Buffett has repeatedly mentioned in its shareholder letters that an ordinary investor can also win over a professional investor with a fixed index fund. It can be seen that learning Indices is also an important part of learning the US stock market.

However, the U.S. stock market has various types of indices, including market indices, industry indices, commodity indices, and global market-based indices, and more. So which one is worth investing in?

To answer this, investors need to understand information such as the constituent stocks, compilation methods, and industry distributions behind each index. Only by mastering the rules of index running can you make better investment decisions.

Therefore, in the future, this column will also bring you to study various indices, starting with market indices.

When it comes to the U.S. equity market, it is believed that most investors immediately think of three major market indicators: the S&P 500 Index (S&P 500), the Dow Jones Industrial Average (DJIA), and the Nasdaq Composite Index.

But in addition to these three major indices, there is one market index that investors pay close attention to, the Russell 2000 Index.

In this article, let's talk about this index, why it is important, what its constituent stocks are, what are the characteristics of the index, whether it is worth investing, and how to invest.

* This content is for informational and educational purposes only and does not constitute a recommendation or endorsement of any particular securities or investment strategies.

What is Russell 2000 Index?

Before introducing the Russell 2000 Index, you first need to understand what the Russell Index is.

Russell Indices are primarily a series of U.S. indices launched by Frank Russell in 1984 to measure the U.S. market and track the performance of U.S. stocks and small stocks.

Given that there were no strict criteria for distinguishing “large, medium, and small stocks” in the stock market in the past, Foxx has developed three different indices so that investors can easily distinguish the differences in their movements.

These three different indices include:

1. Russell 3000 Index: tracks the performance of the 3000 largest companies by market capitalization in the United States, covering the market capitalization range of 98% of investable stocks, including large, medium, small and micro stocks;

2. Russell 1000 Index: To track the top 1000 company stocks with the largest market capitalization from the Russell 3000 index, covering the market capitalization range of 93% of investable stocks;

3. Russell 2000 Index: Tracks of 2000 companies with the lowest market capitalization from the Russell 3000 index, and their total market capitalization represents only about 7% of the total market capitalization of the Russell 3000 Index.

As a result, the Russell 2000 Index is primarily used to track the performance of U.S. small company stocks, reflecting the performance of U.S. small businesses. It is a key indicator for U.S. investors to track the performance of U.S. small cap stocks.

Features of Russell 2000 Index

You may be asking, how is the Russell 2000 Index different from other mainstream market indices? It has the following three characteristics:

1. Small Fluctuations

The Russell 2000 index has a smaller market capitalization and includes many emerging growth companies. Compared to large companies, these companies tend to be more unstable. In other words, Russell 2000 index volatility tends to exceed the majors, so the risk is relatively high.

2. With high growth potential

While small cap stocks tend to be more volatile, their growth potential is often higher than that of large companies. As a common example, Apple is the company with the highest market capitalization right now, and the difficulty of doubling its market capitalization may be much more difficult than a new technology company with a market value of $1 billion.

3. More Diversification

Since the Russell 2000 Index contains 2000 small companies, it is more diversified than other mainstream market indices. First of all, it is neither as critical of large companies nor as dependent on the performance of a few large companies. In addition, its industry distribution is more decentralized and does not unduly bias a particular industry.

Russell 2000 Index Listing Rules

Like the S&P 500 and Nasdaq Composite Index, the Russell 2000 Index is a market-weighted index. This means that companies with a higher domestic market value in the index have a greater influence on the index.

To ensure that the index is fully representative of small companies, the Russell 2000 Index's constituent stocks are updated annually. In short, if a company's market capitalization is too large, it will be removed from the Russell 2000 index and possibly included in the Russell 1000 index.

Such a rule ensures that the Russell 2000 index does not experience a rise in the index dominated by several major company stocks, which is currently the case for both the S&P 500 and the Nasdaq Composite Index.

The index is usually adjusted from May to June each year. Since mutual fund managers and individual investors closely track the Russell 2000 Index, speculating on which companies will be included or excluded from the index can cause relatively large volatility in some companies' stock prices in the short term.

What are the components of Russell 2000 Index?

By definition, the Russell 2000 Index tracks the share price performance of 2000 small companies in the United States, but the number of its constituent stocks is not necessarily 2000, and sometimes exceeds or less than this number.

