Banks slash payments to index funds for Russell rebalance

Thu Jun 25, 2015 1:17am EDT
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By Jessica Toonkel

NEW YORK (Reuters) - With the annual rebalance of the Russell stock indexes just a day away, brokerage firms are shaving the discounts they typically offer to big index funds on what is usually one of the biggest trading days of the year.

On Friday, Russell will announce the names of some 128 companies that it is adding to its widely-followed Russell 2000 index of small companies. And that’s when the big index fund providers – including Vanguard Group, Dimensional Fund Advisors and BlackRock Inc (BLK.N: Quote) - must adjust their portfolios by buying the new stocks and selling the old.

As recently as three years ago, big brokerages such as Bank of America Merrill Lynch (BAC.N: Quote) and Goldman Sachs (GS.N: Quote) would vie for those orders, confident that they could hand the big fund companies discounts of around .05 percent off of market-priced trades and still make money, mainly by stockpiling the right stocks in advance of the big trade.

But in recent years, that has become harder to do. With FTSE Russell disclosing probable additions and deletions in advance, as well as increased competition from other institutional and retail investors, brokers have not found reconstitution day delivering the easy money it once did.

Now, most brokers are offering the index funds closer to .01 percent to .02 percent, current and former executives at brokerage firms and index fund providers told Reuters. All of the executives wished to remain anonymous because they are not permitted to speak to the media.

"The brokers are finding it is not as lucrative as it once was," said one index fund manager.

There is big money involved. Roughly $835 billion is invested in index funds that track the Russell indices, Russell said. More than $50 billion is expected to change hands in the final moments of Friday, according to New York-based Investment Technology Group.

For example, at BlackRock alone, $41.9 billion in funds track the Russell 2000 index. With about 10.7 percent of those indexes expected to turn over, brokers would pay between $450,000 and $900,000 for the privilege of doing those rebalancing trades - and more to trade for the BlackRock institutional portfolios that also track those indexes. In the era of 0.05 percent discounts, brokers might have paid $2.2 million or more to BlackRock to handle the same volume   Continued...

The BlackRock logo is seen outside of its offices in New York January 18, 2012. 
REUTERS/Shannon Stapleton