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A More Stylish Fit
Letting the numbers - and not the name - determine the benchmark
by Robert J. Waid
Choosing the most appropriate benchmark benefits both the investor and the investment manager. The benchmark should be representative of the manager's investment universe, or it should at least have comparable investment risk exposures. When there is a match, the investor receives the desired style exposure and the manager can demonstrate skill.
Figure 1
In this study, we examined self-described Russell style managers to determine whether Russell or Dow Jones Wilshire size indexes better match their portfolios.[1] Despite the names, we found that the Dow Jones Wilshire indexes were a better investment universe and performance match for these managers - especially in the small-cap arena.
Index Differences[2]
This study compares and contrasts two pairs of indexes: the Russell 1000 Index and Dow Jones Wilshire U.S. Large-Cap Index, and the Russell 2000 Index and Dow Jones Wilshire U.S. Small-Cap Index.
All four indexes track U.S. stocks and use market-capitalization rankings to determine which stocks enter which index. The Russell 1000 is a large-cap index consisting of the 1,000 largest U.S. companies as ranked each June by market capitalization.[3] The Russell 2000 is a small-cap index made up of the next 2,000 largest companies. Similarly, the Dow Jones Wilshire U.S. Large-Cap Index consists of the 750 largest U.S. companies as ranked by market capitalization each March and September, while the Dow Jones Wilshire U.S. Small-Cap Index is made up of the next 1,750 largest companies.[4] (See Figure 1)
The main difference between the indexes is that the Russell 1000 includes an additional 250 "smaller" companies when compared with the Dow Jones Wilshire Large-Cap Index.[5] Necessarily, this difference spills over into the capitalization coverage of the small-cap indexes as well, with the 250 companies excluded from the Dow Jones Wilshire U.S. Large-Cap Index entering the Dow Jones Wilshire U.S. Small-Cap Index. These 250 companies have a relatively minimal impact on the large-cap indexes, but they have a striking impact on the small-cap indexes. What accounts for just 4 percent of the Russell 1000 large-cap index accounts for more than 30 percent of the Dow Jones Wilshire Small-Cap Index.
On the small-cap end of the spectrum, the Russell 2000 includes 500 companies that the Dow Figure 2 Jones Wilshire indexing system considers to be microcap stocks. These 500 companies account for a little more than 7 percent of the Russell small-cap index. Thus, both Russell size indexes are larger by count (250) than their corresponding Dow Jones Wilshire size indexes, while the Dow Jones indexes are skewed higher on market capitalization.
On June 30, 2005, for instance, the Russell 2000 had a market-cap range of $182 million to $1.8 billion, while the DJ Wilshire Small-Cap Index had a market-cap range of $326 million to $2.8 billion.[6]
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