{"id":79,"date":"2008-06-06T12:57:43","date_gmt":"2008-06-06T20:57:43","guid":{"rendered":"http:\/\/marketriders\/weblog\/?p=79"},"modified":"2016-12-21T07:33:05","modified_gmt":"2016-12-21T15:33:05","slug":"why-the-sp-smallcap-index-beat-the-russell-2000-index-by-52","status":"publish","type":"post","link":"https:\/\/www.marketriders.com\/investing\/why-the-sp-smallcap-index-beat-the-russell-2000-index-by-52\/","title":{"rendered":"Why The S&P SmallCap Index Beat The Russell 2000 Index by 52%"},"content":{"rendered":"

From May 2000 through May 2008, the S&P SmallCap index
\n(IJR) is up over 50% from its competitive index the Russell 2000 (IWM). <\/span>Both indices, IJR (S&P 600 SmallCap
\nIndex) and IWM (Russell 2000 Index) purport to give an investor exposure to
\nsmall cap stocks in the US
\nstock market. <\/span>The average market caps
\nare similar and many of the same companies exist in each index. <\/span>But why does IJR do so much better than IWM?<\/p>\n

\n

\n

The ETF industry started with the stodgiest of benchmarks \u2013
\nSPY \u2013 the S&P 500. <\/span>But today, there
\nare over 700 indexes so the term \u201cbenchmark\u201d is now a lot less meaningful. <\/span>Friday\u2019s opening of the famous \u201cRussell
\nTrade\u201d got me to take a step back and assess \u2013 where are we going with our
\ndiscussions regarding ETFs on MarketRiders? <\/span>Which ETFs are dangerous and why? <\/span>Where can an investor get stung, even with
\nETFs? <\/span><\/p>\n

\n

I avoid Russell indices like the plague and so should anyone
\nbuilding an ETF portfolio that they want to hold for a long time. <\/span>On www.marketriders.com<\/a>,
\nwe don\u2019t use them in our free template portfolios. <\/span>The have tremendous shortcomings, namely the
\nway the indices are constructed. <\/span>Why? <\/span>The Russell 2000 is rules-based. <\/span>Every May 31st<\/sup>, the smallest 2000
\nsecurities in size below the largest 1000 securities, are rank ordered by
\nmarket capitalizations. <\/span>Those that make
\nit each year are kept in and those companies that suffered are booted off. <\/span>This creates an enormous turnover rate
\naveraging around 25% each year that creates taxable income for investors. <\/span><\/p>\n

\n

Worse yet, the rules-based process for the annual
\nreconstitution, creates another cost for investors. <\/span>As David Swensen so aptly described in
\n\u201cUnconventional Success\u201d:<\/p>\n

\n

\u201cAs the May 31st<\/sup> date of capitalization ranking
\nnears, sharp-witted arbitrageurs identify those securities most likely to enter
\nor exit\u2026 the index. <\/span>Knowing that index
\nmanagers mechanistically buy new joiners and mindlessly sell old exiters, the
\narbitrageurs buy the stocks likely to enter and sell the stocks likely to
\nleave. <\/span>When the July reconstitution
\noccurs, the arbitrage activity causes the index fund manager to pay more for
\npurchases and receive less for sales.\u201d<\/p>\n

\n

To illustrate Swensen\u2019s point, I\u2019ve posted a copy of a
\nreport on MarketRiders<\/a> from an investment bank detailing the 2008 \u201cRussell Trade\u201d to illustrate how
\nprofessional money managers are about to game the system. <\/span>For example, 157 stocks are expected to leave
\nthe Russell 2000 and 259 will be added. <\/span>For money manager who want to use this strategy to make money in the
\nnext month, the piece suggests buying small companies with low volume that will
\nbe added to the index like Griffin Land and Nurseries (GRIF) or Ames National
\nCorp (ATLO) where the number of shares that index fund and ETF provides will need
\nto buy to rebalance their Russell 2000 products will be equal to hundreds of
\ndays of trading volume. <\/span>(In fair
\ndisclosure, I\u2019m holding Intersections (INTX) just for this \u201ctrade\u201d and will
\nsell it on July 1st<\/sup>)<\/p>\n

\n

In contrast, S&P, while its SmallCap index holds many of
\nthe same companies, but uses, in Swensen\u2019s words, \u201ca committee-based,
\nmoderate-turnover approach to selection stocks.\u201d <\/span>In other words \u2013 no one knows what the
\ncommittee will let in and out of the benchmark and when so its impossible to
\n\u201cgame.\u201d<\/p>\n

\n

In summary — for a small cap mutual fund manager, the
\nRussell 2000 index is an excellent benchmark. <\/span>For the rest of us, investing in it is not the smartest thing to
\ndo. <\/span><\/p>\n

\n

All of this raises a broader question that I would hope more
\nof us can discuss on MarketRiders: <\/span>What defines
\na superior index? <\/span>While its interesting
\nthat every company except for Walmart is now issuing new ETFs, I\u2019m hoping we
\ncan all explore whether they belong in a portfolio and if so, what kind. <\/span>I\u2019d like to know from more of you, what you
\nthink is a good index for a permanent ETF portfolio that I would hold for my
\nentire life, and why. <\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

From May 2000 through May 2008, the S&P SmallCap index (IJR) is up over 50% from its competitive index the Russell 2000 (IWM). Both indices, IJR (S&P 600 SmallCap Index) … Read more →<\/span><\/a><\/p>\n","protected":false},"author":8,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_wp_rev_ctl_limit":""},"categories":[22],"tags":[],"yoast_head":"\nWhy The S&P SmallCap Index Beat The Russell 2000 Index by 52% | MarketRiders<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.marketriders.com\/investing\/why-the-sp-smallcap-index-beat-the-russell-2000-index-by-52\/\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:title\" content=\"Why The S&P SmallCap Index Beat The Russell 2000 Index by 52% | MarketRiders\" \/>\n<meta name=\"twitter:description\" content=\"From May 2000 through May 2008, the S&P SmallCap index (IJR) is up over 50% from its competitive index the Russell 2000 (IWM). 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