Indexology^® Blog

Sometimes first isn’t better, and sometimes bigger isn’t better.  In this case, first and bigger are mostly worse.  Here’s some background behind the launch timing of the Russell 2000 versus the S&P SmallCap 600.  The timing and business around the Russell 2000 launch really helped the popularity of the index, but with an extra decade’s worth of research, the S&P SmallCap 600 has a higher quality design, resulting in higher performance and less risk.

This blog series will contain excerpts from our new paper where we discuss the outperformance of the S&P SmallCap 600 versus the Russell 2000, the performance of the indices compared with active managers, and the case supporting the performance.

A recent paper by FTSE Russell rightly pointed out the well-timed launch of the Russell 2000® in 1984, an index meant to measure the small-cap segment of the U.S. equity market. The launch was on the back of breakthrough research by Rolf Banz finding that “smaller firms have had
higher risk-adjusted returns, on average, than larger firms.”  At the time, the launch of this benchmark enabled Russell Investment’s consulting clients to gauge the success of small-cap managers.

However, it was not until the early 1990s when the “small-cap premium” concept was really solidified. Nobel Prize winner Eugene F. Fama and co-author Kenneth R. French introduced the three-factor model of market risk, value, and small-cap factors that now serves as the foundation for much of the current research on the topic.  Following this research, the S&P SmallCap 600 was launched in 1994.

Although the S&P SmallCap 600 took an extra decade’s worth of research into account in its construction as a benchmark, the Russell 2000 is far more widely used. According to eVestment Alliance, as of June 30, 2017, 93% of small-cap funds and 81% of assets in the space are benchmarked to the Russell 2000, compared with 3% of funds and 5% of assets benchmarked to the S&P SmallCap 600.

Perhaps the longevity and prevalence of the Russell 2000 as a small-cap benchmark is why it has been widely used in research doubting whether the small-cap premium exists.  Even in FTSE Russell’s own research, they show the Russell 2000 had a lower Sharpe ratio than the large and mid-cap Russell 1000 (0.34 versus 0.41, respectively) from June 1996 through August 2015. According to eVestment Alliance, from June 1996 through September 2017 the Sharpe ratio of the Russell 2000 was 0.31 while that of the Russell 1000 was 0.42.

However, the S&P SmallCap 600 had a Sharpe ratio of 0.43 over the same period. Not only has the S&P SmallCap 600 had a higher Sharpe ratio than the Russell 2000 historically, but the S&P SmallCap 600 has outperformed the Russell 2000 over various time periods and market cycles. Furthermore, according to the S&P Dow Jones Indices SPIVA® U.S. Mid-Year 2017 Scorecard, the S&P SmallCap 600 outperformed 93.8% of all small-cap funds over a five-year period.

In the next post of this series, we will show the actual outperformance of the S&P SmallCap 600 versus the Russell 2000 over the long term, the higher returns and lower risk over different time periods, and through different bull and bear market cycles.

In the last year, plain old beta performed remarkably well in comparison to the so-called “smart” alternatives tracking large-cap U.S. equities.  Of the 17 different strategies reported in our year-end factor dashboard, less than a third outperformed the S&P 500’s total return of 21.83% over the last 12 months.

When they are criticized as the basis of investment strategies (or at any rate when alternatives are promoted) cap-weighted equity benchmarks tend to be ascribed with certain “flaws” – in particular: an undue concentration in the largest stocks or sectors; a disregard for valuations; and a propensity to overweight recent outperformers.  Ironically, it was the supposed flaws of capitalization-weighted benchmarks that drove their relatively strong performance last year.

In 2017, size mattered.  The smallest quintile of S&P 500 constituents (based on prior year-end market capitalizations) averaged a total return of only 8.4%, while the largest stocks gained 22.3%.  In between, returns increased monotonically with size quintile.

Moreover, the U.S. market’s largest sector (Information Technology) had a banner year, soaring by 39% over the year and driving strong correlations between an index’s allocation to the sector, and its total return over the year. 

These size and sector perspectives are useful because nearly all smart beta strategies will – unless explicitly controlled for – underweight the largest stocks or sectors.   (Strategies based on momentum, growth or quality can provide occasional exceptions.)

As we’ve argued previously, the performance of an equal weight index is a useful tool to gauge whether capitalization weighting alone helped or hindered returns.  Last year, the S&P 500 Equal Weight underperformed its parent by around 3% – a material hurdle for smart beta to overcome through stock selection and additional weighting tweaks.  Those that did outperform largely did so through exposures to the factors said to weaken market benchmarks – owning larger stocks, or underweighting value, or simply following the trend.

Yesterday, the first markets day of the New Year, the Dow Jones Industrial Average^® continued its advance, finishing up 104.79 points for a 0.42% gain. How does that stack up against the post-holiday return to trading in prior years? Meh…it was nothing special.

Not to look a gift horse in the mouth, mind you. A gain is a gain is a gain. But it’s far from the best first day ever. In fact, it only ranks as 51^st of 121 observations since the DJIA’s inception. The best—Jan. 4, 1988—came as world banks reported buying dollars to curb the U.S. currency’s decline.

But wait. How does the first day presage annual performance? Is it at all predictive of the year, does it set the tone for the next 12 months? Well, when the Dow rises on Day 1, the whole year experiences a positive return 68% of the time. Sounds good, right? Not really. Similarly, when the Dow falls on Day 1, the whole year is up 65% of the time.

