Dow Jones Debuts Enhanced Micro-Cap Index

June 28, 2005

Things are getting mighty crowded in the micro-cap space, with a new enhanced index from Dow Jones and two ETFs in the works.

Dow Jones pulled the cover off of a new micro-cap index yesterday, June 27, becoming the third major indexing player to enter the micro-cap space in the past year.  Unlike recently launched products from Russell and MSCI, however, the new Dow Jones index does not attempt to track the micro-cap sector as a whole.  Rather, Dow Jones' product aims to beat the micro-cap sector, using quantitative screens to select a subset of micro-cap stocks that (it hopes) will offer above-average returns for investors.

An exchange-traded fund (ETF) tracking the index will hit the market soon, with First Trust Advisors as the sponsor.

"Micro-cap stocks perform very differently from larger stocks, and have yielded even greater rewards in recent years," said Michael A. Petronella, president, Dow Jones Indexes/Ventures. "The Dow Jones Select MicroCap Index follows a superior methodology, which eliminates problems usually associated with this category-such as illiquid financially instable stocks."

By creating a screened micro-cap index, Dow Jones joins a growing list of investors and indexers trying to beat the market using what's called "enhanced indexing."  Relying on quantitative screens and sophisticated computer algorithims, enhanced indexing aim to deliver above-average returns with below-average risk. 

A family of enhanced indexes created by the American Stock Exchange - called Intellidexes - form the basis for a growing suite of ETFs from PowerShares Capital Management. Together, those funds have more than $1 billion in assets, and to date, have largely succeeded in delivering above-market returns.

Dow Jones said that it will look at "price-to-earnings ratio, price-to-sales ratio, per-share profit change for the previous quarter, operating profit margin and six-month totla return" when selecting stocks.  As currently constructed, the new index has a p/e ratio of about 16, and a small dividend yield.

Dow Jones defines the micro-cap opportunity set as those stocks with market capitalizations matching the smallest 20 percent of companies listed on the New York Stock Exchange.  Currently, that translates into a maximum market capitalization of about $1 billion - significantly larger than competing micro-cap indexes.  The Russell Micro-Cap Index has a maximum market capitalization of approximately $500 million, while MSCI's index tops out at $290 million.  A fourth micro-cap index created earlier by the Wilshire division of Dow Jones includes stocks with market capitalizations up to $292 million.

Recently, Barclays Global Investors filed to create an ETF based on the Russell Micro-Cap Index; no launch date has yet been set.


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