Curiously, the Russell 2000’s failure to keep up hasn’t dampened its popularity on Wall Street as a small-cap yardstick. Almost 90 percent of total indexed small-cap assets by market share are linked to the Russell 2000 compared to roughly 5 percent for the S&P SmallCap 600. As such, the Russell 2000 is the benchmarking darling for Wall Street’s small-cap fund managers.
If the Russell 2000 is an inferior index, then why is it so heavily benchmarked by small-cap managers and other Wall Street types? Clearly, it's to give the investing public the false impression that money managers are delivering "superior performance" when all they really did was outperform an inferior opponent. This, by the way, is referred to as “benchmark cherry picking.” And although it’s technically legal, the process of benchmark cherry picking produces misleading results.
It seems that half the battle of being a great Wall Street money manager is being smart enough to cherry pick a substandard and beatable benchmark like the Russell 2000. On the other hand, if you're a small-cap fund manager who has the stones to want to measure up against the best, then you benchmark your fund's performance to a major-league yardstick like the S&P Small Cap 600. Of course, the latter move is a strategically poor choice career wise, which is why many managers hitch their wagon to the Russell 2000.
In summary, the Russell 2000 is a case study on why popular index benchmarks are sometimes suboptimal investment choices. Claims of greater diversification with the Russell 2000 versus smaller peers like the S&P Small Cap 600 haven’t helped its lackluster long-term performance results. For advisors and investors alike, it means choosing your small-cap ETF exposure wisely.
This opinion piece was provided by Ron DeLegge, founder and chief portfolio strategist at ETFguide.