Fact is, the DJIA has a positive annual return 66% of the time. Period. In other words, the DJIA closes the year with a gain two-thirds of the time, regardless of what happens on Day 1. So, no. No predictive power whatsoever. But, of course, you already knew that. There is simply too much time, too many things that influence stocks over the course of a year. The first day no more sets the tone than does Bangladeshi butter production.

Turns out this post is a tale, told by this idiot, full of sound and fury and signifying nothing. Go back to your business.

The S&P BSE SENSEX Series comprises three indices, namely the S&P BSE SENSEX, the S&P BSE SENSEX 50, and the S&P BSE SENSEX Next 50. The S&P BSE SENSEX is the oldest and the most-tracked index in India and comprises 30 large, well-established, and financially sound companies within the S&P BSE 100. The S&P BSE SENSEX 50 is designed to measure 50 of the largest and most liquid companies within the S&P BSE 100. The S&P BSE SENSEX Next 50 is designed to measure 50 of the largest and most liquid companies within the S&P BSE 100 that are not members of the S&P BSE SENSEX 50.

Let us now compare the returns of the S&P BSE SENSEX, the S&P BSE SENSEX 50, and the S&P BSE SENSEX Next 50 for this calendar year, as of Dec. 31, 2017.

Source: S&P Dow Jones Indices LLC. Data from Dec. 31, 2016, to Dec. 31, 2017. Past performance is no guarantee of future results. Table is provided for illustrative purposes and reflects hypothetical historical performance. The S&P BSE SENSEX Next 50 was launched on Feb. 27, 2017.

In Exhibit 1, we see that in the 12-month period ending Dec. 31, 2017, the absolute returns of the S&P BSE SENSEX, S&P BSE SENSEX 50, and S&P BSE SENSEX Next 50 were 29.56%, 31.96%, and 40.90%, respectively.

Exhibit 2: Index Total Returns

Source: S&P Dow Jones Indices LLC. Data from Dec. 31, 2016, to Dec. 31, 2017. Past performance is no guarantee of future results. Chart is provided for illustrative purposes and reflects hypothetical historical performance. The S&P BSE SENSEX Next 50 was launched on Feb. 27, 2017.

In Exhibit 2, we see the total return index level chart for the S&P BSE SENSEX, the S&P BSE SENSEX 50, and the S&P BSE SENSEX Next 50. The S&P BSE SENSEX Next 50 consistently outperformed the S&P BSE SENSEX and S&P BSE SENSEX 50 during the 12-month period ending Dec. 31, 2017.

Exhibit 3: Sector Breakdown of the S&P BSE SENSEX, S&P BSE SENSEX 50, and S&P BSE SENSEX Next 50 

Source: S&P Dow Jones Indices LLC. Data as on Dec. 31, 2017. Chart is provided for illustrative purposes.

From Exhibit 3, we can see that as of Dec. 31, 2017, the financial sector had the highest weight in the S&P BSE SENSEX Series, while the real estate sector had the lowest weight.

For the year ending Dec. 31, 2017, we can state that the S&P BSE SENSEX Series has shown promising returns. The S&P BSE SENSEX added over 14 lakh crores of market cap during this period. We can conclude by saying that 2017 has been a great year for the S&P BSE SENSEX Series, as the indices have given outstanding returns.

The S&P Pan Asia Bond Index, which seeks to track local currency bonds in 10 countries and is calculated in USD, reversed its loss in 2016 and delivered a total return of 7.86% in 2017. Meanwhile, its yield-to-maturity widened 123 bps to 4.64% YTD. The S&P Pan Asia Corporate Bond Index outperformed the S&P Pan Asia Government Bond Index and gained 8.30% over the same period. The size of Asia’s local currency bond markets, as measured by the S&P Pan Asia Bond Index, continued to expand and grew 17% to reach USD 12.1 trillion in 2017.

The 10 country-level bond indices calculated in local currencies ended the year with mixed returns. The three outperforming countries within the S&P Pan Asia Bond Index were Indonesia, Malaysia, and India. The S&P Indonesia Bond Index jumped 15.25% in 2017, while its yield-to-maturity tightened 16 bps to 6.35%, making Indonesia the best-performing country in Pan Asia for the year. The S&P Malaysia Bond Index rose 5.19% YTD, while its yield-to-maturity tightened 2 bps to 3.88%. The S&P BSE India Bond Index gained 4.21% YTD, and its yield-to-maturity widened 24 bps to 7.47%.

The S&P China Bond Index lost 0.29% in 2017; it was the only country within Pan Asian bond markets that posted a negative return. Meanwhile, its yield-to-maturity widened 19 bps to 4.77%. The performance of the S&P South Korea Bond Index also lagged other countries, but it was still up 0.53% YTD (see Exhibit 1).

Looking at the yield-to-maturity in Exhibit 2, India had the highest yield, at 7.47%, followed by Indonesia with 6.35%, and China with 4.77%. On the other hand, the lowest-yielding country was Taiwan with 0.89%, followed by Hong Kong, which was slightly higher at 1.10%.

Exhibit 1: Total Return of the S&P Pan Asia Bond Index Family in 2017

Exhibit 2: Yield-to-Maturity of the S&P Pan Asia Bond Index Family in 2017