Below is a long-term return chart for the Russell 3000 Index. As discussed last week this represents the largest 3000 companies in the US stock market. Some of these stocks are large capitalization companies and some are medium and small capitalization companies. It is a good representation of the US stock market. Here is the chart:

This chart begins in 1978. For most investors, capturing the above return is more than satisfactory for meeting long term return objectives for at least a meaningful portion of their wealth and subject to their personal needs, circumstances and risk tolerance. But a funny thing happens when creative ideas, computing power, and mathematics are applied to an index to reveal subtexts and additional “factors” that may be lurking beneath the surface of a broad-based index like the Russell 3000 Index.

As discussed last week, the Russell 3000 Index can be divided into distinct categories by capitalization (Large and Small) and style (Growth and Value). When this happens, a series of sub-indexes emerges that show meaningful performance differences over extended periods of time. Below are two charts. The first shows the period 1995-2015. The second shows the period 2016-2024 YTD. One can see that the indexes that led and lagged in period one flipped dramatically in period two. Here are the two periods:

There are a few observations from these charts: 1) If you don’t look at the components inside of the Russell 3000 Index, most likely you would be very satisfied with the returns of the Russell 3000 index. 2) But, if you start looking at component index returns, you can be drawn into trying to pick a winner and avoid a loser. 3) All of these returns are passive in nature meaning they are indexes. There is zero stock picking skill necessary to produce either substantial gains or losses versus the Russell 3000 Index. 4) Even though lengthy periods pass with one sub index leading or lagging substantially, there really is no rhyme, reason, or pattern to the differences or fluctuations. If you were looking at the chart at the end of 2015, what would you be tempted to do? Buy small cap or large cap value? If you had, then you would have been sorely disappointed come 2024 because all small cap stocks lagged terribly as did all value stocks.

To make this easier to see, we look at the annual calendar returns of the Russell 3000 and its subcomponents next.

When looking at these returns over calendar years, it is very important to keep in mind these are just indexes: there is zero stock selection skill here. All the different return cells above are generated from inside of the Russell 3000 Index by applying rules and using computers to create sub-indexes that reveal cap and style return patterns from within the Russell 3000 Index. One can see that it is quite easy to select a sub-index or specific stocks from a sub-index and either look brilliant or dim based on that selection. It is possible to outperform or underperform the Russell Index by substantial amounts in any given year and still have it be purely passively driven without ANY skill. Sampling and luck can drive big return differences in portfolios that have nothing to do with skill.

Disingenuous practitioners will do and say all sorts of things to either claim skill or bad luck when discussing performance outcomes. The above indexes can be very useful for comparing specific investment returns from various managers to control for their biases or preferred investment approach and to ascertain non skills-based factors that are influencing their returns. When we at WealthPlan evaluate outside money managers, we are careful to consider such factors. We are also careful to not get sucked into chasing the returns of the segments revealed above. There is so much rotation of the subcomponents of the Russell 3000, that chasing their returns can be a fool’s errand.

While one might be tempted to load up on large cap growth or funds or managers emphasizing such due to its dominance, it might be a good idea to do nothing, and stick with your long term goals and objectives. Ask yourself, “Am I getting what I want and need from my investment portfolio? Am I on track to meet my long term objectives?” If the answer to these question is “yes” then stick with your plan. If the answer is “no” then maybe it is a good idea to sit down and discuss it with an advisor. We are here to help if necessary.

In the last installment in this series, we will dive deeper into why trying to concoct active trading rules based the data above is so difficult.

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DISCLOSURES

The Russell 3000 Index is a capitalization-weighted stock market index, maintained by FTSE Russell, that seeks to be a benchmark of the entire U.S stock market. It measures the performance of the 3,000 largest publicly held companies incorporated in America as measured by total market capitalization and is approximately 98% of the American public equity market. The index, which was launched on January 1, 1984, is maintained by FTSE Russell, a subsidiary of the London Stock Exchange Group.

The Russell 1000 index is a United States market index that tracks the 1000 largest companies. The Russell 1000 index is an important gauge for how US Large Cap stocks are doing. This index is very closely correlated to the S&P 500 since they both cover large cap US stocks. Additionally, the Russell 1000 has had its largest drawdowns during the Tech Bubble in 2002, and the housing crisis leading to a recession in 2009.

The Russell 2000 tracks the roughly 2000 securities that are considered to be US small cap companies. The Russell 2000 serves as an important benchmark when investors want to track their small cap performances versus other sized companies. The Russell 2000 tends to have a larger standard deviation in comparison to the S&P 500.

The Russell 3000 Value Index covers United States securities with a focus on value from a fundamental perspective. This index can be important for investors that would like to benchmark for a value or conservative portfolio. Historically, the Russell 3000 Value index tends to have smaller drawdowns during pullbacks in the market, but also lower returns when the overall market is trending higher because of the characteristics of the underlying holdings.

The Russell 3000 Growth Index covers United States securities with a focus on higher growth rates overall. This index can be important for investors that would like to benchmark for a growth or aggressive portfolio. Historically, the Russell Growth index tends to have larger drawdowns during pullbacks in the market, but also higher returns when the overall market is trending higher because of the characteristics of the underlying holdings.

Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which Investment(s) may be appropriate for you, consult your financial advisor prior to investing. Information is based on sources believed to be reliable, however, their accuracy or completeness cannot be guaranteed.

No investment strategy can assure success or completely protect against loss, given the volatility of all securities markets. Statements of forecast and trends are for informational purposes and are not guaranteed to occur in the future. All performance referenced is historical and is no guarantee of future results. Securities investing involves risk, including loss of principal. An investor cannot invest directly in an index.

The information in this communication applies solely to the intended audience and in no way amends, revokes, or otherwise alters the existing agreements and relationships between WPIM and its clients.  This communication is not a binding offer, expressed or implied.  WPIM undertakes no obligation to update or revise the information herein or in any referenced third-party resource due to new information, future events or circumstances, or otherwise.

WealthPlan Investment Management (“WPIM”) uses data compiled and/or prepared by third parties (“Third Party Data”) in the delivery of Licensed Research and Data. Third Party Data is not owned by WPIM and user may be required to obtain permission directly from third parties for further use of Third-Party Data and may be required to pay a fee depending on the use contemplated by the user.