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(This post was first published on StojFinance. Thanks a lot to Jasper for the opportunity of guest posting.)
We have already discussed index investing in detail. There are many stock market indexes. Sometimes, it is very difficult to pick a stock market index to invest in. But we have not covered any index in particular. You have probably already heard of the S&P500 index and the Dow Jones Industrial Average (DJIA) index. But have you heard of the Russell 3000 index? It is not as widely known as other indices. But it is a very interesting index that covers a larger part of the United States stock market than more popular indexes.
The Russell 3000 Index is managed by the FTSE group, which also manages many other popular indexes. It contains the 3000 largest U.S. companies in the stock market.
In this article, we discuss the Russell 3000 Index. We will also see a few related indexes from the same group, such as the Russell 2000 Index. Finally, I will compare the S&P 500 index with the Russell 3000 Index. They are both popular indexes, and people often misunderstand the difference.
Russell 3000 Index
The Russell 3000 Index tracks the 3000 largest companies in the United States stock market. Since there are about 3100 companies in the entire U.S. stock market, this index covers more than 97% of the stock market. This makes it much broader than the popular S&P500 index, which only covers about 16% of the stock market in the United States.
It is not a recent index. It was launched in 1984. The FTSE group is responsible for managing and updating this index. Interestingly, the London Stock Exchange and the Financial Times own the FTSE group. It is responsible for managing many stock market indices. There are many Russell indexes and many FTSE indexes, representing various parts of the stock market.
The index never changes during the year. It is only once a year, on the last Friday of June. Currently, the index is entirely reconstituted based on the current stock market capitalization. Interestingly, deciding whether to include a company in the index is based on a mathematical formula. The decision does not involve any committee. This is the case for all the Russell indexes.
Companies in the Russell 3000 Index
Although the index contains 3000 companies, the index contains 3015 holdings, last time I checked. This is a bit counter-intuitive. The reason is that companies and stocks are not the same things. It has more than 3000 holdings because some companies offer several classes of shares. For instance, Alphabet (formerly Google) has two classes of shares, one with voting right and one without any rights.
This index is market-capitalization-weighted. That means that large companies have a large weight on the index. For instance, here are the five largest companies on the index at the time of this writing:
- Apple, with 3.65%%
- Microsoft, with 2.90%
- Amazon, with 2.90%
- Berkshire Hataway, with 1.39%
- Facebook, with 1.31%
As you can see, even though are 3000 companies in the index, the first five make up more than 10%! It is interesting to note that Apple is no longer the most valuable company in the world. Microsoft took the first place after a deep plunge by Apple in late 2018. But since FTSE only updates the index once a year, this will only change in June.
Breaking it down
It is quite interesting that Russell indexes can be composed. The Russell 3000 contains all the stocks in the other Russell indexes. We can break it down into two different indexes: The Russell 2000 and the Russell 1000 index.
The Russell 1000 Index contains the 1000 largest companies in the United States stock market. It is interesting to note that the Russell 1000 already tracks about 90% of the U.S. stock market, although it only tracks a third of the companies of the Russell 3000 index. This is because they use market-capitalization weighting, where very large companies make up most of the index.
Now, you probably think that the Russell 2000 index contains the 2000 largest companies. But it is not the case! It tracks the 2000 smallest companies from the Russell 3000 index. That is the companies between the thousandth largest companies and the three-thousandth companies in the U.S. These are medium and small-cap companies. So these indexes are, in fact, very different. The Russell 2000 Index is very interesting in tracking the performance of small and medium companies in the U.S. However, the name is a bit counter-intuitive.
The Russell 3000 Index has two alternative versions: The Russell 3000 Growth Index and the Russell 3000 Value Index. They are both subsets of the Russell 3000 based on the investing style.
The Russell 3000 Growth Index selects companies that have high forecasted growth. This is based on their Price-to-Book (P/B) ratio and the forecast of their earnings. In investing, we use the P/B ratio to compare the current market value and the book value of the company. It is necessary to estimate the book value since it is very difficult to compute it accurately when taking things such as patents into account. For instance, Apple and Microsoft are in this fund.
