Wealth managers who rotated into small-cap stocks over the past year are showing no signs of retreating, even as geopolitical turmoil clouds the near-term outlook. The iShares Russell 2000 ETF (IWM) has gained 11.5% year-to-date and more than 12% over the past six months, far outpacing the S&P 500's 3.7% and 5% returns over the same periods. Yet over the past five years, the large-cap index has surged nearly 70%, more than triple the Russell's 21% advance.
Lauris Lambergs, vice chair of professional development for the Investments & Wealth Institute, acknowledges that the conflict in Iran has temporarily dampened the small-cap rally. He points to uncertainty around energy prices, inflation, Federal Reserve policy, and GDP growth in the U.S. and China as factors that could pressure corporate earnings, especially for smaller companies. Still, he remains bullish on the longer-term outlook, citing accelerating earnings growth, accommodative Fed policy, and attractive valuations.
“I am a believer in reversion to the mean,” Lambergs said. “Historically, small caps have demanded a risk premium over large caps. They are due to deliver on this over the next three to five years given the past 15-plus years of large-cap relative outperformance.” He favors high-quality, value-oriented names, particularly in energy and industrials, and also recommends expanding into international small caps, which he says offer even more compelling valuations. For clients in moderate or growth-oriented portfolios, he is allocating between 5% and 10% to global small caps.
Francis Gannon, co-chief investment officer at Royce Investment Partners, agrees that the Iran war is the biggest headwind, affecting not just energy supply and prices but also fertilizer, food, and other goods. He also cites pre-existing concerns: sticky inflation, rising unemployment, fears of a large-cap bubble, a sluggish housing market, low consumer confidence, and unease about private credit. Yet he sees significant tailwinds, including small-cap companies that are critical suppliers to the AI revolution and the ongoing effects of the 2021 Infrastructure Investment and Jobs Act (IIJA).
“Catalysts such as reshoring and ongoing infrastructure improvements should help keep small-caps in a sustained leadership role,” Gannon said. “The possibility of a healthy CapEx cycle and the benefits accruing to small-cap companies that are providing the AI infrastructure’s ‘picks & shovels’ also support this view.” He believes the combination of low valuations relative to large caps and forecasts for higher small-cap earnings remains intact.
Aaron Schaechterle, portfolio manager at Janus Henderson Investors, describes the recent outperformance of small caps as “under-discussed.” He notes that for the first time in years, small-cap stocks are expected to grow earnings faster than large caps in 2026. “Historically, the combination of attractive starting valuation and faster earnings growth has been a good formula for small-cap stocks’ outperformance,” he said. He also points out that the Russell 2000's total market capitalization as a percentage of the S&P 500's remains near a 40-year low, suggesting room for continued gains.
“Our study of historical trends indicates that market broadening, after a period of extreme large-cap concentration, tends to be a multi-year cycle,” Schaechterle added. “Large-cap stocks outperformed for approximately 15 years prior to the recent regime change, and historically these cycles have been many years in duration.”
For advisors weighing whether to stick with small caps or rotate back to mega caps, the consensus among these managers is clear: the tailwinds of valuation, earnings growth, and historical precedent argue for patience. As wealth managers detail strategies to prevent cash crunches and navigate uncertain markets, small caps remain a key component of many portfolios. Meanwhile, ETF launches are quietly slowing in the active space, but small-cap funds continue to attract inflows. And as MassMutual's wealth chief notes, AI enhances efficiency but cannot replace the human trust in advisor-client bonds—a reminder that disciplined allocation decisions still rely on seasoned judgment.
