RCM Managed Asset Portfolio: Large Cap and Small Caps, Part I

RCM Managed Asset Portfolio 

By Christopher Chiu, CFA

October 2025

Large Cap and Small Caps, Part I

Small caps have recently performed better than large caps. But this may just be an anomaly. There have been many brief periods when small caps have outperformed large caps. Over the last twenty years, however, large caps have largely outperformed small caps, as seen in the chart below.

Why would this be? There are a number of factors that benefit large cap companies over the small caps. One factor that requires more attention is how both large and small cap indices are constructed and how they are situated against each other. With the S&P 500 representing the five hundred largest publicly traded companies by market cap and the Russell 2000 representing the smaller companies, what is important to keep in mind is how companies can move between the two indices as they increase and decrease in market capitalization.

The fact that there is no other index that captures larger companies than the S&P 500, while the Russell 2000 has the S&P 500 can create an upward bias in the S&P 500 over time. (The Dow Jones index, which is composed of thirty large industry leaders, is sometimes mistakenly thought to be an index of larger companies than those in the S&P 500. But there is no company that is in the Dow Jones index that is not in the S&P 500 index. Nvidia, which is a Dow component, is also in the S&P 500.) I illustrate this upward bias with some hypothetical examples below.

Survivorship bias in the S&P 500

The S&P 500, the large cap index, is biased upward because when companies become more valuable there is no other index for them to get elevated to, so their contributions of size and performance continue to help the performance of that index. When companies begin to fail in the S&P 500, however, they get thrown out, so that their performance does not create a drag on the performance of the S&P 500. In this sense, there is survivorship bias in the S&P 500 because failures do not remain to be counted but successes within it continue to contribute to its performance.

The Drag of Failures and Absence of Infinite Successes in the Russell 2000

The Russell 2000 will often get those former S&P 500 companies that fell out of that index. And if they continue to perform poorly, they become a drag on the performance of the Russell. On the other hand, when the S&P 500 gets new companies, whose performance is surging, generally, these companies come from the Russell 2000. This is a double whammy for the Russell 2000, as the companies that would best help the performance of the Russell go on to benefit the performance of the S&P 500 instead. But when companies begin to slide in performance and market size and start heading toward distress, they contribute negatively to the Russell 2000.

What about Exceptions?

Failing companies will often be kicked out of the S&P 500 especially if their slide is long and slow, allowing for the S&P 500 review process to evaluate their poor performance for removal from that index. However, there will be times when companies will have completed their slide while still in the S&P 500, as was the case with Bear Stearns or Lehman Brothers dramatic downfall in 2008. But this is not so common. Often, companies begin to have bad financial performance long before they reach insolvency, their stock price will reflect this, and during this time they will be delisted from the S&P 500 by its review process, often to be picked up by the Russell 2000 or some other index.

Large Caps Have Not Always Outperformed Small Caps

Despite all these headwinds, for a long time the Russell 2000 had better performance than the S&P 500, for example, from the period of 1970-2005. This is because of the advantages inherent in smaller companies. Operationally, smaller companies can move more quickly and pursue markets that large companies would overlook because they are not worthwhile for larger companies. In other words, there are more opportunities for smaller companies than larger ones.  For these reasons it is easier to grow from a smaller base than a larger one.

Yet for all this, small caps have not performed as well as large caps for the last twenty years. Next month, absent any major economic news, I will discuss (in a Part II) why large cap indices may perform better financially aside from the construction of the index, namely looking at the components of the indices rather than how the indices are constructed. Looking at the individual components only, we may ask why large companies possess an advantage over smaller companies today and why the advantages that smaller companies possessed twenty years ago are less significant now.