Investors used to try to “keep up with the Joneses” by measuring their performance against the Dow Jones Industrial Average. While the S&P 500 Index has grown in popularity over the years, most active U.S. equity managers now rely on a Russell benchmark to gauge relative performance—this is especially true for value and growth strategies, or those focused on smaller companies. While no index is perfect, investors should be aware that the past year’s market environment has led to some significant distortions in many of Russell’s indexes, potentially impacting relative performance for strategies benchmarked to them.

Annual reconstitution may not be enough

Index reconstitution moves slowly. Historically, Russell has reconstituted its benchmarks once per year in June, dividing the U.S. equity market by size (as measured by market capitalization) and style (as measured by various growth and value characteristics such as forecasted earnings growth and price-to-book (P/B) ratios). In calmer markets, this slow pace of  change typically has been sufficient, but in more volatile markets, such as those we have experienced in recent years, stocks’ size and style characteristics can change rapidly. 

Specifically, over the past year or so, the hundreds of billions of dollars invested in artificial intelligence (AI) created a massive tailwind for companies set to benefit from that spending, sending their stock prices and growth rates skyrocketing. Almost overnight, many of these companies went from small caps to large caps and from value stocks to growth stocks. And yet, it took until late June 2026 for these stocks to move out of their value or small-cap benchmarks. In these types of market environments, annual reconstitution may not be enough for benchmark providers to keep pace with stocks’ shifting sizes and styles. (Note: Russell, to its credit, recently announced that it will add a size-only reconstitution in December1. While we view this as a positive development, we would still like to see more frequent evaluations of benchmark holdings.)

Case study 1: Sandisk Corporation (Large-cap value indexes)

In one notable example of a value company shifting to a growth stock, Sandisk Corporation had a P/B ratio of 0.7 on June 30, 2025, fitting Russell’s framework for a value stock. However, by June 30, 2026, its P/B ratio was 24.4 and its one-year forward earnings-per-share (EPS) had ballooned by over 1,500%—most would agree that it was no longer a value stock. While it would have been reasonable for a value manager to purchase Sandisk in June 2025, we would not expect a true value manager to maintain a position in the stock a year later, and yet it remained in the index until the annual reconstitution in late June 2026. In addition to Sandisk, Exhibit 1 presents several examples of Russell 1000 Value Index stocks that saw meaningful increases in their valuations and growth rates over the past year—all five names moved into the Russell 1000 Growth Index during the indexes’ 2026 reconstitution.

Case study 2: Bloom Energy (Small-cap indexes)

This kind of drift is not exclusive to value and growth indexes; rapid growth can push small-cap index constituents into the mid- or even large-cap space. Bloom Energy, for example, had a market cap of roughly $5 billion in June 2025, but grewnearly 16-fold by June 2026, shedding its small-cap status. For comparison, the weighted-average market cap for the smallcap Russell 2000 Index went from around $4 billion to nearly $8 billion over that period. Bloom Energy is now included in both the Russell Midcap Index and Russell 1000 Index following its June 2026 reconstitution. Exhibit 2 highlights the significant growth in market cap for Bloom Energy and a few other notable stocks in the Russell 2000 Index.

We’ve witnessed similar situations in the Russell 2500 Index of small- and mid-cap stocks. Using Sandisk again (Note: Prior to June 2026, the stock was included in the Russell 1000, Russell Midcap, and Russell 2500 indexes), the stock’s market cap skyrocketed from a little under $7 billion to over $250 billion. That is an increase of more than 35 times, putting Sandisk in the Russell Top 200 Index of the largest 200 U.S. stocks in June 2026. Exhibit 3 shows Sandisk’s meteoric rise in market cap over the past year.

