|
Major
stock market barometers are a part of our daily lives. We hear them
mentioned on the television or the radio almost every day: the Dow, the Nasdaq,
and the S&P 500. Many news
broadcasts lead off their shows every half-hour with an announcement of how
these market indicators are moving.
Although many people are aware that these indices show how stocks are
performing, most people do not know what these benchmarks really mean and what
information they are supposed to communicate.
This can lead to confusion for even the most experienced investor about
how these indices should be used to measure the performance of their individual
portfolio. At this time, we will take a
closer look at some of the major market benchmarks and examine the pros and
cons of each.
The
following list provides a discussion of some of the most widely known market
indices.
Investment
companies generally use more specialized benchmarks to manage portfolios. While the
benchmarks listed above provide insight into the direction of the US equity
market, they are not ideally suited for measuring the success of a specialized
investment strategy or portfolio. This is because many portfolio managers focus
on a specific market segment (large cap or small cap) or investment style
(growth or value). For example, a large
cap value manager would not want to use the S&P 500 as a benchmark, as the
index contains many large cap growth stocks.
Similarly, a small cap manager would not want to be compared to the Wilshire
5000, as the Wilshire index is driven primarily by the performance of large cap
stocks. Portfolio managers generally
choose more focused indices to measure the performance of their funds.
SEI
has chosen Russell Indices to measure the performance of US equity strategies. The broadest Russell index, the Russell 3000, captures the
performance of the 3,000 largest US stocks, gauged by market capitalization.
This index captures roughly 98% of the investable US stock market.
To
segregate market capitalization, the Russell 3000 is broken down into the
Russell 1000 and the Russell 2000. To
focus on investment style, both the Russell 1000 and the Russell 2000 are
broken down into growth and value components, resulting in the Russell 1000
Growth, Russell 1000 Value, Russell 2000 Growth and Russell 2000 Value indices.
The
following list provides a discussion of some of the most widely known market indices:
The Dow Industrials is the most quoted market
measure due primarily to stature as the oldest market indicator. Created by Charles Dow in 1884 and first
introduced in 1896, the Dow provided the first widely used method of measuring
stock market performance. In today’s
market, however, the Dow is of limited use primarily because of its very
limited scope; the Dow comprises just 30 stocks, hand-selected by editors of
the Wall Street Journal.
Representation: US Large Cap Stocks
Companies in Index: 30
Index Weighting: Price weighted
Inclusion in Index: Selected by the editors of the Wall Street Journal to represent US industry.
Changes: No regularly scheduled changes. Last changed November 1999.
Pros: Widely known and easy to understand.
Cons: Narrowly defined representation of the overall US market. Ambiguous criteria for inclusion in the index. Less common price weighting methodology used for index measurement. Not widely used as a benchmark for portfolio performance.
The Nasdaq Stock Market began trading in 1971 to
consolidate and regulate the over-the-counter (OTC) stock market. The Nasdaq Composite Index is an indicator
of the performance of stocks within this marketplace. It is widely considered a bellwether for the technology sector,
because many technology firms are small; the Nasdaq is not a strong indicator
of broad equity market performance.
Representation: Nasdaq Stock Market
Companies in Index: 5,000+.
Index Weighting: Market capitalization weighted.
Inclusion in Index: All US common stocks traded on the Nasdaq.
Changes: As needed.
Pros: Widely known, clear index methodology.
Cons: Narrowly focused on the one-third of the US equity market that trades on the exchange. Heavy emphasis on technology and financial stocks relative to the broader market. Highly concentrated with a handful of very large cap companies (i.e. Microsoft, Intel, Cisco, etc.) dictating index performance.
The S&P 500 Index was first reported in the
1920s as a measure of broad US stock market performance. The index, which is
maintained by Standard & Poor’s, consists of 500 US stocks chosen by a
variety of measures including market size, liquidity and industry group representation.
The S&P 500 is a commonly used measure of large cap stock performance.
