By Catherine Yoshimoto, director, product management
After an unprecedented stretch of low volatility, the 12-month period ending January 31, 2019 saw considerable US equity market turbulence. While whipsawing markets can be unsettling for investors, they can also provide a testing ground for benchmarks designed to protect portfolios during volatile times. The Russell Defensive Indexes®—part of the Russell Stability Indexes®—are an example of such benchmarks, and appeared better suited to weather the volatility storm relative to their Russell US equity index counterparts.
Russell Stability Indexes are style-based benchmarks that offer more detail and specificity for investors, effectively adding a third dimension to the Russell Style Indexes that’s independent from traditional definitions of style, such as growth and value. The indexes measure a portion of the market based on sensitivity to economic cycles, credit cycles, and market volatility, referred to as stability. Stability is measured at the company level in terms of volatility (price and earnings), leverage, and return on assets. The more stable half of the parent index (i.e., Russell 1000 and Russell 2000) is called the Defensive Index and the less stable half is called the Dynamic Index.
The past year’s unstable equity market conditions presented the opportunity to test whether the Defensive Index performed true to its design. As shown below, when I compared the Russell 1000® and Russell 2000® Indexes to their Growth/Value and Defensive/Dynamic stability counterparts, the Defensive versions of the indexes posted higher risk-adjusted returns in both cases.
Source: FTSE Russell as of January 31, 2019. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
By design, the Russell Defensive index variations tend to exhibit lower volatility, higher Sharpe ratios and a bias toward more established larger-cap names, while the Dynamic indexes tend to exhibit higher volatility, lower Sharpe ratios and a bias toward smaller-cap names. This case study speaks to the Russell Stability Index construction methodology, and its ability to identify company risk. As such, the data offers validation that this “third dimension” introduced through these indexes—in addition to size and style—can be described as the “risk dimension of equity style.”
The Russell Stability Indexes make for a comprehensive, modular suite of style indexes, giving investors the ability to effectively benchmark manager performance in accordance with their beliefs, or as a tool when seeking desired investment objectives. An index can only be useful for these purposes if it is constructed to perform true to its design. And when put to the test during a volatile year, it is evident that the Russell Defensive Indexes decisively passed.
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