Small Caps, Big Strides

February 20, 2026

2026 has begun with an asset class performance reversal in the United States. Small capitalization stocks, which lagged their larger-cap peers last year, have come out of the gate roaring ahead.¹ There are several reasons for this shift. One is valuation: traditional investment theory suggests that valuations tend to revert toward a mean over time, and asset classes had become somewhat stretched relative to one another.

Another factor is interest rates. Small caps tend to benefit from the prospect of lower rates, and markets appear to expect that may be coming. Smaller companies generally carry more debt, and that debt is often shorter in duration.²

Consider a hypothetical example. Imagine you are an investment banker, and Apple Inc. (large cap) and Crocs Inc. (small cap) approach you to raise debt capital.

Crocs may say, "Look, contrary to your sartorial instincts, we are quite fashionable. And we designed this new texture on the bottom of the sandal that kind of massages your foot as you walk. We think people are going to love it!" You may think "My feet are tingling, but that's not much of a competitive advantage. I could take a little chisel and change the sandal mold myself fairly easily."

Then it's Apple's turn. There's a little swagger in their pitch because they are Apple. Maybe they say "Ok, it's true we’ve stumbled with Siri for three consecutive years. And our text autocorrect has probably broken up a few marriages. But have the customers left? No. They're deeply embedded in our ecosystem. And if needed, and we will hire our biggest competitor, Google, to help improve it." You think, "That's a very durable protective moat and large competitive advantage."

Under this scenario, Apple secures the long-duration, low-cost debt financing. And Crocs doesn't. But in theory, it means that when rates come down, Crocs, and small caps, will benefit more. As interest expenses fall for companies like Crocs, profitability improves, and markets often respond positively.

Moving beyond the hypothetical, I want to clear up a little definitional confusion about indexes, index funds, mutual funds, and ETFs.

An index is simply a defined collection of securities that you are going to invest in. It’s essentially a rules-based list. Constructing that list is harder than it sounds. Most large fund companies, such as State Street, BlackRock, or Vanguard, license these lists from index providers. As an example, the S&P 500 is created and maintained by Standard & Poor’s, an index provider.

Once the fund companies have the license, they then build funds that we can invest in for you. These generally take the form of either mutual funds or ETFs. Each form has advantages and disadvantages. But we almost always will use an ETF for liquidity and tax efficiency reasons.

Importantly, the ETF or mutual fund is simply the wrapper — the basket that holds the underlying securities defined by the index.

~Dan Cunningham

1. Small vs large-cap performance: Stockcharts.com
2. More technical discussion if you are interested: Debt exposure is quite different between small and large caps. Net Debt to EBITDA is 3x for small cap vs large cap. (Source: State Street 7/18/25). Floating rate debt of the Russell 2000 is more than 5x the S&P 500 (Source: Goldman Sachs 11/4/25). Constituents of the Russell 2000 had weighted average debt maturity of 4.8 years versus 8.8 for large companies as of late 2022 (Source: Boyar Research Q3 2023 letter), meaning they have to refinance sooner into higher rates, or pay off debt sooner.