By Russell Investment Group

Small caps maintaining their edge during the three-year bear market, when more defensive, blue chip stocks might have been expected to fare better, furthers the assertion that over or underweighting certain styles may create more risk than an investor is comfortable with.

"Recent history has taught us a valuable lesson why a market-oriented asset allocation of equities makes good sense," Warburton said.

In 1989 and 1990, large caps, as represented by the Russell 1000, substantially outperformed small caps (Russell 2000) in down markets. From 1991 to 1993, small caps led the way during recovery. Then large caps pulled ahead from 1994 through 1998 during a period of sustained growth.

"There's an important lesson here," Warburton says. "That phrase about past performance not being an indication of future results isn't just a legality. It's a fact of life. No asset class or style behaves in a consistent, predictable pattern, so it's very difficult for investors to make forecasts by looking backward. Rules get broken frequently."

As attractive as small-cap performance currently is, risk tolerance for a more volatile asset must be considered when rebalancing a portfolio. Small-cap stocks make up approximately 8% of the broad-market Russell 3000® Index. Only investors who are interested in increasing the risk of their portfolio may be comfortable with overweighting small caps.

Maintaining Perspective
With signs increasingly pointing to a growing US economy, investors have been optimistic. But today's world still presents dangers in the multiple shadows of global corporate, economic and geopolitical issues.

"Asset allocation and diversification remain the keys," says Warburton. Whether investors have stayed in the market or are just coming back, diversifying assets among capitalization tiers — as well as equity styles — continues to make sense.

Of course, holding small-cap stocks in proportion to their market representation can't halt the ups and downs of the economy and the market. "But, it can prevent the consequences of guesswork," Warburton said.

History does demonstrate one thing. Patience and discipline offer most investors the best tools for reaching their goals over time.

The data source for all small-cap information in this article is the Russell 2000 Index.

The data source for all large-cap information in this article is the Russell 1000 Index.




Copyright© Frank Russell Company 2003. All rights reserved. See Important Legal Information. Date of first use: November 25, 2003.

This is a publication of our parent, Frank Russell Company. It should not be construed as investment, legal, or tax advice. The contents are for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have. For further information about these contents, please contact Frank Russel Canada Limited.

Diversification does not assure a profit or guarantee against loss in declining markets.

As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. Rebalancing your portfolio may create tax consequences on the taxable portion.

Small company issues are subject to considerable price fluctuations and are more volatile than large company stocks. Small cap funds may involve considerably more risk than funds investing in larger-cap companies.

Russell 1000® Value Index: Measures the performance of those Russell 1000® Index securities with lower price-to-book ratios and lower forecasted growth values, representative of US securities exhibiting value characteristics.

Russell 1000® Growth Index: Measures the performance of those Russell 1000® Index securities with higher price-to-book ratios and higher forecasted growth values, representative of US securities exhibiting growth characteristics.

Russell 2000® Growth Index: Measures the performance of those Russell 2000® Index securities with higher price-to-book ratios and higher forecasted growth values, representative of US securities exhibiting growth characteristics.

Russell 2000® Value Index: Measures the performance of those Russell 2000® Index securities with lower price-to-book ratios and lower forecasted growth values, representative of US securities exhibiting value characteristics.

Russell 3000® Growth Index measures the performance of those Russell 3000® Index companies with higher price-to-book ratios and higher forecasted growth values, representative of US securities exhibiting growth characteristics.

Russell 3000® Value Index: Measures the performance of those Russell 3000® Index companies with lower price-to-book ratios and lower forecasted growth values, representative of US securities exhibiting value characteristics.

Frank Russell Company is the owner of the trademarks and copyrights related to its indexes.

Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

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