July 30, 2009

Huge disparity in performance among microcap indexes

Something strange is afoot among the indexes tracking the smallest company stocks (microcaps). Through the first half of the year, the performance of these indexes varied widely.

Here was the year-to-date performance of the various microcap indexes as of June 30:

Russell 2000 (small stocks) 2.6%
Russell Microcap (tiny stocks) 6.0%
MSCI Microcap 22.5%
Dow Jones Select Microcap -3.2%
Zacks Microcap -5.0%

In the latest newsletter (PDF) from Perritt Funds (Perrit Micro Cap Oppportunity is our current top pick in Category 3), Perritt's portfolio manager Michael Corbett explains what's going on:

The substantial difference in the performance of the various microcap indexes is somewhat astounding.... [T]here is a difference of nearly 30% between the best and worst performing microcap indexes year-to-date, all of which are supposedly tracking the same sector of the market.
A closer look reveals that a possible explanation to this irregularity is related to the number of companies being tracked by each index and how they are chosen. In its entirety, the microcap universe is made up of approximately 5,000 names.

The Russell 2000 and the Russell Microcap Index each track 2000 companies, the Morgan Stanley MicroCap Index tracks 1,300 companies, and the Dow Jones Select Microcap Index and Zacks Microcap Index each track less than 500 companies.

This serves as a good reminder that when investing in an index fund, make sure you know which index the fund is tracking and what that index actually measures — especially when you get down to the small cap and microcap area.

We offered an overview of the most widely used indexes in our May 2009 Level 3 article.