See the report and projection of adds and deletes for current projections and commentary

The report below is based on data as of April 20th.
Every year, the Russell Reconstitution provides the investment community with surprises, opportunities and risks. The past two years exhibited dramatically different results—2009 was a textbook index rebalance without the involvement of the speculative community (which was risk averse coming out of the credit crisis) and 2010 was influenced by a series of rule changes implemented by Russell. For 2011, however, ITG’s current estimation for the annual Russell Reconstitution suggests a relatively “normal” event, with a significant reduction in projected turnover compared to the past few years. Of note will be the migrations between the Russell 1000 and the Russell 2000, which are expected to experience heightened turnover, with a concentration in Technology.

Highlights and Observations for 2011:

Improved equity market conditions result in higher market capitalization breakpoints for the second year in a row

• The breakpoint for the Russell 1000 ($2.2 billion) is about 28% higher than 2010
• The breakpoint for the Russell 3000 ($126.2 million) is about 13% higher than 2010

Since 2010’s ranking date the Russell 1000 is up 21.93% and the Russell 2000 is up 26.20%.

Decreased turnover is anticipated relative to 2010 with no significant rule changes driving this year’s Reconstitution

Projected percentage turnover is an estimated 55% lower across all Russell indices vs. 2010. Percentage turnover in the Russell 3000 is projected to decrease by 81%. Russell 1000 is estimated at 69% lower. Russell 2000 is estimated to be 14% lower than in 2010.

Country Rule Changes and the addition of Berkshire Hathaway had greatly increased levels of turnover in 2010, especially in the large capitalization stocks. Expected turnover levels are down from 2009 as well, with projected percentage turnover an estimated 27% lower across all Russell indices vs. 2009. As a result of the lack of significant rule changes, the projected rebalance has been “normalized” across the market cap spectrum relative to the large cap skew associated with last year’s event.

There are two projected deletes from the Russell 1000 (deleted from the Russell US Indexes) for 2011, which is more in line with past Reconstitutions. Both are expected to occur because of the Russell Country Rules. Weatherford International Ltd. (WFT, domiciled and headquartered in Switzerland) was one of the largest trades as an addition to the Russell 1000 in the 2010 Reconstitution. In November of 2010 WFT was listed for trading for the first time in Switzerland and by Russell Country Rules became a Swiss company, making it ineligible for the US Indices, hence a delete from the Russell 1000.

The other projected delete, Seagate Technology PLC (STX) trades primarily in the US and changed its domicile and headquarters from the Cayman Islands to Ireland in July of 2010 after the Reconstitution. STX does not trade in Ireland and there is no US determination by assets or sales in 2011. In 2010, it was a US company in the Cayman Islands (BDI Country) but now the headquarters and the default country is Ireland, making it ineligible for the US indices.

Sector Turnover

The most dramatic changes in sector rotation are projected to occur in the Russell 2000 index. The migration of Technology stocks from the Russell 2000 to the Russell 1000 is expected to contribute greatly to the decreased weighting of Technology stocks in the Russell 2000. Technology’s weight in the Russell 2000 is expected to decrease from 18.96% to 17.68%. Sector weight changes to the Russell 1000 are less significant.

Russell 2000 Technology: -128 bps
Russell 2000 Financials: +69 bps
Russell 2000 Industrials: +50 bps
Russell 2000 Materials: -40 bps

The expected migration trade (i.e. stocks moving between the Russell 1000 and Russell 2000) is predicted to be greater in 2011 than it has been for the two prior Reconstitutions. It is expected to generate trading flows about twice the size of the trading flows for the 2010 Reconstitution and is especially concentrated in the Technology space.

What may have contributed to the relative increase in the migration trade and the concentration in technology stocks from the Russell 2000 to the Russell 1000 is the fact that Russell 2000 Technology stocks are up 46.28% from last years’ Reconstitution vs the Russell 2000 gain of 29.43%.

Migrations

It is worth noting that the migration trades generated from the Reconstitution have often played out counter to the general trend in the stock. Stocks that are migrating from the Russell 2000 to the Russell 1000 are stocks that have outperformed their peers and are being moved into the higher capitalization index, a positive sign. The expected trades generated from this migration tend to be better for sale as these stocks move from being a bigger weight in a smaller capitalization pool to a smaller weight in a larger capitalization pool. The opposite tends to occur with stocks moving from the Russell 1000 to the Russell 2000.

Minor Methodology Changes for 2011

This year’s rebalance will see changes to growth/value and country assignment determinations:

• The long-term growth variable will be retired and replaced with two variables: IBES mediumterm (2 year) growth and historical sales per share growth (5 year). Book to price will continue to be the variable used in the value side of the equation. To reduce turnover, Russell will be implementing a band to prevent the occurrence of smaller, less meaningful movements.
• When a country trading volume is used in the determination of country assignment, Russell will begin using the volume included on all exchanges within a country. Previously, Russell only used the volume on the primary exchange. As announced in 2010, Russell will begin using a two year average for revenue and sales, where applicable, for the determination of country assignment. If an IPO is entering a Russell index, Russell will also use the prospectus to help determine country assignment.

Speculative Activity

With a generally benign volatility environment and improved risk tolerance following another strongly positive year for US domestic indices, speculative players may be enticed into participating in the Russell Reconstitution. Unwinding of speculative trades on the effective date could create the potential to mitigate or possibly overwhelm the passive demand produced by the index rebalance. ITG’s Portfolio Trading Desk will closely monitor the behavior of the trade and will provide analysis on request.

Footnotes

1. This report is based on independent research conducted by ITG. Frank Russell Company is not affiliated with ITG. Russell®, Russell 1000® Index, Russell 2000® Index, and Russell 3000® Index are trademarks/service marks of the Frank Russell Company.

Data sources: Bloomberg, Russell. The S&P GICS sector classifications are used throughout the study.

The information contained herein has been taken from trade and statistical services and other sources we deem reliable but we do not represent that such information is accurate or complete and it should not be relied upon as such. Any opinion or estimate constitutes the preparer's best judgment as of the date of preparation, and is subject to change without notice. No guarantee or warranty is made as to the reasonableness of the assumptions or the accuracy of the models or market data we have used or the actual results that may be achieved. All information set forth herein is indicative, based on among other things, market conditions at the time of the publication of this document and is subject to change without notice. These materials do not provide any form of advice (investment, tax or legal). The information contained herein is directed for the use by professional and/or institutional investors only, and is not designed for the general investing public. Investment Technology Group, Inc. is not a registered investment adviser and does not provide investment advice or recommendations to buy or sell securities, to hire any investment adviser or to pursue any investment or trading strategy.

This presentation may contain forward-looking statements that reflect management’s expectations for the future. A variety of important factors could cause results to differ materially from such statements. These factors are noted throughout ITG’s 2008 Annual Report, on its Form 10-K, and on its Form 10-Qs and include, but are not limited to, the actions of both current and potential new competitors, rapid changes in technology, fluctuations in market trading volumes, financial market volatility, changes in commission pricing, evolving industry regulations, errors or malfunctions in our systems or technology, cash flows into or redemptions from equity funds, effects of inflation, customer trading patterns, the success of our products and service offerings, our ability to continue to innovate and meet the demands of our customers for new or enhanced products, our ability to successfully integrate companies we have acquired, changes in tax policy or accounting rules, fluctuations in foreign exchange rates, as well as general economic, business, credit and financial market conditions, internationally or nationally, and adverse changes or volatility in interest rates.

This analysis is intended only for institutional customers, as defined under FINRA rules.