S&P Combines Small- and Mid-Caps in New Index By John Spence January 16, 2002

Index provider Standard & Poor's yesterday launched the new S&P 1000 index, which folds together the S&P MidCap 400 and the S&P SmallCap 600.

Like the Wilshire 4500 extended market index, the S&P 1000 is a basket of mid- and small-cap stocks with S&P 500 companies removed. The Vanguard Group recently introduced a VIPERs exchange-traded fund as a separate share class of its existing Extended Market Index Fund.

S&P officials said the new index was introduced in response to demand by "investors who want to allocate assets between large capitalization stocks and the rest of the investable market." The new S&P 1000 represents about 10.5% of the market capitalization of the S&P SuperComposite 1500, which includes the S&P 500. Over $31 billion dollars are indexed to the S&P MidCap 400 and more than $12 billion dollars are tied to the S&P SmallCap 600, according to the New York-based index provider.

Although S&P said the index has yet to be licensed, it seems a safe bet that there will be an ETF hitched to the index down the road. San Francisco-based indexing powerhouse Barclays Global Investor offers a family of iShares based on the S&P style indexes, and thus far only Vanguard offers an extended market ETF.

The launch of another extended market index highlights the change in the way many investors are thinking about market cap-weighted equity indexes. When small- and mid-caps are held in separate index funds or ETFs, an investor pays taxes as a stock moves up the capitalization ladder and jumps from one index to another. Holding small- and mid-caps in one fund reduces frequent rebalancings and transaction costs, since companies tend move around frequently between these two indexes.

However, Morningstar senior fund analyst Scott Cooley notes that there is a trade off by lumping together small- and mid-cap companies in one index.

"Small- and mid-cap indexes were especially tax-inefficient in the late 1990s, when a lot of companies quickly migrated into large-cap territory," said Cooley, whose own firm recently announced its upcoming foray into indexes. "Of course, the issue is that the more you slice up the stock universe, the more you harm tax efficiency. But the more you shift toward a total stock market approach, which is more tax-efficient, the less control you have over asset-allocation decisions."

In any case, the ongoing rollout of equity indexes and passively-managed ETFs are allowing investors to get as simple or as complex as they want to when building a low-cost stock portfolio.