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The stocks of small capitalization companies are on a tear this year—the Russell 2000 Index of U.S. small-cap companies has posted a 20.8% return year to date, compared with 12.93% for the S&P 500, reviving institutional investor interest in small caps.
“Institutional investors have gotten away with and have become comfortable not having exposure to small caps, as large-cap growth has treated them so well,” says Drew Cupps, a portfolio manager at Polen Capital. “There is … movement back, an interest, a curiosity again. … The institutional investors are open to talking, whereas for many years they really weren’t interested in talking to small-cap [managers]—that is indeed starting to change.”
For some institutional investors, small-cap U.S. stocks have been their best-performing strategy. The $129.5 billion Massachusetts Pension Reserves Investment Management last week reported that its small-cap holdings posted a 41% return in fiscal 2026, compared with a 24.2% return for the fund’s total public equity portfolio.
Finding Opportunities
Unlike the S&P 500 and other large-cap indexes—which have become increasingly concentrated around a handful of very large companies in technology and related sectors—small-cap specialists note that the Russell 2000 Index is not as concentrated, with most stocks accounting for less than 1% of the index, and only a few rising to about 3% of the index.
Still, analysts note the importance of security selection, as the small-cap universe has the drawback of including more lower-quality companies, as well as less available information and analyst coverage than stocks in larger-cap indexes.
“The only thing that troubles me about small caps is that there’s still an uncomfortably high portion of zombie companies in the Russell 2000,” says Jason Vaillancourt, chief investment strategist at Columbia Threadneedle.
In 2021, the Federal Reserve Board of Governors described zombie companies as “mature companies that have not generated sufficient profits to cover their debt borrowing costs over a period of years” and cited observers noting that “zombie firms may crowd out lending to productive firms and erode the strength of the U.S. economy.”
But not all small-cap companies are zombies; earnings growth among these stocks is surpassing large caps.
Data from Royce Investments projected stocks in the Russell 2000 to produce 48.1% earnings per share growth in 2026, compared with 22.9% for companies in the large-cap Russell 1000 index. Royce projects 42.7% EPS growth for the Russell 2000 in 2027, compared with 17.3% for the Russell 1000.
Improving earnings fundamentals, combined with attractive valuations, provide a compelling case for small-cap investing, according to Royce. Strong earnings have been a missing link for small-cap performance until recently.
Bill Hench, a portfolio manager at First Eagle Investments, says he likes small caps because they enable investors to “ get … the benefit of early cycle switches. … You saw this in a major way when all the equipment was being made for the internet, where you had companies that, for a short time, really weren’t having great earnings, and growth wasn’t very good. Then all of a sudden, things picked up, and they picked up as they did now. After a couple years of sort of benign growth, all of a sudden, you start to see some nice revenue increases on top of what’s a relatively small asset base.”
Industrials Leading Small Caps
Small-cap stocks, particularly in the industrial sector, are benefiting significantly from the artificial intelligence boom and the build-out of digital infrastructure.
“The real excitement, the real performance in small cap has been more in the industrials,” Cupps says. “The reason [growth has] been more in the industrials is that in order to supply the power we need for the Googles and the Microsofts and OpenAIs and AMDs and Intels to do their thing, we need to bring [online] a lot of power… to light up all these chips. A lot of those companies that make the switch gear and the racks and the components [for the energy sector growth] live in small cap, so the small-cap industrials have been the enablers of building out the power structure that’s needed for AI.”
Tags: investing, Small Cap Stocks