A Closer Look at Small/Mid Cap Indices: Russell 2500 vs. Russell Small Cap Completeness
As index funds play a larger role in the core lineup of defined contribution (DC) plans, plan sponsors have a greater responsibility to ensure that the benchmarks selected for each fund are complementary — and that they don’t introduce unintended gaps or overlaps in market coverage that could lead to meaningful differences in performance and participant outcomes.
An example of how two seemingly similar equity indices can yield different results is found in the comparison of the Russell 2500 Index and the Russell Small Cap Completeness (RSCC) Index. This year alone, the difference in performance was over 10% year-to-date as of September 30, 2020.
In this article, we review the trends toward indexing in DC plans, summarize construction methodologies for the Russell 2500 and RSCC indices and explore why the latter is a more effective complement to the S&P 500 Index in a plan lineup.
Increasing Adoption of Index Funds in DC Plans
With a focus on fees and simplicity, plan sponsors have continued to introduce index funds to plan lineups, with the percentage of plans offering index funds increasing from 79% in 2006 to 91% in 2016 . A recent annual DC survey from a major consultant also reported that the vast majority of plans (92%) offer a mix of active and passive funds, with 18% showing an increase in the proportion of passive funds in 2019 (compared to 5% increasing the proportion of active funds).
While there are a number of benefits to increasing the number of index options in DC plans, this increase also may expose participants to potential unintended risks if the index core lineup is not constructed in a thoughtful manner. Differences in US Small/Mid Cap Index constructions, and the resulting performance differences, highlight the cost to participants of these unintended risks.
A Comparison of US Small/Mid Cap Indices: The Russell 2500 Index vs. the RSCC Index
Within our DC book of business, we find that plan sponsors frequently opt to offer distinct US Large and US Small/Mid Cap Index funds in their DC core lineup. For US Large Cap, the S&P 500 is the benchmark of choice with over $4.6 trillion in assets indexed to it. With regards to US Small/Mid Cap, providers seem split on the preferred benchmark. We lead with a fund benchmarked to the RSCC Index whereas some large providers utilize the Russell 2500 Index. Does it matter?
Historically, the RSCC and the Russell 2500 benchmarks have delivered comparable results; however, in 2020 this differential widened considerably (Figure 1), highlighting how even subtle differences in index construction can lead to a divergence in performance.