August 16, 2014

Comparing U.S. Large Cap Stock Indexes

If you're invested in U.S. stocks, chances are most (if not all) of your money is invested in large cap equities. These companies make up the vast majority of the investable universe and are typically extremely easy to invest in. They're mostly very liquid and available in countless varieties of large cap-focused ETFs. Large caps are so large, in fact, that the top 750 largest companies in the U.S., despite being only 15% of the total number of the 5,000 most actively-traded equities, make up around 89% of the total value of the Wilshire 5000. The next 4,250 stocks make up just around 11% combined.

What many novice investors may not realize is that all large cap funds are not equal. In fact, there are a number of large cap indexes that ETF issuers base their products upon, each with a different methodology.

Many of the most popular large cap ETFs are based on the following cap-weighted indexes (more to come later on equal weighting and other methodologies):
  • S&P 500
  • Russell 1000
  • CRSP US Large Cap Index
  • Dow Jones US Large-Cap Total Stock
Big fish, big stocksThere are other indexes, including the Dow Jones Industrial Average and the NASDAQ Composite, but these are less representative of the total large cap universe and are instead based on strange weightings or the exchange the stocks are listed on.

So what's the difference between the four indexes above? The S&P 500 is by far the most widely-followed and is considered one of the best barometers of total U.S. market performance, covering 75% of U.S. equities. It has a bit of subjectivity built-in, with an Index Committee determining which stocks get added or removed. Companies in the S&P 500 have to have a market cap of at least $4 billion, enough liquidity, and a public float of 50% or more, among other things.

The Russell 1000 is a bit simpler, and more rule-based. With twice the number of equities as the S&P 500, this index simply contains the largest 1,000 companies in the U.S.

CRSP indexes use a different approach. Rather than building indexes based on some specified number of stocks, CRSP tends to define their indexes based on percentiles. The CRSP US Large Cap Index, for example, covers the top 85% of the investable market. At this time, that consists of 665 constituents spanning from mega caps down through some mid caps.

The Dow Jones US Large-Cap Total Stock Index aims for including the top 750 largest companies that meet some basic liquidity requirements.

One might think there would be a substantial difference between an index covering 500 stocks compared to one consisting of 1,000.
One would be wrong. Keep in mind, these indexes cover the vast majority of the total value of the market. That point is emphasized further considering the top 100 stocks in the S&P 500 (the S&P 100) alone make up more than half of the value of the S&P 500. Additional stocks in a large cap index past the first couple hundred or so members mean increasingly less to the overall index.

That said, let's compare the past performance of four popular ETFs, one based on each of the indexes above, to get an idea how closely their performance correlates with one another. The SPY SPDR S&P 500 ETF is the largest and oldest ETF in the country. IVV and VOO from iShares and Vanguard respectively also track the S&P 500, but we'll just look at SPY for now. IWB from iShares tracks the Russell 1000, VV from Vanguard is based on the CRSP US Large Cap Index, and finally, SCHX issued by Schwab uses the Dow Jones US Large-Cap Total Stock. SCHX is the youngest of the four and started trading near the end of 2009, so we'll look at data going back to then.

Historical performance chart of large cap index ETFs: SPY, IWB, VV, SCHX

The Russell 1000 index ETF (IWB) performed the best during this time frame, with a total return of 99%. VV and SCHX returned 98.4% and 98.1% respectively, and SPY was close behind the others at 96.1%.

What can we take away from this? This was a time period where mid caps outperformed large caps significantly, so IWB benefited from the increased mid cap weighting in the Russell 1000 index. VV and SCHX benefited as well, just to a lesser extent. As the S&P 500 is more purely large cap-based, it lagged a small amount.

Ultimately, over the course of over 4 1/2 year, there was less than a 3% difference in returns between the best and worst-performing large cap ETFs. The next time large caps have a period of outperformance in relation to mid and small caps, SPY will probably lead the others.

These indexes correlate correlate so closely over time, you really can't go wrong with buying ETFs based on any of them. They all have plenty of liquidity and solid AUM, so other considerations, like which funds your broker will let you trade commission-free, are probably the best way to make your decision.

Note: I didn't include the Wilshire US Large-Cap Index because it appears that SPDR ETF based on this index (ELR) must have closed and is no longer available for trading.

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