Articles

Index Variation And Overall Portfolio Performance
By Craig Israelsen

Page 2 of 6

A differential of 95 bps is material—particularly when evaluating the performance variance between actively managed large-cap blend funds and index-based large-cap blend funds. As it pertains to "active vs. passive" comparisons, the performance of actively managed large-cap blend funds will be more compelling if compared against the Morningstar Large Cap Index and less compelling if compared against the Dow Jones US Large Cap Index.

The performance differences among the large-cap U.S. equity indexes demonstrated in Figure 1 represent various index composition methodologies at work. They are all different: some slightly different and others significantly different. What is noteworthy is the amount of variation in any given year between the best- and worst-performing U.S. large-cap index. For instance, in 2009, the gap between the best-performing large-cap blend index (Russell 1000) and the worst-performing index (Morningstar Large Cap) was 367 bps.

Among large-cap value indexes, the annual difference between the best- and worst-performing index ranged from 133 bps in 2005 to 980 bps in 2009. The S&P 500/Citigroup Value Index had a return of 21.2 percent in 2009 compared with a return of 11.4 percent for the Morningstar Large Value Index. Clearly, an "active vs. passive" comparison would be dramatically impacted based on which of those two indexes was used as the performance bogey for passive investing.

The variation in performance is even more pronounced among large-cap growth indexes. For instance, in 2009, the gap between the best- and worst-performing indexes was 1,280 bps. Even over lengthy time frames, the performance variation among the various large-cap growth indexes can be surprisingly large. For instance, the 10-year average annualized return of the Dow Jones US Large Growth Index was 2.87 percent, whereas the 10-year return for the Morningstar Large Growth Index was 0.34 percent—a difference of 253 bps.

Midcap US Equity Indexes
Next we examine midcap U.S. equity indexes (see Figure 2). Among the five midcap U.S. equity value indexes, there was an annual performance differential that ranged from 64 bps in 2002 to 929 bps in 2004. This level of performance variation reveals significant heterogeneity among the various builders of indexes. Such heterogeneity is seldom discussed in the numerous articles and presentations that discuss and debate the topic of active vs. passive investing despite the fact that such differences could dramatically impact the findings.

Mid-Cap US Equity Indexes

Among midcap blend indexes, the annual performance differences ranged from 124 bps in 2011 to 718 in 2009. Significant variation among midcap indexes is observed in the growth category. For instance, in 2009, the S&P Midcap 400/Citigroup Growth Index had a one-year return of 41.1 percent compared with a return of 55.6 percent for the Dow Jones US Mid-Cap Growth Index. Between the best- and worst-performing midcap growth indexes, the performance differential exceeded 1,200 bps in three of the 10 years. Between the Morningstar Mid Growth Index and the Dow Jones US Mid-Cap Growth Index was a 328 bps difference in their 10-year average annualized returns.