Asset class index funds are often considered a way to get passive exposure to a market segment. But indices are just representations of the market, composed according to the rules determined by the index. This is particularly evident in the US small cap stock space, where overlap statistics indicate substantial differences in holdings. For example, the Russell 2000 Index and CRSP US Small Cap Index have less than a third of their weight in common (32.7%).
All portfolios, even those that are indexed, require decisions about what stocks to include, how to weight them, and when to rebalance. Investors should evaluate how those decisions are made. For example, broad market and small cap index funds often hold small cap stocks with low profitability or high asset growth, segments shown by research to strongly underperform the market. Excluding these stocks can increase expected returns for strategies holding small caps.
Exhibit 1- Overlap in Weight Among US Small Cap Indices as of December 31, 2024
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