The role of a benchmark is to represent the return to an investment strategy in an investment universe. Active managers’ skills can be distinguished from random results by comparing their investment returns to a benchmark that represents their investment universe. In general, a benchmark represents a return to a passive strategy. If benchmarks are assumed to represent a passive strategy in a given investment universe, then returns among various benchmarks should be similar. This similarity appears to be the case in the U.S. large-cap equity universe, by looking at how the returns on the Russell 1000® and the S&P 500® Index closely track each other.
However, in the small-cap universe, returns between the Russell 2000 and the S&P SmallCap 600 are significantly different. Using monthly total returns from 1994¬2008, Exhibit 1 charts the growth of an investment of US$ 1 in the S&P 500 and Russell 1000, and in the S&P SmallCap 600 and Russell 2000.
Exhibit 1. Cumulative Return On Investments
Source: Standard & Poor’s, Frank Russell
In the U.S. large-cap universe, US$ 1 invested in the S&P 500 and the Russell 1000 from December 1993-December 2008 would have returned US$ 2.63 and US$ 2.67, respectively. Conversely, US$ 1 invested in the S&P SmallCap 600 and the Russell 2000 over the same investment horizon would have returned US$ 3.06 and US$ 2.38, respectively.
Since its launch in 1994, the S&P SmallCap 600 has outperformed the Russell 2000 in 11 out of the 15 years. From January 1994 through May 2009, the S&P SmallCap 600 returns exceeded those of the Russell 2000 by about 2% per year. Exhibit 2 highlights the risk/return profile of the two indices.
Exhibit 2. Risk/Return Profile
Source: Standard & Poor’s, Frank Russell. Data from January 1994 – May 2009.
The substantial divergence of returns between the two small-cap indices merits further study, and an understanding of the factors contributing to the divergence. In this paper, we examine the sources of the return differential.
Smart beta isn’t smarter than cap weighting, but it is different, and that’s great for investors.
Trial by fire is one way to discover why ETF transparency matters.
Most people now realize leveraged ETFs can hurt you, but how, then, to use them?
What would a shift out of a mutual fund and into an ETF look like up close?