by ETFZone staff

Investors who use index-linked exchange-traded funds to slice and dice various parts of the U.S. market can choose from benchmarks from Russell, S&P/Barra, and Dow Jones. Since each index family is governed by its own unique set of rules, they can at times perform differently, especially in volatile markets.

"Sometimes you'll see significant divergence in style indices, especially those from S&P/Barra and Russell," said Brad Pope, head of index strategy and research at Barclays Global Investors. "A lot of this has to do with reconstitution methodology. Russell reconstitutes its growth and value indices once a year; S&P/Barra does it twice. Let's say there's some major market movement between June and December. When the S&P/Barra indexes reconstitute, they may have a whole different set of stocks than Russell does in the style indices. This has happened periodically in the past."

BGI manages iShares based on the Russell and S&P/Barra indexes, while State Street Global Advisors offers four ETFs tied to the Dow Jones Style indexes.

Source for all: Morningstar

The index providers also have different methodologies for determining if a stock belongs in the growth or style index.

"There is something to be said for more than one [style] factor," said Pope. "Each index provider has progressed a little further along in terms of adding factors. The S&P/Barra indices use a single factor [p/b], and a company is 100% forced into one [style or growth] index. On the other hand, Russell uses an additional factor [long-term earnings growth], while stocks can be in both the growth and value indices."

Dow Jones has gone a step further by adding more style factors - six in all. Dow Jones has also created a 'neutral' category for stocks that are not clearly growth or value. Neutral stocks are withheld from the growth and value indexes, which results in more concentrated indexes by definition.

Index providers are slowly moving away from an absolute boundary or "line in the sand" between indexes to cut down on excessive turnover. For example, Vanguard is transitioning many of its U.S. index funds to new benchmarks maintained by Morgan Stanley Capital International (MSCI) that use "buffer zones" to curb turnover. Vanguard will likely introduce new ETFs based on the MSCI style indexes, so investors may soon have even more options.

"Forced ranking or drawing a line can create index turnover that may not necessarily be productive," said BGI's Pope. "For example, a few years ago, tech companies in the [small-cap] Russell 2000 were growing at a tremendous rate and moving into the [large-cap] Russell 1000 index. As a result, many companies were pushed down into the Russell 2000. A year and half later, the exact opposite happened [when tech crashed]. The bottom line is that many companies moved into and out of an index when their market capitalization didn't vary much, rather the market had moved around them."