Small cap stocks have historically been relied on for enhancing returns and adding exposure to high-growth companies that might one day graduate to join the blue chips. However, today's small cap universe looks different from its predecessors. 46% of the Russell 2000 now consists of unprofitable companies — a dramatic shift from the 27% average before the global financial crisis.

Two structural trends sit behind this shift. First, private equity financing allows younger companies to stay private for longer, often achieving mid-to-large cap scale before their initial public offering (IPO). Second, the high regulatory costs and scrutiny of public markets land hardest on smaller issuers. This combination has lowered both the quality and the number of businesses in the small-cap space.

The transformation of the small cap universe

The growth of private equity, with USD 2.4billion in "dry powder" available to deploy in 2025, means that innovative companies can fund their entire growth journey without ever needing to hammer the opening bell at a stock exchange.

Companies that do choose to IPO are doing so later in their growth journey. The median time to IPO has stretched from five years in 2000, to fourteen years today, with some of the more compelling names debuting straight into large cap indices.

These factors are partly behind the failure of small-cap indices to deliver on their higher growth expectation relative to large caps. Average U.S. small cap revenue growth has not exceeded large cap revenue growth since 2010.

Meanwhile, the sector composition has shifted away from growth. Technology and communications now represent a smaller share of small cap indices compared to their large cap counterparts.

Where has the growth gone?

If the goal is exposure to smaller, faster-growing businesses, where is that growth being created and captured today? Increasingly, in private markets. There are now 795 so-called "unicorns" — private companies valued at over USD 1billion — up from just 100 in 2015.

Aside from the sector composition weighted towards tech, private equity can apply different strategies to enhance growth. Management teams are incentivized to deliver over long time horizons, typically executing plans over 5-7 year holding periods. This keeps them focused on the future. However, they can also move quickly when needed.

As companies face tariffs and labor challenges, this flexibility is valuable not just for growth, but also in preserving the bottom line. Management teams can make bold strategic pivots — divesting underperforming divisions or completely restructuring operations — without quarterly earnings pressures.

The importance of being active

This does not mean small caps are obsolete. It does mean investors may want to be more selective. Dispersion within small-cap benchmarks is near all-time highs. This strongly favors active management rather than a passive approach.

Investors value the accessibility of small cap stocks. However, the advent of private equity fund structures with lower minimums has helped to level the playing field. As allocators reassess their growth equity exposure, allocating to carefully selected private equity strategies may offer superior risk-adjusted returns while capturing the dynamism that once defined small cap investing.

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