Representation: US Large Cap Stocks
Companies in Index: 500
Index Weighting: Market capitalization weighted.
Inclusion in Index: Selected by S&P using extensive criteria.
Changes: Periodically. Several changes a month on average.
Pros: Widely known. Represents over 80% of the total US stock market capitalization. The strong liquidity and high quality of the stocks in the index are promoted by rigorous membership criteria.
Cons: Narrowly focused on the large cap segment of the equity market. Largely ignores the mid-cap and small cap segments. Does not differentiate between growth and value stocks. Details of inclusion methodology not publicly available.
The Wilshire 5000 Index was introduced in the 1970s
as a tool to measure the overall US equity market. Any US stock that has pricing data available is included in the
index. As a result, the index actually
includes over 7000 US stocks and is often referred to as the Wilshire Total
Market Index.
Representation: Broad US Stock Market
Companies in Index: 7000+
Index Weighting: Market capitalization weighted.
Inclusion in Index: All US stocks for which prices are available.
Changes: As needed.
Pros: The most comprehensive measure of the entire US stock market. Excellent approximation of dollar changes in the US equity market. Clear index methodology.
Cons: Difficult to replicate given the size of the index and the limited liquidity of many stocks in the index.
The
Russell 1000 Growth Index is the benchmark for the SEI Large Cap Growth Fund.
The
Russell 1000 Value Index is the benchmark for the SEI Large Cap Value Fund.
The Russell 1000 Index is a large cap indicator
that measures the performance of the 1,000 largest companies in the Russell
3000 Index. The Russell 1000 captures
over 90% of the US equity market and includes virtually all large- and mid-cap
stocks. The Russell 1000 Index is
broken down into growth and value components. Because of the
methodology used to construct the index, some stocks are included in both the
Russell 1000 Growth and Russell 1000 Value Indices. The Russell 1000 indices
are reconstituted once a year, at the beginning of July. If a company drops out
for reasons such as merger or bankruptcy, it is not replaced immediately.
Representation: US Large and Mid Cap Value and US Large and Mid Cap Growth Stocks.
Companies in Index: 1,000 (at reconstitution), 943 (as of 5/30/01)
Russell 1000 Growth: 521 Russell 1000 Value: 715
Index Weighting: Market capitalization weighted based on available capitalization
Inclusion in Index: Top 1,000 stocks in the Russell 3000 Index, ranked by market capitalization.
Changes: Reconstituted once a year at the beginning of July.
Pros: Clear index methodology. Provides a targeted universe of large cap stocks for both large cap growth and large cap value managers.
Cons: Does not include companies that are registered outside of the US but are generally considered US companies (i.e. Tyco International, Global Crossing, Carnival, Schlumberger).
The
Russell 2000 Growth Index is the benchmark for the SEI Small Cap Growth Fund.
The Russell 2000 Value Index is the benchmark for the SEI Small Cap Value Fund.
The Russell 2000 is a small cap indicator, as it
measures the performance of the 2,000 smallest companies in the Russell 3000
Index. This Index captures roughly 7% of the US equity market. Much like the Russell 1000, the Russell 2000
is broken down into growth and value components in the form of
the Russell 2000 Growth and Russell 2000 Value Indices. These indices are also
reconstituted once a year in the beginning of July. Due to the methodology used
to construct the index, some stocks are included in both the Russell 2000
Growth and Russell 2000 Value Indices.
Representation: US Small Cap Value and US Small Cap Growth Stocks
Companies in Index: 2,000 (at reconstitution), 1,839 (as of 5/30/01)
Russell 2000 Growth: 1,200 Russell 2000 Value: 1,196
Index Weighting: Market capitalization weighted based on available capitalization
Inclusion in Index: Smallest 2,000 stocks in the Russell 3000 Index by market capitalization.
Changes: Reconstituted once a year at the beginning of July.
Pros: Clear index methodology. Provides a targeted universe of small cap stocks each for small cap growth and small cap value managers.
Cons: Does not include companies that are registered outside of the US but are generally considered US companies.