An allocation to small-cap equities could help institutional investors achieve a few common goals. For example, adding or increasing a small-cap allocation can potentially help boost near-term performance or improve diversification. And for liability-aware investors increasing fixed income in their portfolios to reduce risk, allocating to small-cap also could help offset the potential reduction in expected return.

Economic dynamics and relative valuations supporting small caps today

We believe that, while there’s always a case for considering small caps, right now may be a particularly compelling time to focus on the asset class. As the post-pandemic recovery continues, small caps are supported by economic dynamics and attractive relative valuations.

Small caps have historically performed well relative to their larger peers in the years following a recession. This is due to small caps’ more domestically oriented exposure and higher operational leverage, among other factors. Consider the dot-com bubble in the early 2000s. In the three-year period following that bear market, small caps1 outperformed large caps2 by 42% (Table 1). We saw a similar pattern play out following the 2008 Global Financial Crisis (GFC). In the three-years following the GFC, small caps outperformed large caps by 32% (Table 2).

Table 1: Dot-com bubble