Index provider FTSE Russell is modifying 20 indexes, and billions of dollars are likely to change hands as a result.
The adjustment is coming in light of heightened market concentration, which has caused some index funds to violate regulated investment company diversification requirements. RIC rules, explained in more detail here, require mutual funds and exchange-traded funds to maintain a minimum level of diversification to qualify for favorable tax treatment from the IRS.
RICs must pass two diversification tests, sometimes referred to as the 25/5/50 rule:
- No company can exceed 25% of the fund’s total assets.
- The sum of assets in companies representing 5% or more of the fund cannot exceed 50% of the fund’s total assets.
Growth of the “Magnificent Seven” group of stocks has brought these rules into sharper focus. In concentrated market segments, index providers embed rules to prevent associated funds from breaching these limits.
Changes to Russell US Style Indexes
FTSE Russell will now cap holdings in several prominent indexes. The change is effective at the close on March 21.
The update adds a strict 22.5/4.5/45 rule to its suite of Russell US Style Indexes to avoid breaking RIC thresholds. This means:
- No company can exceed 22.5% of the fund’s total assets.
- The sum of assets in companies representing 4.5% or more of the fund cannot exceed 45% of the fund’s total assets.
These rules are among the most restrictive across index providers and may influence the portfolios of associated index funds and ETFs.
Immediate Effects of FTSE Russell Change on Index Funds and ETFs
Eight of the 20 affected indexes have US-domiciled funds or ETFs tracking them. The largest of them are noted below.
The updated methodology covers 32 index funds and ETFs holding roughly $370 billion. Of that group, 10 funds tracking the Russell 1000 Growth Index and Russell Top 200 Growth Index with almost $200 billion of combined assets are most likely to see a material change to their portfolios on March 24, market volatility notwithstanding.
The four ETFs and six mutual funds tracking those indexes will trim stakes in their largest holdings and distribute the assets pro rata to smaller positions. The largest holdings of iShares Russell 1000 Growth ETF IWF and iShares Russell Top 200 Growth ETF IWY may see their collective stake lowered by several percentage points.
Six of the Magnificent Seven stocks—Apple AAPL, Microsoft MSFT, Nvidia NVDA, Amazon.com AMZN, Alphabet GOOG/GOOGL, and Meta Platforms META—are the holdings in question. Tesla TSLA, the final member of the Magnificent Seven, isn’t a large enough holding for its stake to be lowered. Billions of dollars are likely to change hands as a result of this reshuffling. S&P implemented a similar adjustment to its Select Sector indexes in September 2024. Top holdings in The Technology Select Sector SPDR ETF XLK saw trading volume well above their historic norm on the day of the change. Top holdings in both Russell indexes may also see heightened trading activity on March 24.
Concentration in the Russell Top 200 Growth Index Prompted the Change
Russell’s US style indexes did not cap holdings prior to the change. This caused the Russell Top 200 Growth Index to breach RIC thresholds for the first time in 2024 and prompted a closer look at the broader suite of style indexes. FTSE Russell began a formal consultation with market participants in August 2024 with the resolution to apply caps finalized on Nov. 1.
The solid red line in the chart above represents the combined portfolio weight of positions greater than 5%, while the solid blue line represents the combined portfolio weight of positions greater than 4.5%. If the solid red line crosses above the dotted red line, the ETF is in violation of RIC diversification rules. If the solid blue line crosses above the dotted blue line, the ETF is in violation of Russell’s new 4.5%/45% rule.
Beginning March 24, neither the red nor blue line should breach either threshold.
Nvidia likely catalyzed Russell’s call to action. The stock’s meteoric rise brought its market cap nearly level with multi-trillion-dollar firms Apple and Microsoft. Those three stocks claimed more than 36% of the above portfolio on May 31, 2024. Positions weighing more than 5% totaled 51% collectively, violating RIC diversification rules and highlighting the update’s urgency.
iShares Russell 1000 Growth ETF Should Now Stay RIC-Compliant
The widely followed iShares Russell 1000 Growth ETF also recently became noncompliant with RIC rules, surpassing the 50% threshold for the first time in January 2025.
Funds in violation of RIC rules at quarter-end have 30 days to become compliant. If market concentration worsens, Russell US Style Indexes would have no guardrails to prevent persistent overconcentration without capping rules.
The update appears to be coming at a good time.
