What it means
The Russell 3000 is an index of the 3,000 largest US companies by market value and represents the vast majority of the US stock market. FTSE Russell splits it into growth and value segments.
The growth segment holds the companies that the market expects to expand earnings and sales more quickly than average. The selection uses measures such as price-to-book ratio (how a share price compares with the company's accounting net worth per share) and forecast growth.
Companies with higher price-to-book ratios and stronger forecast growth are placed in the growth index. Some companies can appear partly in both the growth and value indices, because the methodology allows shares to be split between them.
Growth stocks are often found in technology, healthcare and consumer sectors, where firms reinvest heavily to expand. They often pay low or no dividends because profits are put back into the business.
Their share prices depend heavily on future earnings, so they can fall sharply if growth expectations are cut or interest rates rise. For finance professionals the index serves as a benchmark.
A growth fund manager is judged on whether she beats the index, and investors use the index to see whether the growth style is in or out of favour. Because it covers small, medium and large companies, it is broader than large-cap-only growth benchmarks.
Understanding which benchmark applies helps avoid unfair comparisons. A broad growth benchmark such as this one suits a fund that invests across company sizes, while a large-cap growth fund is better compared with a large-cap growth index.
The index is also a handy tool for judging the overall market mood. When growth outperforms value, investors are generally willing to pay more today for earnings they expect in the future, and when it lags, they are favouring established earnings and dividends.
Neither is permanently better, and leadership often swaps over several years.
In practice
Real-world examples.
Example
A fund manager who invests in fast-growing companies of all sizes reports her returns against the Russell 3000 Growth index. Her investors can see whether her stock picking added value.
Example
A financial adviser explains to a client that his portfolio has a growth tilt. He shows the client how it has performed relative to the Russell 3000 Growth index over three years.
Example
A corporate pension committee reviews a $20,000,000 growth allocation. It decides that the Russell 3000 Growth index is the right comparison because the manager invests across large, mid and small companies.
Formula
Calculation
Index price return = (Ending index level - Starting index level) / Starting index level x 100.
Suppose the Russell 3000 Growth index starts a year at 10,000 and ends at 11,200. The return is (11,200 - 10,000) / 10,000 = 1,200 / 10,000 = 0.12, or 12%. If a growth fund that started with $500,000 ends with $550,000, its return is $50,000 / $500,000 = 10%, so it trailed the index by 2 percentage points. A fund that trails by 2 percentage points would also be compared on risk and fees, since a fund can lag a benchmark and still be a sensible holding if it takes less risk.Case study
Seen in the real world.
Summit Ridge Advisors is an entirely fictional firm that manages a growth strategy for local business owners. In this illustrative story, the firm reports its performance against a large-cap growth index even though a third of its holdings are small and mid-sized companies.
A client points out that the comparison seems to flatter the fund, because small and mid-sized growth stocks had a weak year. The firm's compliance officer agrees and switches the benchmark to the Russell 3000 Growth index.
Reported out-performance falls from 4 percentage points to 1 percentage point, but the client's trust increases. The illustrative lesson is that choosing the right benchmark is part of honest reporting. She also added a short note in the client report explaining how the benchmark is chosen, so the choice can be questioned.
Watch out
Common mistakes.
- Assuming the index holds only large companies, when the Russell 3000 covers small, mid-sized and large ones.
- Assuming growth stocks are always better than value stocks, when each style leads at different times.
- Using the wrong benchmark, such as a large-cap growth index for a fund that holds small and mid-sized companies.
Questions
People also ask.
What makes a stock a growth stock?
It has higher valuations and stronger expected growth in earnings or sales than the average company.
Does the index pay dividends?
Its members may pay dividends, but growth companies often pay little, and the price index does not count dividends unless it is the total return version.
How often is it updated?
FTSE Russell reviews membership on a regular schedule so that the index continues to reflect its rules.
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