For plan sponsors with small-cap exposure, the Russell 2000 index has likely been your preferred benchmark. But why? We would suggest, especially if you have your small-cap manager(s) on a performance fee, that you begin to use the S&P 600 as the benchmark.
For the 20-years ending September 30, 2017, the S&P 600 has beaten the Russell 2000 index by 1.8%. The advantage is not period specific, as the S&P 600 also bests the R2000 by 1.5% for 10-years, 2.1% for 7-years, 1.8% for 5-years, and 1.9% for 3-years. The advantage is not just related to the annual June rebalance, although that event does explain some of the differentials, as some front-running does occur given that the index is more rules-based than the S&P 600, whose construction is driven by a committee.
The S&P 600 is also propelled by screens for liquidity and profitability. Given that the S&P 600 averages less turnover annually than the R2000, the liquidity screen will reduce transaction costs, while the profitability screen (a company must have 4 consecutive quarters of profitability), creates a higher “quality” index.
As the equity markets have rocketed forward this year, lower quality names have been favored, but even in this environment the S&P 600 still maintains an advantage over the R2000 by 0.4% for the first nine months. Don’t make it easy for your managers to earn their small-cap fees. Use the S&P 600 and make them work a little harder.