Appendix I: Index Provider Methodologies
Dow Jones: The Dow Jones U.S. Index and its subindexes are constructed and maintained according to a transparent, rules-based methodology. The indexes are weighted based on float-adjusted market capitalization and are calculated in real time. They are rebalanced quarterly (style indexes semiannually), and in addition are reviewed on an ongoing basis to account for mergers, acquisitions and other extraordinary events affecting index components. The large-cap and mid-cap indexes measure the top 70 percent and next 20 percent of stocks by market capitalization. The small-cap index represents the next 5 percent of stocks, excluding the smallest companies based on market capitalization and turnover. The Dow Jones U.S. Style Indexes measure growth stocks and value stocks. Companies determined to be style-neutral are excluded from the indexes. The style classifications are determined using a multifactor model that accounts for projected price-to-earnings ratio (P/E), projected earnings growth, price-to-book ratio, dividend yield, trailing P/E and trailing earnings growth. (www.djindexes.com)
Dow Jones Wilshire: Dow Jones Wilshire U.S. Style Indexes are constructed by separating the Dow Jones Wilshire 5000 universe of stocks into four capitalization groups using full market capitalization and then splitting the capitalization groups into growth and value stocks. The resulting 10 indexes are float-adjusted and market-capitalization weighted. Instead of 12 subindexes there are 10 style benchmarks because the smallest capitalization group, microcap stocks, is not split into growth and value. Large cap is defined as the 750 largest stocks by market capitalization, small cap is the next 1,750 largest stocks from 751 to 2,500, mid cap is a combination of 500 large and small stocks from the 501st largest to the 1,000th largest, and micro cap is all stocks in the bottom half of the Dow Jones Wilshire 5000 Index (below the 2,501st largest). The Dow Jones Wilshire style methodology uses six intuitive fundamentals to define a company as growth or value: next year’s price-to-earnings ratio, forecast long-term earnings growth, price-to-book ratio, dividend yield, trailing revenue growth for the previous five years, trailing earnings growth for the previous 21 quarters. The Dow Jones Wilshire Indexes were rebranded as the Dow Jones Total Stock Market Indexes as of March 31, 2009, following the termination of the joint venture agreement between Dow Jones Indexes and Wilshire. (www.djindexes.com)
Morningstar: Large cap is defined as the largest 70 percent of investable securities by free-float market capitalization, mid cap is the next 20 percent by market capitalization (70th to 90th percentile), and small cap is the next 7 percent (90th to 97th percentile). Within each capitalization class, index constituents are assigned to one of three style orientations—value, growth or core—based on the stock’s overall style score. A stock’s value orientation and growth orientation are measured separately using related but different variables. Value factors: price/projected earnings (50.0 percent), price/book (12.5 percent) price/sales (12.5 percent), price/cash flow (12.5 percent), dividend yield (12.5 percent). Growth factors: long-term projected earnings growth (50.0 percent), historical earnings growth (12.5 percent), sales growth (12.5 percent), cash flow growth (12.5 percent), book value growth (12.5 percent). Morningstar rebalances constituent shares and weights of its indexes quarterly in March, June, September and December (on the Monday following the third Friday). Immediate rebalancing occurs if two constituents merge or a company’s free-float changes by 10 percent or more. The indexes are reconstituted twice annually, in June and December. (www.morningstar.com)
MSCI: MSCI’s domestic indices are subsets of the MSCI US Investable Market 2500, which are the Large Cap 300, Mid Cap 450 and Small Cap 1750 indexes. Market capitalization is based on a free-float adjustment. Indexes are reviewed quarterly and rebalanced semiannually. MSCI employs a “buffer zone” approach among size and value/growth dimensions to reduce turnover and to better reflect the investment process of asset managers. Eight different variables (three for value and five for growth) are used to better represent value and growth styles. Value attributes are: book value to price ratio, 12-months forward earnings to price ratio, and dividend yield. Growth attributes are: long-term forward earnings per share (EPS) growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, long-term historical sales per share growth trend. (www.mscibarra.com)
Standard & Poor’s: Standard & Poor’s U.S. indexes are maintained by the U.S. Index Committee, which meets monthly and comprises eight full-time professional members of Standard & Poor’s staff. Unadjusted market capitalization of $3 billion or more for the S&P 500 (approximately 75 percent of U.S. equities), $750 million to $3.3 billion for the S&P Mid Cap 400 (approximately 7 percent of U.S. equities), and $200 million to $1.0 billion for the S&P Small Cap 600 (approximately 3 percent of U.S. equities). The market cap of a potential addition to an index is looked at in the context of its short- and medium-term historical trends, as well as those of its industry. Adequate liquidity and reasonable price—the ratio of annual dollar value traded to market capitalization—should be 0.3 or greater. Various domicile requirements; public float of at least 50 percent of the stock; rules to minimize turnover. Changes to the U.S. indexes are made as needed, with no annual or semiannual reconstitution.
The Style index series divides the complete market capitalization of each parent index approximately equally into growth and value indexes. This series covers all stocks in the parent index universe, and uses the conventional, cost-efficient market-cap-weighting scheme. The style indexes measure growth and value along two separate dimensions, with three factors used to measure growth and four factors used to measure value. Growth factors: five-year earnings per share growth, five-year sales per share growth rate and five-year internal growth rate (IGR). Value factors: book value to price ratio, cash flow to price ratio, sales to price ratio, and dividend yield. A growth score for each company is computed as the average of the standardized values of the three growth factors. Similarly, a value score for each company is computed as the average of the standardized values of the four value factors.
Style Index Series: This series divides the complete market capitalization of each parent index approximately equally into growth and value indexes while limiting the number of stocks that overlap between them. This series is exhaustive (i.e., covering all stocks in the parent index universe) and uses the conventional, cost-efficient, market-capitalization-weighting scheme.
Pure Style Index Series: The pure style index series identifies approximately one-third of the parent index’s market capitalization as pure growth and one-third as pure value. There are no overlapping stocks, and these indexes do not have the size bias induced by market-capitalization weighting; rather, stocks are weighted in proportion to their relative style attractiveness. (http://www2.standardandpoors.com/)
Russell: U.S. common stocks are ranked from largest to smallest based on free-float market capitalization at each annual reconstitution date, which is May 31. The largest 1,000 stocks become the Russell 1000 Index, the largest 800 stocks in the Russell 1000 become the Russell Mid Cap Index and the next largest 2,000 stocks (after the largest 1,000 stocks) become the Russell 2000 Index. Style is determined by ranking each stock by two variables: the book to price ratio and the I/B/E/S forecast long-term growth mean. The variables are combined to create a composite value score (CVS) for each stock. The stocks are then ranked by their CVS, and a nonlinear probability algorithm is applied to the distribution to determine style membership weights. Roughly 70 percent are classified as all value or all growth and 30 percent are weighted proportionately to both value and growth. (www.russell.com)