What goes up…

While questions of benchmark composition may feel esoteric, scenarios like these, where stocks have “outgrown” their benchmarks but lingered there for months prior to the annual reconstitution, can have a very real impact on relative performance for managers. Indeed, this is exactly what happened in the second quarter and into July 2026. Many value and small-cap managers did not own the stocks from our earlier case studies at all in 2026 due to size or style concerns, and the impact was felt most acutely in the second quarter. At the same time, these stocks had become very large weights in their respective indexes due to their outperformance, meaning their performance in the quarter was likely to have a meaningful impact on excess returns. Unfortunately, the majority of these so-called “AI winners” delivered extremely strong returns over the period, creating a significant headwind to the managers who did not own them. The aforementioned Sandisk, for example, returned more than 200% for the quarter, on the heels of massive AI-related demand for its memory products.

In an unfortunate twist, many of the same managers that had been punished for avoiding these stocks also failed to benefit when they subsequently sold off in July 2026 (Sandisk, for example, fell more than 40% in July). As these stocks had been removed from the benchmarks just weeks earlier, managers saw no relative performance benefit as a result of not owning them. In short, style consistency drove these active managers to suffer coming and going—missing out on the stocks’ gains, but also on the relative performance benefit of their subsequent losses. Experienced managers know that what goes up quickly can often come down just as fast. In this case, the timing of the reconstitution simply worked against them.

Exhibit 4 shows how various Russell benchmarks would have performed in July had they not undergone their reconstitutions in late June, compared to the performance of the actual, post-reconstitution benchmarks. Had the reconstitution not occurred, managers’ relative year-to-date performance would be anywhere from two-to-five percentage points better, depending on the benchmark in question. (Of course, our argument is not that this reconstitution shouldn’t have occurred; it is that it should have occurred much sooner). Situations like this highlight how style drift in benchmarks can lead to adverse or, at a minimum, misleading relative performance outcomes for investors.

Active management may provide style consistency

SEI seeks managers with deliberate investment philosophies and processes that align with our alpha source framework of value, momentum, and quality factors. We expect these managers to stay true to their mandates even when their assigned benchmark’s style starts to drift. As investors, SEI aims to provide style consistency over fidelity to a benchmark that has strayed from its stated intent. While benchmark holdings can certainly inform investment decisions, our preferred managers will not deviate meaningfully from their stated investment styles due to benchmark drift. We believe SEI’s adherence to a given strategy’s stated goals and investment style should provide our clients with a level of comfort, knowing that we do not simply follow the market’s whims. Presumably, these investors expect their value and small-cap portfolios to exhibit characteristics of value and small-cap investing even when their benchmarks may not. Our active approach strives to achieve this consistency.

Tracking error is to be expected

When investing in SEI’s actively managed funds, investors should expect some level of tracking error. Active investors, particularly those seeking purer style implementations, should recognize that tracking error is a necessary element in generating alpha. In environments where manager benchmarks have drifted meaningfully from their intended characteristics (e.g., late in a reconstitution cycle), we expect this tracking error to increase as our managers remain true to their stated investment approaches and styles. We believe this higher potential tracking error is often warranted in the name of style consistency. Investors should take note that remaining true to one’s style can result in distorted performance results, most acutely in the months leading up to a benchmark’s annual reconstitution—when index drift is most likely to have occurred. As long as index providers like Russell update their benchmarks only once a year, what happened in the second quarter of 2026 could happen again.

What now?

Though we welcome Russell’s new size-only reconstitution process each December, we’d like to see more frequent overall reconstitutions. However, we recognize that with this would come increased costs and operational burdens, particularly for index providers and passive investors. This reality will likely continue to place a limit on reconstitution frequency―however warranted we feel it may be. In the meantime, we believe investors should be mindful of what’s in their funds’ benchmarks—especially late in the reconstitution cycle. For much of the early part of 2026, this was a headwind for value and small-cap investors as the AI trade hit a crescendo. Importantly, we don’t believe that this experience is predictive of future outcomes. Index drift can lead to tracking error for style-pure managers, and that tracking error can cut both ways over any finite horizon. However, we believe that investors are best served by remaining true to rewarded risk factors like value, momentum, and quality, rather than chasing indexes that have drifted from their original intent.

GLOSSARY AND INDEX DEFINITIONS

For financial term and index definitions, please see: https://www.seic.com/ent/imu-communications-financial-glossary












IMPORTANT INFORMATION

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