Measuring the World
Catherine Yoshimoto
The Russell US Indexes were launched in 1984 and introduced an objective, rules-based methodology and modular structure to segment the investable equity market by size, from mega-cap through micro-cap.
In 1987, Russell introduced the Russell US Style Indexes, designed to measure the distinct growth and value segments of the equity market.
Catherine Yoshimoto, FTSE Russell’s director of product management, equities and multi-asset, notes that while the terms “index” and “benchmark” are often used interchangeably, they are not the same. In fact, a benchmark is a type of index with a specific objective—to help the benchmark user measure the return and risk of a particular market or market segment.
“An index measures the performance of a specified group of assets,” Yoshimoto says. “Investors use benchmarks to measure the performance of their portfolios or managers or define an allocation; they may even provide a reference for a financial product.”
Yoshimoto says investors should consider benchmark selection carefully and begin with purpose: The benchmark should help investors distinguish market exposure from active decisions and to identify unintended risks.
“Its value ultimately lies in providing a durable, credible representation of the market or market segment selected by the investor,” Yoshimoto says.
Preserving Objectivity and Transparency While Ensuring Market Reflection
This doesn’t mean benchmarks are set in stone. The rules-based methodologies used by FTSE Russell indexes and benchmarks reflect market evolution. This is because new securities emerge, trading and ownership structures may change, accessibility shifts, and the relative importance of market segments changes.
Changes in the index rules are relatively rare, but they do occur. Yoshimoto says any changes made to index methodologies are driven by evidence, rather than performance. Proposed changes are evaluated against the index objective, investability, turnover, implementation costs and continuity, with formal oversight and broader market consultation where appropriate.
Back-tested performance results may help illustrate the potential effects of a proposal, but they do not determine the outcome, as methodology changes are not adopted to optimize historical performance, she reiterates.
Modular Market Segmentation for More Precise and Consistent Portfolios
Within the Russell US Indexes, the Russell 1000 and Russell 2000 form distinct large- and small-cap segments that combine to form the Russell 3000, without intentional gaps or overlaps. Yoshimoto says FTSE Russell is extending this methodology globally with the launch of the Russell 9000 Global Index. This provides a 3,000-stock building block for each of the three core regions commonly used by investment managers: the U.S., the developed world excluding the U.S., and emerging markets. She says this construction framework supports more precise allocations across regions, capitalization ranges and styles, while maintaining consistency across the total portfolio.
Institutional investors can assign managers to different segments, create completion portfolios or adjust exposures, while reducing the risk of unintended gaps or overlaps.
“Because the segments share a common framework, modularity also supports clearer performance attribution and portfolio oversight,” Yoshimoto adds.
Assessing Appropriateness Over Time
To assess whether an index continues to represent its intended market accurately and remains appropriate for institutional use over time, FTSE Russell starts with the index’s stated objective, Yoshimoto says.
“The central question is whether its composition and characteristics still map accurately to the market it is intended to represent,” she explains. “That assessment can include market capitalization coverage, constituent size, liquidity, free float, market accessibility, and the treatment of new listings and corporate events, as well as practical measures such as turnover, capacity, transaction costs and replicability.”
FTSE Russell performs regular reconstitutions to keep its indexes aligned with their construction rules. For example, large companies may fall out of that size category, while other small companies may grow to join it.
Yoshimoto says a more detailed review of the index methodology asks whether the rules themselves remain fit for purpose.
“That process is supported by formal governance, oversight and, where appropriate, advisory input and market consultation,” she says. “No single metric provides the answer: An effective benchmark is representative, transparent and explainable—even when the market segment it measures is out of favor.”
Yoshimoto adds that the operational work falls principally on portfolio managers, although investors may experience indirect effects through turnover, transaction costs and tracking differences.
“One of the things we consider when setting the frequency of the Russell US Indexes’ reconstitution is that each reconstitution brings turnover and associated trading costs,” she notes.
Beginning in December, the Russell US Indexes will return to a semi-annual reconstitution cadence, following annual reconstitution since 1989. The move to semi-annual reconstitution marks the first change to the schedule in decades, Yoshimoto says.
“Annual reconstitution had long balanced a wish to maintain accurate market representation with a desire to limit unnecessary turnover,” she explains. “However, valuations and company characteristics change continuously, and periods of greater volatility and dispersion can create more drift between annual resets.”
So FTSE Russell assessed whether a second reconstitution per year would improve representation, while remaining practical for institutions and index-tracking products. According to Yoshimoto, the review included market-depth, turnover and transaction-cost analysis, operational and resilience considerations, and feedback gathered through market consultation.
“The decision illustrates how methodology should evolve: to preserve the benchmark’s accuracy and usefulness as the market and its implementation ecosystem change,” she says.
Considerations When Selecting a Benchmark
Yoshimoto says institutional investors might assume indexes with the same market label are interchangeable, but differences in universe definition, constituent selection, size breakpoints, weighting, free-float adjustments and review schedules can produce materially different exposures.
Furthermore, when selecting or monitoring a benchmark for asset allocation, manager evaluation or investment implementation, the investor’s due diligence should extend beyond the index methodology to the governance and regulatory framework of the index administrator, Yoshimoto says.
Investors should understand which entity administers the benchmark, the applicable regulatory or principles-based framework, and the controls governing conflicts of interest, methodology changes, data quality, operational resilience and accountability, she explains.
Yoshimoto notes that the International Organization of Securities Commissions’ Principles for Financial Benchmarks, introduced in 2013, provide globally recognized standards for benchmarks’ governance, methodology quality and accountability.
Additionally, the frameworks established by the EU’s and the U.K.’s Benchmarks Regulation impose governance, methodology, control and accountability requirements on benchmarks and administrators within their respective scopes.
“Because regulatory status can vary by benchmark, administrator and jurisdiction, investors should evaluate each benchmark individually rather than assume uniform treatment across a provider’s index range,” Yoshimoto says.
According to Yoshimoto, FTSE Russell’s governance framework is designed to meet the IOSCO Principles and the applicable EU and U.K. BMR requirements.
Yoshimoto suggests institutional investors should ask these questions when selecting a benchmark:
- What opportunity set does the benchmark represent and what does it exclude?
- Are its rules transparent and predictable?
- How are new securities, corporate events and methodology changes handled?
- What governance body oversees these decisions?
- Is the administrator appropriately authorized?
- Does it publish benchmark statements, IOSCO disclosures or assurance reports? and
- How does it plan for operational disruption, material methodology changes or benchmark cessation?
“These answers should be evaluated against the benchmark’s intended use,” Yoshimoto says. “The most appropriate benchmark is not the one with the strongest recent returns, but the one for which the objective, construction, governance and regulatory framework best support the investment decision it is intended to inform.” —Rebecca Moore