The Russell 3000 Value Index selects companies that have low P/B ratios. That means their stock value is lower than their real book value. So people expect the stock to rise in the future since it has more value. For instance, Berkshire Hataway and Intel are in this fund.
All the stocks of the Russell 3000 are graded based on their P/B ratio and the forecasted earnings. Then, they are separated into Value and Growth. If you are interested in the details, the FTSE Russell group uses a non-linear probability method to separate them. What is really interesting is that the stocks in the middle of the scale are classified as both Growth and Value. Therefore, the Russell 3000 Value and Russell 3000 Growth indexes are not mutually exclusive! This is very different from most other indexes where a company cannot be classified as Growth and Value.
Russell 3000 vs S&P 500
The Standard & Poor’s 500 (S&P 500) is probably the most famous index in index investing. It is interesting to compare these two indexes in more detail.
As I mentioned, the FTSE group only updates the constituents of the Russell 3000 index once a year, based on a formula. On the other hand, the S&P 500 index is generally updated several times a year, around once a quarter, by a committee. For instance, on January 18, 2019, Teleflex was added to the S&P500 index because PG&E Corp filed for bankruptcy. There could be an advantage to frequent updates in some cases to reflect the market better. However, too frequent updates may mean more changes in the funds implementing the index. I will let you judge which one you prefer, for that matter.
One would probably argue that the biggest difference between the indexes is the number of companies. The Russell index has six times more companies than the S&P 500 companies. That means that Russell 3000 has a lot of small-cap and mid-cap companies, whereas the S&P 500 only has large-cap companies. However, since it is a market-cap-weighted index, small and medium companies form a very small part. Therefore, there is still a large correlation between the two indexes.
For comparison, here are the valuations in the last year for the two indexes:
As you can see, it is almost exactly the same curve. This is because there is a large correlation between the two indexes. Because of market-cap weighting, the first companies make up a large part of the index returns.
Both indexes have advantages and disadvantages. But there is no big difference between both in the end. Many people think they have a large exposure to small and medium companies with the Russell 3000. But in fact, this is very small. If you want real exposure to small and medium companies, use Russell 1000 index and Russell 2000 with your own allocations.
Russell 3000 ETFs
Now, you cannot directly invest in an index. You need to invest through an Exchange Traded Fund (ETF) or through a mutual fund. Generally, for almost every ETF out there, the fund provider also offers a mutual fund. Therefore, we will look at the ETF offer only.
There are two main ETFs for the Russell 3000 Index:
- iShares Russell 3000 ETF (IWV). This fund has 0.20% fees and manages about 9.4 billion dollars. It contains 2969 holdings.
- Vanguard Russell 3000 ETF (VTHR). This fund has 0.15% fees and manages about 400 million dollars. It contains 1550 holdings.
The Vanguard fund has a lower TER, which is great. However, it is quite small. It is twenty times smaller than the iShares fund and has almost twice fewer holdings. It is missing almost 50% of the companies on the index. If I wanted to invest in the Russell 3000 index, I would choose the Ishares Russell 3000 ETF and not the Vanguard one.
That is it for the Russell 3000 Index! It is a very broad index that represents about 97% of the United States stock market. It has a few peculiarities that are not present in some more popular indexes. For instance, it is only updated once a year. And the selection of the stocks does not involve any committee. Also, a company can be present in the Growth Index and the Value Index.
Overall, it is a great index. If you are comparing stock market indexes, it may be a good option for you. It is broader than the more popular S&P 500. However, because it is market-capitalization weighted, there is a large correlation between both indexes. This index is not a good option if you want to get a large exposure to small-cap and mid-cap stocks. For this case, you could use the Russell 2000 Index, which contains the 2000 smallest companies from the Russell 3000 Index.
If you liked this in-depth guide about the Russell 3000 Index, you will like another in-depth guide about the Standard & Poor’s 500 (S&P500) index.
What do you think about the Russell 3000 Index? Are you investing in this index?
(This post was first published on StojFinance. Thanks to Jasper for the opportunity of guest posting.)
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