Insights from the Value Equities Investment Committee | PDF

Benchmark index construction rules generally do not account for fundamentals, underlying quality, or risk management

We’ve written at length about the rules that determine the composition of the style indexes against which many active managers are benchmarked. An index’s composition is a function of mechanical rules, not a stable definition of “value” or “growth.” Those rules cause companies to shuffle in and out of the Growth and Value indexes, and cause weightings to evolve dramatically over short periods, based on market sentiment. As a result, the Russell 1000 Value Index carries a risk profile that can change (and has changed) meaningfully within a single year and could shift again at each style reconstitution in June.

We don’t expect clients to monitor every nuance of index construction methodology. But we do think it is important for advisors to understand just how dynamic a style index’s risk profile really is, particularly since most clients have risk profiles that remain stable from year to year.

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