The Case for an Active Approach to Small-Cap Investing

As investors consider ways to refresh portfolios in market uncertainty, one segment that may be receiving some new interest is small-caps. Small-cap investing can provide exposure to undervalued names and offset lingering concentration risk. Of course, not all small-cap strategies are created equal. An active approach to small-caps can get more out of the category and outperform small-cap peers.

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Small-cap firms could see a stronger end to 2025 and potentially rewarding start to 2026. September’s rate cut may or may not be followed by further cuts. Either way, however, cheaper borrowing costs can certainly help small firms that often rely on debt servicing in advance of future revenues.

Small-Cap Investing

At the same time, as mentioned above, stagflation and concentration risk remain potential issues for portfolios. U.S. investors are heavily exposed to the megacap tech space, making smaller firms a nice alternative. At the same time, small firms can offer some exciting upside, even as persistent inflation pairs with a broader slowdown.

Active management can help find small-caps best poised to rise above those issues and deliver for investors. Active managers can lean on fundamental research to identify those small-cap firms that may be best positioned for a breakout or to do well even amid rising market uncertainty.

The T. Rowe Price Small-Mid Cap ETF (TMSL) provides one option in the space that’s worth considering. TMSL charges a 55 basis point fee to actively invest in small- and midcap firms. Specifically, the fund invests in those firms based on either growth or value characteristics with a bottom-up approach. TMSL uses a SMID approach to small companies which allows for a greater pool of small-sized companies. By including some mid-cap companies, it lets some winning companies continue to grow beyond their small-cap label. It also increases the potential to identify higher quality companies poised for even more significant growth. Its managers consider metrics including profitability, stability, earnings quality, and more. 

Together, that has helped TMSL return 9.1% YTD, per ETF Database data. That outperformed both the fund’s ETF Database Category and FactSet Segment averages in that time. Those returns came in at 6.9% and 6%, respectively. Looking ahead, the fund could make for an intriguing addition to equity allocations ahead of the new year. 

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