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Index Evolution: Guillermo Cano Looks at the New Generation of Equity Indexes

Russell Indexes has long been known as “the small-cap company,” due to the success of its flagship Russell 2000, which is comprised of the smallest 2000 stocks by market capitalization. These firms’ market caps range from roughly $129 million to $2.6 billion, as of May 2013, and represent the bottom two-thirds of the 3000 largest publicly held firms in the U.S.

According to Guillermo Cano, Senior Product Manager at Russell Investments, the firm has evolved considerably since its start in 1984. In fact, equity indexes in general have come a long way in recent years. “The indexes we created in the early years, are simple,” says Cano, “because we were dealing with products that are cap-weighted. You would basically hold every stock at market cap weight.”

Subsequent generations of indexes involved “slicing and dicing” and playing with the weightings to create new products such as equal weight indexes, which take a group of stocks and hold each name in equal amounts, rather than weighting them by capitalization. Newer indexes have introduced the concept of factor modeling, whereby an investor can invest by or filter for certain criteria such as value, volatility, momentum or quality. “We talk to clients to find the needs they are trying to address,” says Cano. One may say “volatility is too high” and another that “our exposure is too concentrated.” The company then creates indexes based on the intelligence it receives.

A recent trend among index creators is so-called “smart beta,” which is sort of a hybrid between passive and active investing. What Russell has found is that some of the returns generated by active managers over the past 10-20 years can be explained by certain systematic factors. Smart beta indexes seek to replicate the performance of such factors. 

Indexing firms are continually following the trends to further fine-tune and “individualize” index investing. It’s all about choice.

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