Russell 2000's Rebalancing Act May Be Taxing Matter for Fund Investors

There's a rumble coming in the Russell 2000 small-cap stock index and it might leave small-cap fund managers and their shareholders with a taxing headache.

On Friday night investment management consultant Frank Russell Co. released a preliminary list (see Russell's Web site ) of the stocks entering and leaving the Russell 3000, an index of the 3000 largest U.S. stocks ranked by market capitalization. As the Tacoma, Wash.-based firm prepares for the annual June 30 rebalancing of its 21 stock indices, most eyes are focused on the small fry, a.k.a. the Russell 2000, which is essentially an index of the 2000 smallest stocks in the Russell 3000.

Why? Experts say a host of tech-stock graduations from the sub-$1.5 billion market-cap arena that typically defines small-cap and the addition of recent initial public offerings to the index will make this year's turnover higher than usual. This year more than 520 new names are expected to end up in the index, which adds up to 33% turnover, compared with 27% last year. Since the benchmark is the model for most small-cap index funds and the yardstick for most actively managed small-cap funds, a big shift could leave fund managers with tough decisions and stick their shareholders with taxable capital gains distributions. ...