When looking at small-caps, a recent poll revealed that they represented 82% of the top 100 U.S. stocks in 2024. Even with market volatility in mind, this is emblematic of the historical outperformance and resilience of small caps. However, despite what the data demonstrates, investors often overlook small caps and what they could bring to their portfolios.
“I think so much of the attention is just captured by where returns have been these last number of years, so the stronger returns seem to come on the large-cap side. Listen, those stocks are really well-known. Some of them have done exceptionally well. And so, I think it just naturally leads to small-caps getting forgotten, right?” Tom Harvey, senior equity specialist for Aberdeen Investments, pointed out during VettaFi’s Rediscover the Diversification Potential of Small Caps webcast.
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Part of that comes down to the way people lean towards larger companies, such as the mega-cap Magnificent Seven, for example, as noted by Christopher Colarik, head of U.S. small companies for Aberdeen Investments. He also observes that, despite most investors’ tendency to have less faith in smaller caps, many smaller companies perform exceptionally well. He hopes to see more people become informed about the space by engaging with facts and embracing what works consistently.
Aberdeen Investments’ Active Management Approach
When examining Aberdeen’s approach to small-cap investing, there’s a focus on quality and profitability in its active management and on identifying a sustainable business model. Straightforward stuff, sure, but still essential when attempting to maintain a concentrated portfolio and for negotiating the challenges and risks that small-cap stocks represent.
As Harvey explains, “We talk about active management, obviously at Aberdeen Investments — it’s near and dear to our heart. Actively picking from the bottom up, leading to fundamental research, we handle stock ideas within small-caps, and it’s what we’ve done for decades now.”
Without delving too deeply into the details regarding the significant fluctuations of the asset class over the years, it’s notable how first-rate companies consistently manage to outperform in the long term across various market regimes. That behavior serves as a way to identify high-quality stocks worth monitoring due to their steadiness.
Catalysts for the Present & Future of Small-Cap Investment
However, investors may wonder how fund managers have the confidence to select the right companies or stocks within the small-cap universe. As Harvey and Colarik clarify, certain systematic processes allow Aberdeen to eliminate a lot of what’s in the broad Russell 2000 Index right away. This is based on some obvious data points and a quality screening process. Then, it comes down to relying on the experienced team to sift through what’s available to find the stocks they believe will offer the best performance.
Harvey continues, “Of course, we leverage outside resources. But we’ve been doing this for a very long time. We have a very experienced team. And like I said, we’ve been doing it for a long time in a systematic approach, and I don’t see any reason why we won’t be able to continue to deliver in the future.”
What will be interesting, Colarik says, is the impact of interest rates and corporate tax cuts. Could the deregulation of small-cap stocks have an effect that ultimately results in lower interest rates for smaller companies?
Harvey adds, “When you think about the debt perspective between larger and smaller companies, smaller companies tend to have more variable debt, so that lower interest rates are going to give a bigger boost with lower interest expense. Ultimately, that translates into more profitability.”
With that in mind, it is clear that earnings and sales growth are crucial drivers of small-cap performance, which could also lead to a strong second half of the year. One can only consider the potential impact of tariffs on small-cap stocks and what strategies will be needed to contend with such shifts and increased costs.
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