SOURCE: Russell Investments

Russell Investments

December 18, 2013 11:00 ET

Fundamental Complement: Combining Alternatively Weighted Index With Market Cap-Weighted Index Can Lessen Price Sensitivity, as Reflected by the Russell Indexes

SEATTLE, WA--(Marketwired - Dec 18, 2013) - Apple is often in the headlines, driving a relatively volatile stock price and bumpy ride for most investors. However, a closer look at two index approaches using Apple as a lens reveals a potential alternative for index-based investors seeking exposure to Apple but less sensitivity to individual large cap stock prices.

When examining stock price and index weight in recent years, Apple's weight within the market capitalization-based Russell 1000® Index has closely mirrored its price. On the other hand, within the alternatively weighted Russell Fundamental US Large Company Index, Apple's annually rebalanced weight has stayed more consistent over time. And, for the year-to-date, one, three and five year periods as of November 29, the fundamentally weighted methodology has contributed to strong relative performance for the Russell Fundamental US Large Company Index relative to the capitalization-weighted index.

Fundamentally weighted indexes select and weight securities based on economic factors such as adjusted sales, retained operating cash flow, and dividends plus buybacks, rather than stock price. The target weights created by this process provide an anchor for rebalancing, which reduces stock price sensitivity. Corresponding company weightings within the index and resulting performance can be substantially different than and complementary to a market cap-weighted index.

"The larger-cap bias of market-cap indexes means they're likely to outperform when the biggest companies are outperforming the overall market, but fundamentally weighted indexes tend to outperform in value cycles and periods of mean reversion," said Tony Davidow, vice president, Alternative Beta and Asset Allocation Strategist, Schwab Center for Financial Research. "Therefore, we view fundamental index strategies as a complement to market-cap indexes. Based on our research, combining market-cap and fundamental index strategies can help reduce overall portfolio price sensitivity."

Russell Index   5 Years a/o 11/29 (annualized)     3 Years a/o 11/29 (annualized)     1 Year a/o 11/29     2013 YTD a/o 11/29  
Russell 1000® Index   18.3 %   17.8 %   31.0 %   29.6 %
Russell 1000 Fundamental U.S. LC Index   20.3 %   19.3 %   33.9 %   31.6 %

"Comparing the variations in Apple's weight within the Russell 1000 Index and the Russell 1000 Fundamental U.S. Large Company Index, as well as the relative performance for the Indexes, helps illustrate the potential diversification advantages of including both approaches in an investment strategy," said Tom Goodwin, senior research director for Russell Indexes. "A mix of cap-weighted and fundamentally weighted indexes can potentially produce a 'Goldilocks' market exposure that participates in the upside, protects on the downside and may reduce overall price sensitivity."

Go to the Russell Indexes website for a more detailed research report on this topic and more information about the Russell Fundamental Index® Series.

Source: Russell Investments. Returns are denominated in US dollars.

The Russell Global Index measures the performance of the global equity market based on all investable equity securities, and is constructed to provide a comprehensive and unbiased barometer for the global segment, The index includes more than 10,000 securities in 47 countries, and covers 98% of the investable global market. All securities in the Russell Global Index are classified according to size, region, country and sector; as a result the index can be segmented into more than 300 distinct benchmarks.

Please note: Indexes 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. Russell's publication of the Indexes or Index constituents in no way suggests or implies a representation or opinion by Russell as to the attractiveness of investing in a particular security. Inclusion of a security in an Index is not a promotion, sponsorship or endorsement of a security by Russell and Russell makes no representation, warranty or guarantee with respect to the performance of any security included in a Russell Index. 

Opinions expressed by Mr. Davidow and Mr. Goodwin reflect market performance and observations as of November 29, 2013 and are subject to change at any time based on market or other conditions without notice. Past performance does not guarantee future performance. 

This material is not an offer, solicitation or recommendation to purchase any security.

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional. The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Russell Investments and Research Affiliates LLC have entered into a strategic alliance with respect to the Russell Fundamental Index® Series. Subject to Research Affiliate's intellectual property rights in certain content, Russell Investments is the owner of all copyrights related to the Russell Fundamental Indexes. Russell Investments and Research Affiliates jointly own all trademark and service mark rights in and to the Russell Fundamental Index® Series. Research Affiliates is the owner of the trademarks, service marks, patents and copyrights related to the Fundamental Index and the Fundamental Index methodology.

Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company.