Pacific Exchange ponders use of new stock index.

Wilshire Small Cap Index receives SEC approval

Starting next year, the Pacific Stock Exchange may offer a new index of small company stocks, now that the Securities and Exchange Commission has approved the proposal.

The PSE is gearing up to begin trading options on the Wilshire Small Cap Index, recently created by Wilshire Associates Inc., a consulting and asset management firm based in Santa Monica. The new index is comprised of 250 stocks from a broad range of companies with a median capitalization of $404 million.

A new product for the PSE, the Wilshire Small Cap Index may boost the West Coast's image as a financial power center, supporters say.

"We're (the PSE and Wilshire Associates) both West Coast-based," said Scott Stark, manager of new products for the stock exchange. "We're trying to make a coordinated effort to get the West Coast known because there is a lot of money out here. New York is not the only financial center."

Stark said the market is the first ever developed specifically as a trading vehicle to track the performance of small cap stocks.

"We're not creating a new index as much as a trading vehicle for small cap securities," agreed Thomas D. Steven, Wilshire Associate's chief investment officer. "This is an instrument to make small cap money management easier."

Traditionally, fund managers have had difficulty tracking performance of small cap indexes due to the sheer number of companies included, lack of liquidity, and the high turnover when indexes are re-created.

"The whole point of our exercise was to come up with as liquid a universe as possible, paired down, but with the same features as other small cap indexes," such as the Russell 2000, said Steven.

Wilshire Associates is no novice when it comes to stock index creation. It derived the Wilshire Small Cap Index from the Wilshire Next 1750. The 1750 was created from the Wilshire 2500, which represents the largest 2500 securities in the Wilshire 5000 Index.

Nearly 20 years old, the Wilshire 5000 is one of the broadest measures of the U.S. stock market. It includes 5,800 securities and has a total capitalization of more than $4 trillion.

Stark said the PSE, along with the Chicago Board of Trade, which received approval to trade futures on the Wilshire Small Cap Index, have not announced when trading will start because they are still educating potential investors.

"We are trying to have a joint marketing effort so people understand what the small cap index is," said Stark.

While it is clear the PSE is poised to benefit financially from the new index, Stark said he could not reveal estimates on potential trading revenues.

Steven predicted trading would begin on the index within 60 days, and said it would allow investors and money managers to quickly gain experience in the small cap arena.

"We're not trying to confuse everyone by creating a new index," said Steven. "We're saying continue to use the Russell 2000, the NASDAQ. But this is a vehicle that should be a lot easier to use."

DeWitt F. Bowman, chief investment officer of the California Public Employees' Retirement System, which pegs more than $18 billion to the Wilshire 2500, hailed the creation of the new small cap index. However, he said CalPERS, with about $70 billion in total assets, had no immediate plans to participate.

"I believe it will be a real benefit to Wilshire," said Bowman. "It's a good index for smaller funds that want to get small cap exposure, and we may even find it beneficial in that sense."

The market will allow for the development of derivative products, something other indexes have not done very successfully, said Steven.

"Up 'til now, there have been no successful derivative products for small cap stocks," he said. In its Nov. 3 approval of the PSE request to trade options on the new index, the SEC said, "the general broad diversification, capitalizations, and relatively liquid markets of the index's component stocks significantly minimize the potential for manipulation of the index."

The SEC also said maintenance and selection criteria developed by Wilshire Associates, "will serve to ensure that the index will not be dominated by low-priced stocks with small capitalizations, floats, and trading volumes."

The index is composed of stocks representing nine different industries: capital goods, consumer durables, consumer non-durables, energy, financials, materials and services, technology, transportation and utilities.

Steven said although it wasn't intentional, West Coast-based companies are "very well represented" on the index.