The reason for this is that the No Replace Rule is used when the index is compiled, i.e. if a stock is excluded for a specific reason (such as low liquidity, being bought in tandem, etc.), it is not replaced by another stock.

As of November 30, 2023, the Russell 2000 Index tracked 1967 smaller-company stocks.

To better understand the characteristics of the Russell 2000 Index, you can analyze its constituent stocks in the following three aspects.

1. PREVIEW TEN SHARE

As of December 26, 2023, by market capitalization, the top ten shares of the Russell 2000 Index are as follows:

The first is Microcomputer (SMCI), with a market capitalization of $163.47 billion. In 10th place is cosmetics company e.l.f. Beauty (ELF), with a market capitalization of nearly $80 billion.

2. See industry distribution

In terms of the overall industry distribution, the Russell 2000 index's component industries are relatively evenly distributed.

As of November 30, 2023, the Russell 2000 Index had the highest share of industrial segments (18.7%), followed by Financials (15.6%), Healthcare (14.3%), Non-Essential Consumer Goods (13.2%), and Information Technology (12.66%), with the lowest in the Communications segment (1.34%).

This means that they are less affected by a single industry. For example, technology stocks are currently higher in the S&P 500 and Nasdaq Composite Index. Therefore, these indices are greatly affected when there is significant volatility in the technology industry.

3. Growth and Value

While the Russell 2000 Index tracks all small companies, these companies are not necessarily high-growth companies. The companies in its index can be divided into value-driven and growth-based.

There are three main criteria for determining criteria: Price-to-Book Ratio, I/B/E/S forecast medium-term growth, and Historical sales per share growth.

Simply put, companies with higher net market rates, faster I/B/E/S expected growth, and faster earnings per share growth are growth-oriented; conversely, value-driven companies. Therefore, the Russell 2000 Index can be divided into Russell 2000 Growth Index and Russell 2000 Value Index.

As of November 30, 2023, the Russell 2000 Growth Index was comprised of 1,073 constituent stocks, with the industrial, healthcare and technology sectors contributing the largest. The Russell 2000 Value Index has 1432 constituent stocks, with the financial, industrial and non-essential consumer goods sectors contributing the most. It should also be noted that many Russell 2000 stocks are included in both of these subindices.

Therefore, Russell 2000 may be a better choice if investors want the tech component in the index to be a little higher.

Russell 2000 Index Moves

As just mentioned, Apple's difficulty in doubling its market capitalization can be much harder than a new tech company with a market capitalization of $100 billion, so many investors often subconsciously feel that small-cap returns may be higher than large-cap stocks.

But for the index as a whole, does a small-cap index necessarily outperform a large-cap index? The answer doesn't have to be that either.

The following chart is a comparison of Russell 2000 and S&P 500 price charts. It can be seen that in the beginning of 2021, the Russell 2000 index began to significantly lag behind the S&P 500 index.

You might be wondering why the small-cap index has outperformed the majors over the past few years?

GME Group once conducted a review comparing the historical trends of the Russell 2000 and S&P 500 indices between 1979 and 2020, and analyzed the economic environment at the time. They came to a rather unexpected conclusion: Small-cap stocks typically perform better during downturns; and large-cap stocks perform better during periods of economic boom or expansion.

• 1979-1982: During the US economic recession, the Russell 2000 Index overtook the S&P 500 by 76%.

• 1983-1990: Entering an economic boom in the 1980s, the S&P 500 beat the Russell 2000 by 92%.

• 1990-1993: At this time of economic recession coupled with a slow recovery, the Russell 2000 Index overtakes the S&P 500 by 48%.

• 1994-1999: The U.S. economy expanded in the late 1990s, with the S&P 500 beating the Russell 2000 index 92%.

• 1999-2013: A lot has happened during this time, the bursting of the Internet bubble in 2000, the 911 incident, two wars, and the 2007 financial crisis, with the Russell 2000 index winning the S&P 500 114%.

• 2013-2020: At this time when the US economy is in a recovery period, the S&P 500 index overtakes the Russell 2000 index.

After 2020, the Russell 2000 Index has not beaten the S&P 500 as small businesses have been hit harder by the pandemic.

Is Russell 2000 Index worth investing in?

To answer this question, you need to understand the cyclicality, influencing factors, and potential risks of the Russell 2000 Index.

