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Research & Insights

Small cap defensive: Oxymoron, or simply overlooked?

An analysis of Russell 2000® Defensive Index® performance, characteristics and factors compared to the Russell 2000® Index

Key points

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Passive and fundamental index investing: A factor analysis

Interest in passive investing has risen in recent years. Many investors, increasingly cost-sensitive in the wake of the financial crisis, are not convinced that active management will deliver excess returns, net of fees, over their benchmarks. Passive investing has traditionally focused on replicating cap-weighted benchmark indexes, either through index mutual funds, exchange traded funds (ETFs) or the creation of matching in-house portfolios. Cap-weighted indexes provide cost-effective exposure to various segments of the equity market with a high degree of liquidity and capacity.

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The Russell 2000 Index in a rising interest rate environment - Evidence from past cycles

  • During the last three periods of rising interest rates, the Russell 2000 Index experienced initial declines, but in two of these three instances, it recovered from intra-year lows to finish each subsequent 12-month period in positive territory. There was no clear pattern in sector leadership.
  • All three periods of interest rate hikes we examined have occurred at or near an inflection point in market volatility. However, for two of the periods, volatility began to increase after the Fed began raising rates, while in the third, volatility actually declined.
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FTSE GDP Weighted Indexes

GDP-weighted indexes

From time to time the weighting of certain countries within capitalisation-weighted equity indexes may diverge significantly from those countries’ share of global GDP.

An example of a dramatic divergence between a country’s global equity market footprint and its economic importance comes from late-1980s Japan. In 1989, according to the International Monetary Fund (IMF), Japan’s share of world economic output, based upon a purchasing power parity (PPP) valuation of global currencies, was just under 10 percent.

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Global index standards - Emerging market partnerships

FTSE Russell Emerging and Frontier market Indexes are used by market participants worldwide to benchmark the performance of active and passive managers, and as the foundation of index tracking products.

A combination of transparent country classification, rules-based index methodologies and world leading index governance, has made FTSE Russell the Emerging Market index provider of choice for institutions worldwide.

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Frontier Markets - Accessing the next frontier

Frontier Markets constitute the one segment of the equity market that is typically missing within institutional portfolios. These markets represent developing countries with high rates of economic growth, but small and relatively illiquid stock markets. Frontier Markets are often in their infancy and have attracted attention due to their diversification opportunities and growth potential.

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Factor exposure indexes - Index construction methodology

The premise of a factor approach to indexes is to construct a stock index that has an intentional and greater exposure to a factor of interest than a given benchmark. By factor, we mean a stock level characteristic such as volatility or value represented by for example, Book to Price. When the benchmark is the Market Portfolio and a positive excess return (or factor premium) exists over the long term, this is often termed a “factor anomaly”, contradicting as it does the “Efficient Market Hypothesis”.

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Factor exposure indexes - Momentum factor

In this paper we construct and investigate the properties and robustness of a set of momentum factors. We also construct illustrative indexes, based on a preferred momentum definition and show that the resulting indexes exhibit a substantial exposure to momentum and relatively low levels of turnover.

We identify candidate momentum factors from a survey of the academic literature and current market practice. The candidate factors are assessed and formation and holding periods examined for the FTSE Developed universe over the period 2001 – 2014.

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Factor exposure indexes - Quality factor

Following Asness et al. (2013), we consider quality as the consistent ability to generate strong future cash flows. We assess quality from several perspectives: profitability, operating efficiency, earnings quality (accruals) and leverage. Current profitability is related to future levels of profitability and the persistency of profitability is a key indicator of quality. Profitability improvements that are the result of increased operating efficiency or asset utilisation are likely to be more sustainable and therefore symptomatic of quality.

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Factor exposure indexes - Value factor

1. Summary

The value effect is one of the most studied market anomalies [2-5]. The value effect or value premium refers to the tendency of stocks with lower valuation ratios to earn above average returns over the long run. For example, the cross-sectional variation of stock returns across countries can be partly explained by a global value factor [6]. Such a value effect has been observed across many different markets, regions and sample periods [1].

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