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
- 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
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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.