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Russell 2000 myth buster no. 2: Isn’t one small cap index the same as any other?

By: Mat Lystra, Senior Research Analyst

The Russell 2000® Index hit an all-time high on June 23, once again putting the spotlight on small cap stocks. As of June 30, 2015 the Russell 2000 index performance was 4.75% for the first half of the year. The index outperformed both the Russell Top 200® Index (a measure of large cap stocks) at 1.42% (+3.3%), and the Russell Mid Cap® Index at 2.35% (+2.4 %) in the first half. Index performance was driven by an increase in the value of biotech stocks, a rebound in U.S. economic activity in Q2, and a pick-up in M&A activity.

But for investors, an index’s performance is arguably less important than its construction, because index construction information is used by investors to help analyze markets and form investment decisions. Index performance can actually be indicative of the differences in construction between seemingly similar benchmarks, as shown in the chart below. When this happens the investor should be cautioned that they are in fact not designed to measure the same things. Just because an index promotes itself as “small cap,” doesn’t mean that it accurately reflects that segment of the market as much as it’s an easy way to categorize the product.  There are many different varieties of “red wine” for example, but just as many differences in the characteristics of each when sampled by the connoisseur.

At Russell, we believe that an index should stay true to the market segment it has been designed to track so that index users can reliably measure their approach. The Russell 2000 Index is constructed to capture the investable universe of U.S. small cap securities.  It is created following a transparent and rules-based methodology.

FTSE Russell uses a consistent approach to size definitions within the Russell U.S. index family. Some index providers allow for the definitions of large, mid, and small companies to intermix, and index users need to have a clear understanding of how each index defines and maintains its capitalization segments.   Furthering our red wine analogy, if the wine maker wanted to create a one-third blend of merlot, cabernet sauvignon and syrah but any of the individual components had already been mixed together, the desired flavor profile couldn’t be achieved.

Russell indexes are also maintained in order to ensure they continue to accurately capture the intended market segment consistently through methodology considerations such as:

  • Daily adjustments for stock splits, dividends and de-listings
  • Month-end adjustment of stock buybacks and equity offerings
  • Quarterly review of IPO additions

The rigor of our methodology underpins another aspect of index selection: marketplace acceptance. Since 1984, index users have widely embraced the Russell 2000 Index making it one of the most followed U.S. small cap index in  the U.S. Institutional marketplace.* An entire ecosystem of investable product offerings has developed around the Russell 2000,* including:

  • 26 Mutual funds
  • 7 Market cap ETFs
  • 6 Smart beta ETFs
  • 9 Leveraged/inverse ETFs
  • VIX Small cap volatility index
  • ETF options
  • Volatility options
  • Cash options
  • ETF futures
  • Futures
  • Collective Investment Funds
  • Customized index portfolios
  • Structured products

Now an industry standard, the Russell 2000 Index debuted at a time when the S&P 500 was the primary cap-weighted index used to measure all U.S. equities. FTSE Russell takes pride in its legacy of U.S. market segmentation and precise representation of the investable opportunity set. The next time you see performance differences between small cap indexes, it is worth asking yourself, is that really a small cap index?

Source: FTSE Russell, data as of June 30, 2015. Past performance is no guarantee of future results.

* Source: Russell Annual Benchmark Survey, compiled by Russell Indexes using data from the Morningstar Direct database as of December 31, 2014.

** As of 05/31/2015

 

 

© 2015 London Stock Exchange Group companies.

London Stock Exchange Group companies includes FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), MTS Next Limited (“MTS”), and FTSE TMX Global Debt Capital Markets Inc (“FTSE TMX”). All rights reserved.

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All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by the London Stock Exchange Group companies nor its licensors for any errors or for any loss from use of this publication.

Neither the London Stock Exchange Group companies nor any of their licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell Indexes or the fitness or suitability of the FTSE Russell Indexes for any particular purpose to which they might be put.

The London Stock Exchange Group companies do not provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. The London Stock Exchange Group companies make no representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the London Stock Exchange Group companies. Distribution of the London Stock Exchange Group companies’ index values and the use of their indexes to create financial products require a license with FTSE, FTSE TMX, MTS and/or Russell and/or its licensors.

Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.

 

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