The Hidden Risk Within Passive Small-Cap

November 01, 2019 | ,

The rise of passive investing has been a multi-year trend among investors and currently accounts for nearly half of all assets within U.S. mutual funds and ETFs. The popularity of passive investing is not surprising given that the majority of actively managed funds charge higher fees and struggle to consistently beat their target benchmarks. However, the small-cap segment of the market bears watching, particularly among those investors that are passively invested.

This week’s Chart of the Week shows the percentage of companies over time within the Russell 2000 index that have no earnings. As of September 30, 2019, the percentage of companies within the Russell 2000 index with no earnings stands at 38%. This is one of the highest readings observed in nearly 25 years and is at levels typically not seen outside of recessionary periods.

Consistently strong passive inflows, a low interest rate environment, and general investor preference towards longer duration assets perceived to have recession-resistant, long-term secular growth drivers have helped to support companies with little to no earnings. This trend may eventually reverse and could bode well for active strategies that are structurally underweight this segment of small-cap. Regardless, it is important to acknowledge the growing trend and potential risk within the small-cap space.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.