DISCLOSURE:
The views expressed are those of the author as of September 2025 and are subject to change without notice. These opinions are not intended to be a forecast of future events, a guarantee of future results or investment advice. Investing involves risk, including the possible loss of principal.
Past performance is not a guarantee of future results.
The Russell 2000 Index measures the performance of roughly 2,000 US small-cap companies.
Aaron Monroe, CFA, Portfolio Manager at Diamond Hill, joined Keith Black, Managing Director of RIA Channel, to discuss how the increasing trend toward passive management along with other factors impacting the small cap market structure may be creating opportunities for investors in small-cap equities.
Monroe estimates that between 50% and 70% of small-cap investors hold passive index positions. That compares to just 10% to 20% during the early 2000s small-cap renaissance. In addition, there has been substantial consolidation in the asset management industry, making it challenging for larger investors to take a meaningful position in these businesses in their portfolios. Sell-side analysts have responded to the decline in active management by dropping coverage of many small-cap companies. These are secular trends that don’t seem to be abating soon, and this neglect has created a dynamic where capital is seemingly asleep which can lead to opportunities for active managers.
With nearly 2,000 businesses in the Russell 2000 Index, Monroe describes how he tends to view this universe: on one end you have a third of the index that is more distressed and highly leveraged and tends to be path-dependent, on the other side you have the portion of the index which are innovative companies that tend to have more binary outcomes, this still leaves a large portion of the universe in the middle with ample opportunity to find attractive businesses.
Successful investment strategies must have a repeatable process. Investors willing to roll up their sleeves and investigate the small-cap space may be able to find durable and profitable companies, namely companies that have positive long-term opportunities and the resources to survive challenging times. Monroe notes that patient investors who put the work in are likely to be rewarded with returns in the long run. Diamond Hill places heavy emphasis on the qualitative attributes and business prospects of each company in combination with the valuation of the stock relative to its intrinsic value. Ideally, the company’s management owns a large portion of the stock and acts like an owner of the firm. This aligns all shareholders to the long-term success of the company.
While a declining interest rate environment can be a near-term positive for the space, especially for those companies with higher debt burdens, Monroe thinks that the current small cap market structure presents a more durable, long-term opportunity for business-first investors.
WEBCAST – Capital Asleep: Small Cap Market Structure
Join us for a webcast where we will discuss:
- How the combination of a rise in passive investing, asset manager consolidation, and fewer sell-side analysts down the cap spectrum, has impacted small cap markets.
- Why we think this is creating a durable and attractive opportunity for small cap investors.
- Why a business-first investment mindset is well-suited for this environment.
Accepted for 1 CFP® / IWI / CFA CE Credit
Resources: Capital Asleep at the Wheel: Neglected Opportunities in Small Companies
DISCLOSURE:
The views expressed are those of the author as of September 2025 and are subject to change without notice. These opinions are not intended to be a forecast of future events, a guarantee of future results or investment advice. Investing involves risk, including the possible loss of principal.
Past performance is not a guarantee of future results.
The Russell 2000 Index measures the performance of roughly 2,000 US small-cap companies.