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ETF Specialist

Small-Cap Indexing: Popularity Can Be a Pain

While the Russell 2000 might be the first and most well-known small-cap stock index, it has underperformed similar indexes.

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The Russell 2000 Index is the most popular benchmark for active small-cap managers to measure themselves against. But here is an industry secret: Active managers pick that index because it is easy to beat. If you're going with a passive strategy, you don't have to limit yourself to that index. 

Among small-cap exchange-traded funds,  iShares Russell 2000 (IWM) is the most popular. It provides diversified exposure to U.S. small-cap stocks and can serve as a core holding to supplement U.S. large- and mid-cap equity funds. Its holdings are widely diversified across sectors and the value-growth spectrum. For those looking to control their market-cap exposure, this small-cap fund works well in combination with the large- and mid-cap stocks in  iShares Russell 1000 (IWB) to cover the majority of the U.S. stock market with minimal overlap. Unlike rival small-cap indexes from S&P and CRSP, the Russell 2000 also holds a sizable stake in volatile micro-cap stocks. Although the index covers 2,000 stocks, they represent only about 8% of the U.S. stock market. Because small-cap stocks represent a small portion of the total stock market, they should constitute only a small part of a passive investor's portfolio.

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Michael Rawson does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.