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Slow Growth, Small Caps and Sec Lending

In a new research paper, FTSE Russell examines the performance of the US small cap market in periods of slow economic growth, as measured by the Russell 2000 Index, and discusses how institutions that seek to access the size factor premium via ETFs can further enhance returns through securities lending programs.

A wide body of research has shown that small cap stocks can help enhance portfolio diversification and can increase potential long-term returns. The Russell 2000 Index was developed over 30 years ago as the industry’s first index to measure the small cap market segment. Research has shown that the Russell 2000 provides a pure and objective picture of the small cap market while other small cap indexes are more similar to “SMID cap” indexes, which blend small cap and mid cap stocks.

Wide adoption of the Russell 2000 has led to a broad financial products “ecosystem” around the index, including active and passive institutional funds, mutual funds, ETFs, futures and options.  Positive asset flows into these products continued in 2015 in spite of mixed return performance.

Small cap stocks have tended to lead in periods of market turmoil and slower economic growth

  • During each of the four biggest market declines since 2000, the Russell 2000 outperformed the larger cap Russell 1000 in all four years: 2000, 2001, 2002 and 2008.
  • Since the Global Financial Crisis, economic growth has been slower than historical norms and forecasts are for that to continue.  The Russell 2000 Index has historically outperformed the Russell 1000® Index on average during periods of slower economic growth between 1979 and 2015.

The Russell 2000 Index has been widely adopted as the small cap index of choice

  • Approximately 96% of small cap products and 86% of small cap assets are benchmarked to the Russell 2000 Index as of May 4, 2016.

The Russell 2000 Index has a broad, liquid ecosystem of financial products

  • Over 98% of small cap ETF daily volume is accounted for by products replicating the Russell 2000 Index.
  • Over 99% of small cap futures and options volume is based on the Russell 2000 Index.

Securities lending programs help support the small cap market

  • Institutional investors have widely adopted the practice of securities lending. Research firm Markit Group estimated that the institutional investor lending pool in the US was approximately $9.7 trillion at the end of the first quarter of 2016.

Small cap securities lending programs may help offset costs and enhance returns

  • Investing in a separate account that holds and lends an ETF based on the Russell 2000 can provide investors exposure to small cap stocks with the benefits of index-based investments—such as low costs, transparency and high liquidity—along with the potential for consistent return enhancement.
  • This type of “long and lend” opportunity exists in the market because it is much easier to hedge small cap beta exposure by shorting a single highly liquid ETF than all 2,000 constituents of the Russell 2000. Using an ETF also allows investors to take advantage of this market dynamic through a physical security, with potentially lower expenses and without some of the risks that may be associated with synthetic alternatives.
  • ETFs based on the Russell 2000 continue to see strong demand for securities lending. For example, the historical gross lending yield on the iShares Russell 2000 ETF (IWM) averaged 63 basis points from January 1, 2010 through March 1, 2016.

1 Ganatti, “Some Small Caps are Larger Than Others,” Wisdom Tree Blog October 31 2013; .Lystra, “The Russell 2000 Index: Pure Small Cap,”
Russell Research, 2011.
2 “The Russell 2000 Index: Small Cap Performance in a Slow Growth Economic Environment,” FTSE Russell Insights, 2016.
3 Economic projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, Federal Open Market Committee
4 “The Russell 2000 Index: Small Cap Performance in a Slow Growth Economic Environment,” FTSE Russell Insights, 2016, Page 9
5 Sources: FactSet, Intercontinental Exchange, CME Group, Options Clearing Corp., as at 31 December 2015.
6 Correspondence with Markit Securities Finance.

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