1. Periodicity

First, small businesses are often more sensitive to economic cycles and interest rate cycles. Because many small businesses are loss-making or more dependent on debt compared to large enterprises. As a result, small businesses are likely to be affected more than large businesses during economic downturns.

However, when the United States is really experiencing an economic downturn, the Fed may consider a rate cut, and a rate cut is good for small businesses, since small companies tend to rely more on short-term debt, and a reduction in interest rates will greatly ease the burden on small businesses.

Therefore, changes in economic cycles and interest rate cycles have their advantages and disadvantages for the operation of small businesses.

Based on historical trends, the Russell 2000 index may perform somewhat better than major stock indices such as the S&P 500 during a difficult time in the US economy. Of course, please note that past trends do not represent the future, and there may be different trends in the future as well.

2. Potential impact factors

In addition to economic cycles and interest rate cycles, the Russell 2000 index's movements may be influenced by other factors, such as valuation and profitability.

Since October 2023, the Russell 2000 Index has performed better than the S&P 500 (as of November 2023). There is analysis that this is mainly due to the following driving factors:

• Interest rates: Concerns about rate hikes have eased.

• PROFITABILITY: SMALL-CAP STOCKS SHOW MORE MARKED PROFIT FLEXIBILITY AS THE ECONOMY RECOVERS. Profits for Russell 2000 index constituents are expected to grow by around 30% next year, after falling 11.5% in 2023, LSEG data show.

• Valuation: The valuation of small-cap stocks is more attractive. According to LSEG Datastream data, the relative value of U.S. smaller-cap stocks and large-cap stocks is near all-time lows.

• INDUSTRY DISTRIBUTION: INVESTORS' DEMAND FOR DIVERSIFIED INVESTMENTS MAKES THE RUSSELL 2000 INDEX MORE ATTRACTIVE. Since 2023, the S&P 500 index, led by the seven giants of the US stock market, is becoming more evident. Because the Russell 2000 Index industry distribution is relatively diversified, some investors want it to be a tool for diversifying the risk of big tech stocks.

• HISTORICAL TREND: HISTORICAL EXPERIENCE HAS FOUND THAT THE RUSSELL INDEX MAY REBOUND AFTER EXTREME LOWS.

From this it can be seen that there can be many factors that affect the movement of indices in different environments. Market conditions are always changing, so investors don't rely on a single indicator to make judgments.

3. Potential risks

Volatility: The Russell 2000 Index includes many emerging growth companies. Compared to large companies, these companies tend to be more unstable, and many companies are not yet profitable. In other words, Russell 2000 index volatility tends to exceed the majors, so the risk is relatively high.

Technology sector underrepresented: Industries covered by the Russell 2000 Index are relatively diversified, mainly concentrated in industrials, finance, healthcare, and non-essential consumer goods. Compared to other major stock indices, the technology sector has a relatively small share. However, the tech sector is one of the hottest industries on the market today, such as artificial intelligence, cloud computing and chips. If future investments remain technology-themed, the Russell 2000 Index may miss out on dividends from the tech sector's gains.

How to Invest in Russell 2000 Index

Like other indices, Russell 2000 is not directly investable, it is only possible to observe the movement of the big plate through indices. But investors can get a similar level of return by buying a fund or ETF that tracks the index.

The following are the top two ETFs that track the Russell 2000 index, which rank among the top two in asset size:

It is worth noting that these ETFs track the Russell 2000 index, so they also inherit the related characteristics of the index, including high index volatility, industry spreads rather than dispersions, etc.

Therefore, investors need to make appropriate investment decisions based on their investment objectives and level of risk tolerance and risk management.

summed

1. The Russell 2000 Index is a key indicator for U.S. investors to track the performance of U.S. small cap stocks. It is made up of stocks of the 2,000 companies that are the smallest in the Russell 3000 index.

2. The index adopts a market capitalization weighting method, that is, companies with a larger market value have a greater impact on the index. To ensure the full representation of small companies, the Russell 2000 Index updates its constituent stocks every year.

3. Compared to other major indexes, Russell 2000 is characterized by small volatility, high growth potential, and a more diversified industry distribution.

4. Despite outperforming large-cap indices such as the S&P 500 since 2021, historical data shows that Russell 2000 often performs better than large-cap indices during economic downturns.

5. Investors can earn similar levels of return by tracking Russell 2000 funds or ETFs, but risk management is required accordingly.