed but for reconstitution schedule – or one that should be included and hasn’t yet. Additionally, managers may have to trade more frequently to account for stocks that are being added or removed from their investment universe.
Bloomberg equity indices aim to strike a precise balance of keeping indices well represented as markets change with a responsive rules-based approach, while still maintaining the low turnover (and low transaction costs), managers expect from their passive benchmarks. It is for these and other reasons that Bloomberg created our indices from the start to reconstitute on a semi-annual basis. Equity markets have evolved, allowing investors greater access at increased levels of speed, resulting in ever-faster moving markets. As such, indices need to be constructed in a way to ensure they maintain representativeness.
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