Index fund managers so far have no plans to create passive investment funds based on the newly unveiled Standard & Poor's Corp. stock index of 600 small-capitalization stocks.
Managers interviewed say they are uncertain of demand and still sorting out whether the new S&P index has advantages in liquidity, turnover, diversification and total returns over its chief rival.
"We have not made any definite decision on the 600" to create an index fund based on it, said P. James Kartalia, managing director-marketing and administration, ANB Investment Management & Trust Co., Chicago, a major index fund manager.
S&P executives are scheduled to visit ANB this week to discuss the new index, he added.
ANB, which created the first S&P 500 index fund in 1973, created one of the first S&P MidCap 400 funds.
"We came out of the box on the 400, but it has not been the most popular fund," Mr. Kartalia said.
ANB manages $400 million in its S&P MidCap 400 fund. By contrast, ANB runs more than $4 billion in its S&P 500 commingled fund alone, in addition to separate account S&P 500 portfolios, whose total amount wasn't available.
"We are taking a wait-and-see attitude" on creating an S&P SmallCap 600 fund, added Paul W. Daley, ANB's vice president and head of passive equity management.
The unveiling of the new S&P small-cap index comes on the heels of a study that challenges the dominance of S&P's long-standing 500 stock index as the primary benchmark for the U.S. stock market and for indexing.
The study by Value Line Inc., New York, calls the Russell 3000 stock index of Frank Russell Co. the best available of all of the stock market indexes, including the S&P 500, Wilshire 5000 and Value Line's own index. The Russell 3000 consists essentially of the 3,000 largest capitalization stocks.
The two developments heighten a growing rivalry between Tacoma, Wash.-based Russell and New York-based S&P over stock market indexes.
"There is definitely competition between S&P and Russell," said Arlene M. Rockefeller, managing director, State Street Bank & Trust Co., Boston, a major indexer.
The S&P SmallCap 600 "is slated to compete with the Russell 2000" index of small-cap stocks, added ANB's Mr. Daley.
S&P plans to begin reporting its small-cap index Oct. 31. Then, by mid-November, it plans to begin reporting a new composite S&P 1500 index, composed of the S&P 500, S&P MidCap 400 and the S&P SmallCap 600.
The new S&P 1500 will, for the first time, give S&P a broad-based stock market index.
Elliott Shurgin, S&P vice president-index products and services, said the date for beginning the S&P 1500 isn't firm yet, awaiting the testing of the first public calculations of the SmallCap 600.
At State Street, Ms. Rockefeller, said creation of an S&P SmallCap 600 fund "depends on the demand."
"So far we haven't seen any demand materialize for it," she added.
In any case, she said, "I doubt money coming in (to any S&P 600 index fund) would be coming from existing small-cap index funds. People already have a Russell 2000 fund. They won't want to change to pay the transaction costs to move to an S&P 600 fund."
Ms. Rockefeller said the S&P SmallCap 600 "should be the better index (over the Russell 2000) in terms of liquidity and turnover, but until people feel it translates into better performance, they might want to hold off indexing."
In terms of turnover, she said stocks "move in and out arbitrarily in the Russell index. In the S&P index, stocks move in and out when there are fundamental changes."
In terms of liquidity, cost of trading and low turnover, the S&P SmallCap 600 has the advantage over the Russell 2000, Mr. Daley said.
On average, he said, the bid/ask spread is 40 basis points for the S&P 500, 90 basis points for the S&P MidCap 400, and 170 basis points for the SmallCap 600. By contrast, the Russell 2000 bid/ask spread is 290 basis points.
In addition, the S&P 600 has a lower turnover than the Russell 2000.
For the past five years, according to S&P, the turnover on the S&P SmallCap 600, which is rebalanced whenever the S&P committee determines, would have been 26 stocks (or 4% of the stocks in the index) for the first nine months of 1994, 54 (or 9%) in 1993, 123 (20%) in 1992, 120 (20%) in 1991 and 95 (16%) in 1990.
