Why small-cap exposure still matters in retirement plans

Small caps can be easy to overlook after a long period of large-cap leadership. Yet they remain a distinct source of equity exposure, with different sector composition, return drivers, and research dynamics.

For retirement plans, the more useful question is not whether small caps have recently been in or out of favor, but rather how to provide an appropriate allocation in a structure that supports long-term participant outcomes.

Here, we’ll explore why small-cap exposure matters, highlighting their growth and diversification potential and exploring why active management is critical to evaluating opportunities in the space.

Growth potential

Small-cap companies give participants access to businesses that are in earlier stages of their growth cycle, which gives them a potentially longer runway for further growth. That potential comes with greater volatility and business risk, but retirement investors often have a long-term horizon over which to ride through market cycles. Small caps should therefore be evaluated as a long-term portfolio allocation, not as a short-term tactical trade.

Forward earnings expectations have also started to tilt toward small caps. Consensus now projects earnings growth for the Russell 2000 Index of roughly 25% in 2026 and 22% in 2027, versus about 33% and 11% for the S&P 500^® Index.¹ The small-cap growth advantage widens into 2027, a reversal from the dynamic that defined the last cycle. For long-horizon retirement investors, that widening differential strengthens the case for a dedicated allocation rather than relying on incidental small-cap exposure.

A different source of diversification

Small-cap growth is not simply a smaller version of large-cap growth. As of July 17, 2026, the iShares Russell 2000 Growth ETF, a commonly used proxy for the Russell 2000 Growth Index, had 26.4% in Technology, 23.2% in Industrials and 21.3% in Healthcare. That is a meaningfully different sector mix from the Russell 1000 Growth Index, which is more than 53% concentrated in Technology.² The difference can broaden the economic exposures within a large-cap-heavy plan menu. Managed accounts can incorporate small caps within a diversified equity allocation and rebalance that exposure for participants over time.

The diversification case is reinforced by how top heavy large-cap results have become. Large-cap earnings grew about 25% year over year, but a meaningful share of that was driven by a handful of mega-cap names and one-time investment gains rather than broad operating strength. Large-cap margins continue to climb to new highs while the typical company’s contribution is far more modest. For a plan menu already anchored in large caps, a small-cap allocation helps offset this concentration risk by broadening the company-level drivers participants are exposed to.

An opportunity for active management

The small-cap universe is broad and uneven. FTSE Russell reported 1,109 holdings in the Russell 2000 Growth Index as of June 30, 2026.³ Active management can evaluate profitability, balance-sheet quality, capital efficiency and growth durability rather than owning every company at its index weight. It can also avoid weaker or unprofitable businesses and focus more on companies with consistent or projected cash flows. Smaller companies also tend to receive less analyst coverage than large companies, which leaves room for differentiated research and security selection.

Small-cap earnings quality also appears to be improving. “Unusual” or one-time expenses, which tend to signal weaker earnings quality and typically rise into slowdowns and recessions, look to have peaked and rolled over, creating a more constructive backdrop for the asset class. That said, the small-cap index still carries a real quality divide: A rising number of loss-makers, along with high-revenue but low-profit businesses, continues to weigh on aggregate margins. This is exactly where active management earns its keep, concentrating on durable, profitable companies and screening out the weaker names that dilute a passive small-cap allocation.

Why the structure matters

For retirement plans, the investment vehicle should support the underlying investment while keeping participant costs and fiduciary considerations in view.

Fund capacity and industry flows are relevant implementation issues in small-cap growth, but plan fiduciaries should also evaluate access, capacity, fees, performance, process, and operational fit in aggregate rather than treating any single fund closure or flow trend as the investment thesis.

CITs: A retirement-focused structure for active small caps

Collective investment trusts have become a significant part of the defined contribution market. The 2025 PLANADVISER DCIO Survey reported that CITs represented 30.4% of surveyed DCIO assets, up from 28.7% the prior year, while mutual funds declined to 38.7% from 43.4%.⁴ The data supports a measured conclusion: CIT use is expanding, but adoption is an evolution rather than a wholesale replacement of other vehicles.

CITs are maintained by a bank or trust company and operate within a trustee-led governance framework. For ERISA-covered plans, the plan fiduciary framework also applies. Since CITs generally have fewer retail distribution, marketing, and shareholder-servicing expenses than mutual funds, they may offer lower institutional pricing, depending on the share class, plan size, and provider arrangement.

The lower vehicle and distribution costs associated with CITs can make research-intensive active management more cost-effective for a retirement plan. In small caps, that matters because teams may need to evaluate a large opportunity set, monitor company fundamentals, and manage liquidity carefully. Cost savings do not automatically translate into additional research spending or better returns, but a more efficient vehicle can improve the overall value equation for participants.

Retirement plan application

For plan sponsors, the question is not whether a single small-cap strategy is inherently superior to another. The more important consideration is whether participants have access to an asset class that can provide differentiated growth exposure within a diversified retirement portfolio.

The potential value proposition is straightforward: access to small-cap growth, active and data-driven security selection, institutional CIT pricing, and a vehicle designed for qualified retirement plans. These strategies should still be evaluated through the same fiduciary lens as any plan investment, including their objective, process, team, performance, risk, fees, capacity, and fit within the overall menu.

Small caps still matter because they can provide long-term growth potential, differentiated sector and economic exposure, and a broad opportunity set for active managers. CITs do not create the investment case, but they can provide an efficient retirement-plan structure through which to deliver it. The strongest case is therefore balanced: Start with the portfolio role, evaluate the merits of active management, and then determine whether the CIT vehicle improves access, governance, and cost for participants.