Historically, finding portfolio growth has been as easy as thinking small. Small-cap stocks have long been top generators of return, outperforming their larger peers. It’s easy to understand why. It’s a lot easier for a smaller firm to double revenues and profits than it is for a larger one. As such, small-caps often feature explosive growth. At least that was the theory until recently. Small-caps have continued to lag over the last decade or so.
At least the broader small-cap indexes.
However, during this period of value-driven returns within the market segment, active managers have had the edge. And that trend will continue. For investors, the secret to getting strong small-cap returns is to go active and use active ETFs as their vehicle.
A Bumpy Couple Of Years
Looking at historic data, when you wanted growth, you went small. The idea behind the small-cap outperformance premium is that smaller stocks can more easily grow their revenues and make a material impact on their bottom line than larger firms. Data provided by economists Fama & French highlighted this fact. From 1926 to 2021, small-cap stocks outperformed large-cap stocks, returning 11.99% annually versus 10.35% for larger firms.
But the last decade hasn’t exactly proven this fact.
Looking at the market-cap’s benchmark— the Russell 2000 Index —small-caps have not outperformed their large-cap counterparts in the Russell 1000 Index since 2016. This streak is the longest stretch of relative underperformance since the inception of the two indices back in 1979. 1
This year has continued the trend. The Russell 2000 is down about 2%, while the Russell 1000 Index is up 6.1% and the largest of the large via the Russell Top 50 Index has gained about 5.2% in 2025.
The reasons for the shift have been vast. Like in many sectors, higher interest rates have plagued small caps with increased borrowing costs. Another issue has been the lack of innovation and the ability of larger firms actually to double their revenues despite their trillion-dollar market cap sizes.
Small-caps used to be the place to find innovation and tech growth. However, many firms are now choosing to stay private until they are much larger. Many of today’s tech IPOs are of substantial, well-established private firms. This lack of tech sector exposure- just 14% of the Russell 2000- has continued to hurt small-cap index performance versus larger peers.
Active Management Wins
So, the small-cap premium is broken, and we should just forget about it. Well, not exactly, and not all small-cap stocks and investors in the market segment are doing poorly. Those choosing an active approach have actually done pretty darn well.
According to a new study from asset manager Royce Associates and using Morningstar data, over monthly rolling 5-year periods, active small-cap managers managed to beat the Russell 2000 58% of the time. Digging into it further, Royce comes up with some interesting points. 2
Looking at the data set, active managers outperformed 82% of the time in value-led periods, but in only 15% of growth-led periods. The kicker? More than 65% of the time, we have been in value-led periods.
This allows active managers in the space to work their magic. As we’ve said before, active management works best in pockets of the market that are inefficient and lend themselves to exploitation. There are literally thousands of small caps, and digging through those stocks can be a real hassle. This is a prime hunting ground for value managers, who can take the time to find the best opportunities for longer-term returns. With that in mind, active managers can outperform passive indexing, which tends to succeed during periods of overall rising market strength.
The real win? The current underperformance of small-cap stocks compared to large-cap stocks has led the group into one of the most significant value periods in history. According to Royce, when comparing the Russell indexes, the enterprise value over earnings before interest and taxes (EV/EBIT) ratio now shows that small-caps are trading at a 25-year low compared to large-cap stocks. This chart shows their findings.
Source: Royce
Small-caps remain cheap on a variety of other valuation metrics as well, including forward P/E, price to book, and even historic dividend yields.
The overall findings in Royce’s paper are that active small-cap managers can and do beat their passive peers and large-cap stocks when the market is right. And that time is now.
Going Active With Your Small-Cap Exposure
The real lesson is that investors shouldn’t give up on small-caps. Strong returns can be had. The question is how to get that exposure. Over 60% of capital currently allocated to small-cap stocks is invested via passive means. Given Royce’s findings, the focus on indexing in the space is wrong. Active managers can truly apply their trade to beat passive benchmarks and find additional alpha during many market periods.
The best piece is that finding active exposure to small-caps has never been easier. The rise of active ETFs has provided low-cost ways to gain from outperformance, tax savings, and additional benefits. Switching their passive indexes to one of these active ETFs helps drive returns and improve results.
Active Small-Cap ETFs
These funds were selected based on their ability to serve various segments of the small-cap space using active management. They are sorted by their YTD total return, which ranges from 6% to 14%. They have expenses between 0.25% to 0.86% and assets under management between $6M and $11B. They are yielding between 0% and 1.6%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| FESM | Fidelity Enhanced Small Cap ETF | $1.9B | 14.1% | 0.6% | 0.29% | ETF | Yes |
| PSC | Principal U.S. Small-Cap ETF | $502M | 12.8% | 0.76% | 0.38% | ETF | Yes |
| NSCS | Nuveen Small Cap Select ETF | $6.87M | 12.4% | 0.11% | 0.86% | ETF | Yes |
| JPSV | JPMorgan Active Small Cap Value ETF | $14.8M | $9.8% | 0% | 0.74% | ETF | Yes |
| DFAS | Dimensional U.S. Small Cap ETF | $7.57B | 8.9% | 0.92% | 0.26% | ETF | Yes |
| TMSL | T. Rowe Price Small-Mid Cap ETF | $829M | 8.6% | 0.4% | 0.55% | ETF | Yes |
| AVUV | Avantis U.S. Small-Cap Value ETF | $10.9B | 7.7% | 1.6% | 0.25% | ETF | Yes |
| DFSV | Dimensional US Small Cap Value ETF | $2.9B | 6% | 1.25% | 0.31% | ETF | Yes |
In the end, small-caps can still provide the growth that investors are used to. They just need to skip the passive indexing to achieve that. All in all, active managers and active ETFs can provide the missing element to help small-caps regain their mojo in a portfolio.
Bottom Line
The key to small-cap premiums? Go active. While the market cap segment has suffered over the last couple of years, active managers have continued to outperform their passive peers. With that outperformance now set to continue, the time to go active is now.
1 Brown Advisory (July 2025). Small Wonders: Embracing U.S. Small Caps
2 Royce/Franklin Templeton (September 2025). US small-caps undiscovered connection: Value-led periods and active management
