Technical and fundamental analysts alike have offered insight on the recent small cap stocks low performance. Technical analysts have cautioned that short-term moving average prices have dipped below long-term moving averages, potentially signaling a bear market in the near future. Fundamental analysts are pointing to overpriced stocks, with price-to-earnings multiples reaching high levels on the heels of strong 2013 performance.
Such stretched valuations are precisely what can shape performance for market capitalization weighted indexes. As a market trends upward, by design cap weighted indexes will become more heavily concentrated in highly favored stocks relative to less favored stocks. In effect, the in-favor names will occupy an increasingly disproportionate share of the index. When relative valuations reach levels such that investors feel the stock is overbought, indexes heavily weighted in these securities are particularly impacted by the ensuing sell-off.
Fundamental weighted indexes are constructed differently, and as a result have the potential to be less impacted by such market downturns. Fundamental indexes seek to mitigate potential concentration concerns of cap weighted indexes and weight companies by their economic footprint or fundamental size. For example, the FTSE RAFI Indexes weight constituents using a composite of fundamental factors, including total cash dividends, free cash flow, total sales and book equity value. Unlike cap weighted indexes, prices and market values are not determinants of the index weights.
A closer look at the year-to-date performance of the FTSE RAFI US 1500 Mid Small Index reveals that while performance was still in negative territory, it was markedly less so than the Russell 2000.
Small Cap Index Performance
Source: FTSE, Russell, data as of September 30 2014. Past performance is no guarantee of future performance.
While the Russell 2000 returned -4.4% for the year-to-date ending September 30 2014, the FTSE RAFI US 1500 Mid Small Index returned -3.0% for the same period. The Russell 2000 has also lagged the FTSE RAFI US 1500 Mid Small Index for the 3-month and 12-month trailing periods. Such data highlights that differing approaches to weighting index constituents can result in varying responses to market movements.
© 2015 London Stock Exchange Group companies.
London Stock Exchange Group companies includes FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), MTS Next Limited (“MTS”), and FTSE TMX Global Debt Capital Markets Inc (“FTSE TMX”). All rights reserved.
“FTSE®”, “Russell®”, “MTS®”, “FTSE TMX®” and “FTSE Russell” and other service marks and trademarks related to the FTSE or Russell indexes are trademarks of the London Stock Exchange Group companies and are used by FTSE, MTS, FTSE TMX and Russell under license.
All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by the London Stock Exchange Group companies nor its licensors for any errors or for any loss from use of this publication.
Neither the London Stock Exchange Group companies nor any of their licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell Indexes or the fitness or suitability of the FTSE Russell Indexes for any particular purpose to which they might be put.
The London Stock Exchange Group companies do not provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. The London Stock Exchange Group companies make no representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the London Stock Exchange Group companies. Distribution of the London Stock Exchange Group companies’ index values and the use of their indexes to create financial products require a license with FTSE, FTSE TMX, MTS and/or Russell and/or its licensors.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.