Benchmark selection is an important portfolio construction consideration, especially in nuanced markets like US small caps. Consider that differences in rules-based benchmark construction have led the S&P® SmallCap 600® Index to outperform the Russell 2000 Index by 676% over the last 30 years — that’s 1.85% per year since 1994.1
The most popular US small-cap benchmarks are the S&P SmallCap 600 Index, Russell 2000 Index, and CRSP US Small Cap Index. All three indices include US-domiciled firms and maintain a reasonable public float.
But there are some stark differences, as shown below. The number of constituents, market capitalization, and time for inclusion after IPO vary widely. And only the S&P SmallCap 600 Index has a financial viability requirement.
Index Construction Details
|S&P® SmallCap 600® Index||Russell 2000 Index||CRSP US Small Cap Index|
|Number of Constituents||600 companies||2000 companies||1471 companies|
|Market Breadth||Represents 3% of US market||Represents 7% of US market||Represents 13% of US market|
|Domicile||Should be a US company||Should be a US company||Should be a US company|
|Public Float||Maintain a public float of at least 10% of its shares outstanding||Maintain a public float of at least 5% of its shares outstanding||Maintain a float of at least 12.5% of shares outstanding|
|Market Capitalization||Meet market capitalization requirement of at least $750M and below $4.6B||Have a market capitalization of at least $30M and closing price of at least $1.00 on rank day||Have a market capitalization of at least $15M|
|IPO Seasoning||6-12 months||None||20 days|
|Reconstitution Frequency||Throughout the year, as corporate actions arise||Only once a year, except for IPOs||Quarterly|
|Financial Viability||Most recent quarter's earnings and the sum of its trailing four consecutive quarter's earnings must be positive||-||-|
Source: S&P, FTSE, CRSP. As of June 30, 2023.
Because each index provider uses a different process to separate parts of the market cap spectrum (i.e., large versus mid versus small), there are differences in how a small-cap versus mid-cap stock are identified.
For example, S&P uses dollar ranges for market cap breakpoints to construct their flagship US size indices, resulting in stocks being owned by only one of the three indices.
The CRSP index ranks the stock universe based on cumulative total market cap from largest to smallest. The largest stocks are selected until 70% of the total market cap for the universe is met. This represents the Mega Cap index. The top 85% of stocks represents the Large Cap index. The middle 70-85% of market cap are selected for the Mid Cap index. And the bottom 85-98% of market cap are selected for the Small Cap index.
For the Russell index, numerical stock breakpoints prevent overlap between large-and-small. However, overlap exists within its mid-cap index. As a subset of the Russell 1000 Index, the Russell Midcap Index includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership.
As a result of how Russell and CRSP break up the stock universe, overlap to other market cap segments reduces the purity of small-cap exposures. The average firm market capitalization for the S&P SmallCap 600 Index is the smallest out of the major small-cap benchmarks, as shown below.
The S&P SmallCap 600 Index’s greater focus on smaller firms means less overlap to mid-cap exposures. In fact the S&P SmallCap 600 Index has little to no exposure to the Russell or CRSP US Mid Cap indices. And due to the specific banding constraints, there is no overlap to the S&P 400 Mid Cap Index. Yet, the CRSP US Small Cap Index has meaningful mid-cap exposure, no matter the definition. And there is some overlap for the Russell 2000 Index to the S&P 400 Mid Cap Index.
Small Cap to Mid Cap Overlap Matrix
|% of Overlap in S&P 400 Mid Cap Index||% of Overlap in Russell US Mid Cap Index||% of Overlap in CRSP US Mid Cap Index|
|S&P SmallCap 600 Index||0.00%||3.70%||0.00%|
|Russell 2000 Index||23.40%||0.00%||0.00%|
|CRSP US Small Cap Index||45.70%||57.60%||5.60%|
Source: Bloomberg Finance L.P. as of June 12, 2023. Characteristics as of the date indicated and are subject to change. To read the table, overlap means that 3.7% of the weight of the S&P SmallCap 600 Index is also in the Russell US Mid Cap Index.
More “smaller” stocks and no overlaps to “bigger” market capitalization styles make the S&P SmallCap 600 Index the more pure small cap exposure.
The S&P SmallCap 600 Index’s financial viability requirement controls for profitability; a firm’s most recent quarter’s earnings and the sum of its trailing four consecutive quarters must be positive for it to be included. Therefore, the S&P SmallCap 600 Index has an entrenched quality bias that other small-cap benchmarks lack.