By contrast, the turnover on the Russell 2000, which is reconstituted every June 30, was 563 stocks (or 28% of the stocks in the index) in 1994, 451 (23%) in 1993, 529 (26%) in 1992, 511 (26%) in 1991 and 365 (18%) in 1990 (the first year Russell began annual rebalancing), according to Russell.
Yet, returns on the Russell 2000 are higher than the SmallCap 600.
For the five and 10 years ended Dec. 31, 1993, the Russell 2000 had total cumulative returns of, respectively, 92.46% and 181.7%, according to Russell.
For the same periods, the SmallCap 600 cumulative total returns, according to S&P's backtests, were 70.3% for five years and 103.25% for 10 years.
ANB's Mr. Daley, however, cautioned about accepting the S&P 600 returns because of S&P's "horrendous" record in backtesting the S&P MidCap 400.
S&P estimates more than $260 billion now is indexed by investors to the S&P 500, or 7.7% of the index's total market capitalization of $3.36 trillion. That $260 billion is more than the entire market value of the new S&P SmallCap 600 index.
For the S&P MidCap 400, the firm estimates more than $8 billion is indexed by investors, or 1.7% of the index's total market capitalization of $469 billion.
According to Russell, $24.1 billion is indexed by investors across all of the Russell indexes, or only 0.5% of the Russell 3000's total market cap of $4.5 trillion. That figure includes $3 billion indexed in the Russell 2000 alone, or 1.5% of the 2000 index's total market cap of $537 billion.
Mr. Daley suggested one reason indexing to the S&P MidCap 400 hasn't caught on is that there never has been a demonstration of any superior performance of the medium-capitalization stocks to the S&P 500, unlike with small-cap stocks, where other small-cap indexes show their outperformance to the S&P 500.
In diversification, the Russell 2000 offers much more coverage than the S&P 600. Its market capitalization is about $430 billion, compared with the S&P SmallCap 600's $181 billion.
So the S&P 600 trades diversification for liquidity, Mr. Daley said.
He suggests the Russell 2000 may be a better investment for the buy-and-hold investor, while the S&P 600 may appeal more to shorter-term investors.
"The Russell 2000 has a higher initial cost (of buying the index), but has longer-term better returns," he said. "But the S&P 600 has greater liquidity."
"It's difficult to quantify which one takes precedence - liquidity or diversification," Mr. Daley added.
"The degree to which one or the other is more important to people will determine the success of the indexes."
"The Russell index leads to greater turnover, but it is more representative of the small-cap segment over longer periods of time," Mr. Daley said.
Herbert Blank, now a senior portfolio manager at Deutsche Bank Securities Corp., New York, wrote the Value Line study in April, although Value Line released it on Oct. 17, the same day S&P unveiled its new index.
Mr. Blank contends the Russell 3000 is a better index for representing the broad market because of its broader coverage than the S&P 500, its better representation of industries, and the more quantitative rules used to select stocks.
Of the 10 criteria Mr. Blank used in the study, the Russell 3000 won eight of them, while it tied for the other two.
But the study generated little reaction.
"I'm surprised the S&P 500 didn't win any of the criterion," Mr. Daley said. "S&P would win for ease of trading."
State Street's Ms. Rockefeller said the study's findings in general already were well known.
"One would hope with 3,000 stocks, one could better represent the market," she said, referring to the Russell 3000.
At S&P, Mr. Shurgin said the firm never has represented the S&P 500 as a broad market index. He said it is meant to be representative of the performance of the large-cap stocks, even though it contains some smaller-cap issues.
Regardless of the Value Line study, Mr. Daley suggests the S&P will continue its dominance of indexes, in part because of the much more active trading in futures and options contracts on the S&P 500 than on the Russell indexes.
"A lot of the S&P 500's popularity is based on its ease of trading and its very liquid futures and options contracts," Mr. Daley said.
"No other index can make those claims. It makes it difficult to topple the S&P 500. It has the backing of the brokerage community and the market in general."