The Small Respect it Deserves

Some indices are favorites of mine.  It might be better for me to be agnostic and dispassionate.  But I can’t help myself when it comes to the S&P SmallCap 600.  As far as indices go, size does matter, and in the case of this index, being small comes with quite a bit of swagger.

I recently moderated a webinar for financial advisors where our objective was to discuss how the S&P SmallCap 600 compares to the Russell 2000.  Larry Whistler, CFA, and President and Chief Investment Officer of Nottingham Advisors, was our guest on that one to help us understand how a wealth manager and asset manager uses small cap US Equities in a portfolio.  Those who watched this webinar learned that these two indices are very different, even though on the surface, they measure the same asset class.  In fact, the S&P SmallCap 600 outperformed the Russell 2000 by 1.72% per annum since 1994.  And that outperformance by the S&P 600 came with less measured risk than in the Russell 2000.  Just to share one stat, through December 2014, the S&P 600 Sharpe Ratio was 0.47 with the Russell 2000 Sharpe Ratio at 0.34 for that same period.

Phil Brzenk, CFA, and part of our Global Research and Design team at S&P DJI, shared more during our webinar about the construction differences which exist between these two indices:

  • The S&P SmallCap and the Russell 2000 include some of the same companies, but the Russell 2000 reaches down into what we describe as MicroCap (companies with a market capitalization below $400 million).
  • Phil shared data and analysis from a recently published whitepaper, A Tale of Two Benchmarks: Five Years Later, indicating that the Russell 2000 annual reconstitution has also historically led to a performance drag.
  • The S&P SmallCap 600 has a rule that companies in that index must demonstrate financial viability. This earnings screening is not a feature that the Russell 2000 shares.  Phil showed us through factor decomposition that this index construction difference led to a higher value factor for the S&P 600 which was a significant factor in explaining the returns difference.

Through year-end 2014, the S&P 600 had higher returns in 1-year, 3- year, 5-year, and 10-year measures.  Now, to be fair, there were 7 years out of 21 years since the inception of the S&P 600 index in 1994 that the Russell 2000 outperformed.   And that .333 batting average by the Russell 2000 (compared to .667 by the S&P 600) had some financial advisors on the webinar asking questions about whether our performance analysis is sensitive to the time period of measurement.  A financial advisor who likes using the Russell 2000 stated that to make our case in performance, we would have to show him rolling returns.  So, if that’s what it takes to persuade him (and those advisors with similar questions on the webinar), then here they are:

Capture

Larry Whistler was our concluding presenter for our webinar.  He stated that an Exchange Traded Fund (ETF) tracking the S&P SmallCap 600 meets his needs for small cap exposure because the index is effective, the ETF he chose for S&P 600 exposure is low cost, and the modularity, or building-block nature, of the three headline S&P indices are precise tools to help him allocate to his size views.

The posts on this blog are opinions, not advice. Please read our disclaimers.

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