The Quality bias relative to other small cap exposures drives outperformance. In fact, controlling for profitability has been proven to increase the robustness of the Size factor.2 To effectively gauge the Quality bias structurally embedded in the S&P SmallCap 600 Index, relative to other small-cap exposures, returns across the major small-cap benchmarks were regressed against Fama-French factors — with a focus on the relationship of the RMW (Robust minus Weak) and CMA (Conservative minus Aggressive) factors.
RMW equals the average return on the two robust operating profitability portfolios minus the average return on the two weak operating profitability portfolios. CMA is the average return of the two conservative investment portfolios minus the average return on the two aggressive investment portfolios. As a result, those two factors are meant to be descriptors for the overall Quality factor.
Based on monthly returns over the past 10 years, the S&P SmallCap 600 Index has the highest loading toward both the RMW and CMA factors. And for both CMA and RMW, the S&P SmallCap 600 Index is the only small-cap index with a positive loading to these two Quality-centric return streams.
Notably, some of these relationships are statistically significant. For RMW, the positive loading for the S&P SmallCap 600 Index is statistically significant at a 95% confidence interval. Meanwhile, the negative loadings for the other two small-cap benchmarks for both RMW and CMA are statistically significant. Yet, the S&P SmallCap 600 Index’s positive loading for CMA is not statistically significant. Additionally, the loading towards SMB (Small minus Big) is higher (and statistically significant) than the other two benchmarks — again illustrating a stronger relationship to the Size factor.
The results are the same for the S&P SmallCap 600 Index versus the Russell 2000 Index over longer time periods (the CRSP Index data only goes back to 2010). Using a 20-year lookback period, the S&P SmallCap 600 Index has higher loading than the Russell 2000 Index to SMB (0.85 to 0.83), RMW (0.15 to -0.09) and CMA (-0.03 to -0.06). Additionally, all except the S&P SmallCap 600 Index’s negative CMA reading are statistically significant at a 95% confidence interval.
These factor traits are further supported by examining current holdings rather than t historical returns through a risk-model. Using the Bloomberg US Equity Fundamental Risk Model, the S&P SmallCap 600 Index has a lower earnings variability, greater profitability, and smaller size than the Russell 2000 Index and the CRSP US Small Cap Index, as shown below. And those Quality characteristics are stronger relative to the Russell 2000 Index, while the Size factor loadings were more noticeable (i.e., a more negative reading) versus the CRSP US Small Cap Index.
Comparing the indices over the past 10 years and since inception, the S&P SmallCap 600 Index has had high greater cumulative annualized returns, as shown below. And these returns aren’t the result of more risk. The S&P SmallCap 600 Index has a higher Sharpe ration compared to the other two small-cap benchmarks over the past ten years (0.45 versus 0.36 for the Russell 2000 Index and 0.44 for the CRSP US Small Cap Index).3
Of course, periodic returns are a snapshot in time, and the start and end dates chosen can impact returns. To mitigate that concern, we anlayzed rolling one-, three-, five-, and ten-year returns across these small-cap exposures to understand the persistency of return trends. The S&P SmallCap 600 Index outperformed the other two small cap exposures on the majority of the periods, as shown below. In fact, as the time horizon was extended, the outperformance hit rate increased — particularly versus the Russell 2000 Index, where the S&P SmallCap 600 Index outperformed on 94% and 100% of all rolling five- and ten-year periods since 1994.
The S&P SmallCap 600 Index’s average magnitude of outperformance is also higher. In fact, on average, on a rolling one-year period, the S&P Small Cap 600 Index has outperformed the other two small-cap benchmarks by more than 1%, as shown below.
Bottom line: The S&P SmallCap 600 Index’s greater emphasis on smaller, more profitable firms — two factor premia with a strong history of adding value — has resulted in stronger returns on both a cumulative and rolling basis, illustrating the index’s breadth and consistency.
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CRSP US Small Cap Index
Includes US companies that fall between the bottom 2%-15% of the investable market capitalization.
Russell 2000 Index
A market-capitalization-weighted stock market index that measures the stock performance of the 2000 smallest publicly traded companies in the Russell 3000 Index.
S&P SmallCap 600 Index
A market-capitalization-weighted stock market index that measures the stock performance of the 600 smallest publicly traded companies in the S&P 1500 Total Market Index.
1 Bloomberg Finance, L.P., as of June 30, 2023, based on the S&P SmallCap 600 Index and the Russsell 2000 Index.
2 “Size Matters, If You Control Your Junk,” Asness, Frazzini, Israel, Moskowitz and Heje Pederson.
3 FactSet as of April 30, 2023. Past performance is not a reliable indicator of future performance.
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