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Market Perspective
How to Properly Use Benchmarks to Measure Your Portfolio's Performance
 by Ernie Ankrim
Director of Portfolio Research
Frank Russell Company
Dec. 13, 2000
"One size fits all" is a misleading tag whether it's stereotyping hats, socks or airline seats but maybe most of all, it's a misfit in the world of investing.
For example, many investors turn to the Standard & Poor's 500 Index to measure the performance of all of their investments. It is a widely recognized benchmark, but only for certain investments. The S&P 500 Index measures the share-price performance of a representative portfolio (selected by S&P) of 500 of the largest publicly traded corporations in the United States. It doesn't reflect the results of the thousands of smaller stocks that make up the rest of the US market. Sometimes the stocks in the S&P 500 do call the tune for the rest of the market. But often there's a big divergence between their performance and that of all the others.
Comparing Apples & Oranges
Why is it important to know what is the most appropriate benchmark for your fund?
Let's say that you want to find out how your fund, which invests in small-cap growth stocks, has performed this year. You learn that it was down about 20% on year-to-date basis through November. Over the same period, the S&P 500 Index was down a mere 9.6%. What went wrong? On the basis of this comparison, you might conclude that the fund manager was doing a terrible job. But you're comparing apples and oranges.
A more relevant benchmark would comprise stocks that are similar to those in which the fund invests. One such benchmark is the Russell 2000® Growth Index. For the year 2000 through November, it was down 26.9%. On that basis, you can see that, while you might wish you'd never been in small-cap growth in the first place, your small-cap growth fund has been holding up very well. The manager's ability to pick stocks in the small-cap growth arena may have been pretty good after all.
Russell's Bellwethers
Russell maintains 21 benchmark indexes that can help you determine how well your investments are performing. Indexes that might be appropriate for small-cap portfolios include:
The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index (or approximately 8% of the total market capitalization of the Russell 3000® Index). As of the latest reconstitution (July 2000), the average company in the Russell 2000® Index had a market capitalization of approximately US$580 million. The largest company in the index had an approximate market capitalization of US$1.5 billion.
The Russell 2000® Index is our most visible benchmark. It is the best representation of small-cap equity performance that we know of — that's why it gets so much play in financial publications worldwide. It can serve as a good benchmark for the performance of small-cap index funds or those that actively invest in both growth- and value-oriented stocks. The Russell 2000® Growth Index measures the performance of those Russell 2000 companies with higher price/book ratios and higher forecasted growth values. It's a good benchmark for funds that focus their investments in small-cap growth-oriented stocks.
The Russell 2000® Value Index measures the performance of those Russell 2000 companies with lower price/book ratios and lower forecasted growth values. It's a good benchmark for funds that focus their investments in small-cap value-oriented stocks.
The Russell 2500™ Index measures the performance of the 2,500 smallest companies in the Russell 3000® Index (or approximately 16% of the total market capitalization of the Russell 3000® Index). As of the latest reconstitution, the market capitalization of the average stock in the Russell 2500™ Index was approximately US$958.8 million. The largest company in the index had an approximate market capitalization of US$4 billion.
Most small-cap managers invest in securities that are, on average, a little bigger in market capitalization than those in the Russell 2000® Index. As a result, most of us at Russell use the Russell 2500™ to gauge the performance of small-cap fund managers.
Russell maintains 17 other indexes by which to benchmark your particular funds most appropriately. Visit the index section for details of each.
Copyright © Russell Investments Canada Limited 2000. All rights reserved. See 'Important Legal Information.' Date of first use: 12/13/00.
Past performance is not a guarantee of future performance.
This is a publication of Russell Investments Canada Limited. It should not be construed as investment, legal, or tax advice. The contents are intended 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 Russell Investments Canada Limited. Frank Russell Company, a Washington, USA, corporation, operates through subsidiaries worldwide.
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