Every June, the Russell benchmarks are reconstituted, with stocks falling out of, or being added to, each index.'  The Russell Investment Group will use today's closing prices to determine the final composition of each of its U.S. stock indexes.

The process begins on May 31, when Russell ranks by market capitalization all stocks traded on U.S. exchanges, and a few overseas large-caps as well.  The top roughly 1,000 stocks qualify for the Russell 1000, the firm's large-cap benchmark.  The next 2,000 qualify for the Russell 2000 small-stock index. And so on.

The event provides an opportunity for arbitragers and active-fund managers to buy those stocks that are due to be added, or sell borrowed shares of the stocks that are due to be dropped, planning to replace the shares later at lower prices.  Some traders may wait for the 6/10/11 list to come out, while others act much sooner, trying to predict Russell's index changes for themselves based on available market data.

In each case, traders count on index funds - mutual funds and ETFs - that link to the indexes to buy and sell the same stocks at the market's close on June 24, so as to keep their fund performances in line with the indexes and reduce "tracking error."  The funds thus buy shares whose prices have been driven up, and sell shares that have already fallen, due to the trades in the preceding weeks.

Nasdaq Prepares for the Reconstitution.   In its recent Equity Trader Alert, Nasdaq reported that there will be no system changes for the Russell Reconstitution, noting that cut-off times and threshold amounts will remain the same.  While Nasdaq is highly confident that its systems will provide the reliability and capacity required to ensure a smooth and successful Reconstitution, Nasdaq published contingency scenarios in order to prepare the industry for unusual market conditions.  Also, Nasdaq, NYSE, NYSE Arca and NYSE Amex will hold a joint market-wide conference call during the Reconstitution on Friday, June 24th, to keep the industry informed.

For further details, go to:   [Nasdaq ETA 11-31, 6/8/11]   [WSJ Online, 6/3/11]