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Style and smart beta meet in “Pure Styles” indexes

By: Tom Goodwin, Senior Research Director

Russell Style Indexes® have long been the prominent standard of US style indexing, with 98% of the institutional market share. More recently, alternatively weighted or “smart beta” indexes have emerged as a new and powerful way to target focused exposures in an index. Russell’s new Pure Styles Indexes® combine these two approaches, providing concentrated style exposure.

Russell Style Index methodology employs a short list of characteristics: price-to-book, forecasted earnings-per-share growth and historical sales-per-share growth. These three have proven to be powerful identifiers of the value and growth styles—value stocks will tend to have very low price-to-book ratios, while growth stocks will tend to have very high earnings and sales-per-share growth.

Smart beta indexes have grown in popularity as investors are increasingly eschewing weighting stocks by market capitalization. Those looking to target specific factor characteristics can instead select a smart beta index weighting stocks by the strength of exposures to one factor or several factors for their benchmarking needs.

Russell’s new Pure Styles Index methodology applies this concept to the traditional Russell Style Indexes. The market-tested characteristics of price-to-book, earnings and sales growth are first used to sort stocks into those with strong growth characteristics and those with strong value characteristics in accordance with the methodology definitions and rules. Then, instead of cap-weighting the stocks in each group, they are weighted according to their combined style scores. This produces a higher octane pair of style indexes.1

The Make-Up of Pure Styles Indexes

 Source: FTSE Russell.

The chart below illustrates how the Russell Pure Styles Indexes have a more tailored, ‘pure’ exposure to only those stocks considered fully value or fully growth. By employing a filter technique used by economists to reveal business cycles, we are able to reveal the value-versus-growth style cycles for both the traditional Russell Style Indexes and the Russell Pure Style indexes. 2

Source: FTSE Russell. Estimates of monthly returns of value-growth cycle using actual historical data (traditional Russell Style Indexes) and simulated data (Russell Pure Style Indexes) as at January 2001 to March 2015. Past performance is no guarantee of future results. Returns shown may reflect hypothetical historical performance.Please see the important legal disclosures at the end of this publication.

This data demonstrates that the Russell Pure Style Indexes can provide users with a strong return separation to gain more insight on time-varying style cycles. These tools can then be used to assist in making decisions relating to style investing.

 

[1] T. Goodwin and M. Paris (2015) “The Russell Pure Style Indexes,” Russell Indexes Research.

[2] L. Christiano and T. Fitzgerald (2003), “The Band Pass Filter,” International Economic Review, 44 (2), 435-465.

 

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