A Report from the Value Equities Investment Committee | PDF

Why Small Caps?

Small capitalization stocks have spent the better part of 10 years in the shadows of their larger cap brethren but now currently provide an attractive opportunity, in our estimation. The divergence has been driven primarily by the narrow focus on a select few mega-cap technology-oriented businesses. This has led the Russell 2000 Index to trade at two standard deviations below its average relative to the Russell 1000 Index (see Figure 1), which was last reached during the Savings and Loan (S&L) Crisis of the late 1980s/early 1990s.

Additionally, the divergence has placed the relative valuation of the Russell 2000 at levels last witnessed toward the end of the dot-com boom of the late 1990s/early 2000s. This has some investors questioning the vitality of small caps. However, we view the relative underperformance as cyclical, driven by the prolonged accommodative monetary policy that followed the Great Financial Crisis of 2008-2009, which seems to have encouraged a more aggressive allocation of capital toward tech and unprofitable small caps.

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