Russell 3000 Index
Guest Post: The Poor Swiss
The Poor Swiss is a 30-year-old computer scientist from Switzerland. He recently obtained his Ph.D. in Computer Science and hopes to become financially independent before age 50.
Definition of The Russell 3000 Index
You have probably already heard of the S&P 500 and the Dow Jones Industrial Average (DJIA) indexes. 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.
It is managed by the FTSE group that also manages many other popular indexes. It contains the 3000 largest U.S. companies on the stock market.
In this post, we are going to see exactly what the Russell 3000 Index is. We are also going to explore a few related indexes from the same group, such as the Russell 2000 Index. Finally, I am going to compare the S&P 500 index with the Russell 3000 Index. They are both popular indexes and people often misunderstand the difference between the two.
Russell 3000 Index – What Is It?
The Russell 3000 Index tracks the 3000 largest companies in the United States stock market. Since there are about 3100 companies listed on US stock exchanges, this index covers more than 98% of the market. This makes it much broader than the popular S&P 500 index, which only covers about 16% of the stock market in the United States.
The Russell 3000 Index was launched in 1984. The FTSE group is responsible for managing and updating this index. Interestingly, the FTSE group is owned by the London Stock Exchange Group and 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 is reconstituted once a year, on the last Friday of June. Before this can take place, the companies must be ranked. This is completed at the end of the trading day on May 11th.
Beginning on June 8th, the index is entirely reconstituted based on the stock market capitalization data prepared in May.
It is very interesting that the decision on 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. Alternately, visit here to learn about the methodology used to rank companies on the Russell US Equity 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 Inc. (formerly Google) has two classes of shares, one with voting right and one without any rights.
The Russell 3000 Index is market-capitalization-weighted. Meaning large companies have a bigger weight on the index. For instance, here are the five largest companies of the index:
- Apple with 3.65%
- Microsoft with 2.90%
- Amazon with 2.90%
- Berkshire Hathaway with 1.39%
- Facebook with 1.31%
As you can see, even though there are 3000 companies in the index, the first five are making up more than 10% of the index! It is interesting to note that Apple is currently no longer the largest company in the world by market cap. 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 how the Russell indexes are 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 are using market capitalization weighting whereby the largest companies make up most of the index.
Now, you probably think the Russell 2000 index contains the 2000 largest companies. But that is not the case! In fact, 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 to track 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 a low P/B ratio. Meaning their stock value is not as high as their real book value. So, people are expecting the stock to rise in the future since it has more value. For instance, Berkshire Hathaway 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. They are then separated into Value and Growth. If you are interested in the details, the FTSE Russell group is using a non-linear probability method to separate them. What is 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 both 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 the days of index investing. I will compare these two indexes in greater detail below.
As I mentioned before, 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 are 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&P 500 index because PG&E Corp filed for bankruptcy. Updating the index more frequently could be advantageous, in that it would provide a better reflection of the market. However, updating too frequently requires more changes in the funds that implement the index. I will let you be the judge of which one you prefer for that matter.
One would probably argue that the biggest difference between the two indexes is in the number of companies. The Russell index has six times more companies than the S&P 500. This means the Russell 3000 has a lot of small-cap and mid-cap companies where the S&P 500 only has large-cap companies. However, since it is a market-cap weighted index, the small and medium companies form a very small part of the index. Therefore, there is still a large correlation between the two indexes.
For comparison, here are the valuations over the past 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 are making up for 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, you should probably 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 are going to 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 2,988 holdings.
Vanguard Russell 3000 ETF (VTHR). This fund has 0.15% fees and manages about 400 million dollars. It contains 2,955 holdings.
The Vanguard fund has a lower TER (total expense ratio) which is great. The Vanguard Group is also widely known and was founded by the late John C. Bogle on May 1st, 1975.
However, it is quite small. Size-wise, it is 1/20th of the iShares fund. If I wanted to invest in the Russell 3000 index, I would choose the iShares Russell 3000 ETF over the Vanguard one.
That’s it for the Russell 3000 Index! It is a very broad index that represents about 98% of all 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 both the Growth Index and the Value Index.
Overall, it is a great index. It is broader than the more popular S&P 500. However, because it is market-capitalization weighted, there is a large correlation 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.