A study conducted by Yen-Cheng Chang found a 5% increase in price among stocks in the Russell 1000 to be added to the Russell 2000 in June from 1996 to 2012. The study also revealed a 5.4% decrease in price among stocks to be moved from the Russell 2000 to the Russell 1000.
Index arbitragers have capitalized on the index changes by front-running trades. However, Petajisto argues that the arbitragers help smooth out transaction costs since index managers’ trades would cause sudden spikes without smaller players to build a market. Consequently, it may be Russell 2000 own fault for being too big as it causes such a large market impact on small, less traded stocks due to its concentrated turnover.
In contrast, the CRSP Index reconstitutes holdings on a quarterly basis and has a larger capacity than the Russell 2000 because of its wider market capitalization. Additionally, the S&P SmallCap 600 makes changes as needed, which allows the index to spread out changes.
Moreover, investors can consider the Schwab U.S. Small-Cap ETF (NYSEArca: SCHA), which tracks the Dow Jones U.S. Small-Cap Total Stock Market Index. SCHA reconstitutes holdings once a year, but its small asset base diminishes market impact on trades. The ETF also does not go as far up on market-cap as the Russell 2000.
For more information on small-capitalization stocks, visit our small-cap category.
Max Chen contributed to this article. Tom Lydon’s clients own shares of IWM.