Value, Growth, or Both?

A Framework for Allocating to Small-Cap U.S. Equity


When added to a broader portfolio, an allocation to small-cap stocks can help diversify risk and increase returns over the long-run. When investors are faced with this decision, they must ask the question: value, growth, or both?


Tina Jones: When added to a broader portfolio, an allocation to small-cap stocks can help diversify risk and increase returns over the long-run. When investors are faced with this decision, they must ask the question: value, growth, or both?

This decision has been complicated by the sharp divergence in historical returns between small-cap value and small-growth stocks. For instance, (see chart at 0:30) in 2016, small-cap value outperformed small-cap growth by over 20%.

This large dispersion was preceded by a seven-year period following the Global Financial Crisis of 2008 when small-cap growth outperformed value by more than 4% per year.

In brief, divergence of performance between small-cap growth and value can be both pronounced and sustained.

The decision may seem purely philosophical but it’s not.

Should an investor place greater emphasis on the price paid for a stock, or the potential of a company to grow?

Beyond the philosophical approach, many investors are surprised at the decision on which small-cap asset class they select will greatly influence their sector exposure.

Douglas J. Levine: For example, (see chart at 01:18) only two out of the 11 sectors—Financials and Industrials—account for about 45% of the Russell 2000® Value Index. One factor to consider when investing is your outlook for these sectors. Some believe that Financials have the potential for sustained tailwinds in a rising interest rate environment. Additionally, the expectations for greater spending on infrastructure could provide a tailwind for Industrials.

Similarly, (see chart at 01:41) about 50% of the Russell 2000 Growth Index is comprised of Information Technology and Health Care companies. Not surprisingly, advocates for investing in Small-Cap Growth argue that investing in these stocks offers the potential to harness the power of some of the most dynamic companies in the economy.

Alternatively, a small-cap core strategy may offer an immediate benefit. This approach has the potential to mute some of the volatile swings if either value or growth falls out of favor.

Part of this benefit stems from the fact that sector weightings in small-cap core tend to be more diversified than either value or growth strategies (see chart at 02:15).

For example (see chart at 02:18), no single sector comprised more than 20% of the Russell 2000 Index.

Tina Jones: In conclusion, before investing in small-cap equities, the merits of the respective growth and value philosophies should not only be considered, but also the relative sector exposures.


All investing involves risk, including the possible loss of the principal amount invested. There is no guarantee that the fund will achieve its investment goal. Equity securities tend to go up or down in value, sometimes rapidly and unpredictably. Small-capitalization companies may be more susceptible to liquidity risk and price volatility risk and more vulnerable to economic, market and industry changes than larger, more established companies. Value companies are those that are thought to be undervalued and perceived as trading for less than their intrinsic values. Growth companies have the potential for above-average or rapid growth but may be subject to greater price volatility risk than investments in “undervalued” companies. There is a risk that the determination that a stock is undervalued is not correct or is not recognized in the market.

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