If your clients are seeking small-cap domestic stock exposure via an index fund, chances are you are looking at portfolio based on the Russell 2000 index, which dominates the category.

But a new study by S&P Dow Jones Indices says your clients will profit more from buying a fund tracking S&P's own SmallCap 600 index.

Clearly, S&P Dow Jones has a horse in this race, but the performance numbers are provocative.

A dollar invested in the S&P SmallCap 600 in January 1994 would have returned $8.59 by the end of December 2014, the study finds, vs. $6.18 if invested in the Russell 2000.

That's despite the fact that the S&P numbers don't show outperformance every year. In fact, the Russell 2000 beat the S&P 600 in one-third of the calendar years under study. "From year to year you are going to see some fluctuations," says  Aye Soe, the company's senior director of global research and design and a co-author of the study.


The key, researchers say, is the compound annual return over time. Over the period of the study, S&P calculates that its small-cap index outpaced the Russell small-cap benchmark by 1.72% annually. "The return differential is quite significant," Soe says.

The study attributes the outperformance in part to the annual reconstitution of the Russell indexes at the end of June. Because stocks that are growing in market cap are moving up to the Russell 1000 and those that are shrinking head down to the Russell 2000, small-cap index fund managers get "forced to sell winners and buy losers," according to the S&P Dow Jones study.

But the study also attributes a larger part of the outperformance to the S&P index's requirement that components be profitable. The study looked at the return of the high-quality stocks (based on gross profit margin) less the return of low-quality stocks, Soe says: "The difference represents the 'return to quality' factor."

Michael Rawson, a research analyst at Morningstar, questions the attribution of outperformance to quality criteria, however. Other mechanical small-cap indexes -- including those from CRSP and MSCI -- also have outpaced the Russell, he notes.

"It's not just about quality," says Rawson. "There's something else going on."


Not surprisingly, the people at Russell also take issue with the S&P Dow Jones study's conclusions.

Rolf Agather, managing director of research and innovation at Russell, thinks that investors and advisors need to be careful in drawing conclusions from the study. "Excess return isn't necessarily a good measure of a fair benchmark," says Agather.

He is critical of the quality screen used for the S&P SmallCap 600. "That's an active decision," says Agather. "If I started adding on criteria to pick better stocks, what does that start to sound like to you?"

Agather says Russell execs "want [the Russell 2000] to be accurately representing U.S. small caps." S&P Dow Jones's own study admits that its own index has a lower exposure to the size factor than the Russell benchmark.

"The Russell 2000 is actually a better reflection of what we think of as U.S. small-cap stocks," Agather says.

Agather also claims the effect of Russell's annual reconstitution has been less in recent years -- and indeed, the average excess return of the S&P index has been lower over the last decade, when he said changes were made. "We've definitely done some things in the last 10 years to help mitigate that impact," he says.

Morningstar's Rawson also sees the study as an attempt by S&P Dow Jones to get more traction in a part of the market dominated by Russell.

Although the S&P 500 is the biggest index in large-cap domestic stocks, Rawson says, "the Russell 2000 is actually more popular in small-cap land than the S&P 600."

One reason, he says is that active small-cap managers like to use it as a benchmark. "Active managers will always pick an index that makes them look better," he says.

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