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This ETF's Index Is a Victim of Its Own Success

Michael Rawson, CFA

Mike Rawson: IShares Russell 2000 ETF (IWM) is, by far, the most popular small-cap ETF, but it tracks an index that has underperformed every other major small-cap index. 

The Russell 2000 Index of small-cap companies may be a victim of its own success. More assets are benchmarked to that index than any other small-cap index. This could cause stocks going into the index to underperform as arbitragers buy these stocks in anticipation of index changes. Compared with the S&P Small Cap 600 Index, the Russell 2000 uses more mechanical index-construction rules. This allows in more low-quality firms, such as firms with negative retained earnings. 

While iShares Russell 2000 ETF is the most liquid small-cap ETF, we prefer Vanguard Small-Cap ETF (VB) or iShares Core S&P Small-Cap (IJR) because each has a lower expense ratio and we have greater confidence in the indexes that these ETFs track relative to the Russell 2000.