Understanding recent trends and why fundamentals still matter
By Canada Life Investment Management | Mar. 10, 2025
What are small-cap funds and why do they matter?
In the United States, small-cap funds, or small caps, invest in U.S. companies with market capitalizations typically between USD $250 million and USD $2 billion
- Are more agile than larger companies
- Can capitalize on new opportunities quickly
- Offer greater growth potential
- Provide diversification beyond large-cap stocks
- Deliver exposure to innovative sectors
Including small caps in a portfolio gives investors access to areas of the market that can deliver outsized returns compared to mature, slower-growing large-cap firms. As a result, small-cap funds could be an essential component of a well-diversified strategy.
While small caps can be more volatile and less liquid than large caps, historically, they’ve outperformed large caps during recessions and early expansion phases. For example, after the July 1990 to March 1991
Table 1: Comparison of large-cap fund and small-cap performance after the 1990 recession and 2008 global financial crisis
S&P 500 Index (S&P 500) tracks the performance of large-cap funds, while Russell 2000 Index (Russell 2000) and Russell Small Cap Completeness Index (Russell Small Cap Completeness) track the performance of small-cap funds.
|
Return year |
1991
|
1992 |
2009 |
2010 |
|---|---|---|---|---|
|
S&P 500 |
30.47% |
7.62% |
26.46% |
15.06% |
|
Russell 2000 |
46.04% |
18.41% |
27.17% |
26.85% |
|
|
46.59%
|
14.15% |
37.68% |
26.64% |
Source: Morningstar Direct
©2026 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
Even with opportunity for great upside, small-caps do come with risks compared to large-cap stocks such as:
- Higher volatility
- Lower liquidity
- Greater sensitivity to economic downturns
These factors can lead to sharp price swings and increased investment risk.
Why recent market events matter
Despite their historic performance, for more than a decade, U.S. small‑cap stocks have struggled to keep pace with large caps. From 2014 to 2025, the Russell 2000 and the Russell Small Cap Complete both underperformed the S&P 500 in 10 of 12 calendar years. In 2024 alone, the S&P 500 beat the Russell 2000 by roughly 14% and the Russell Small Cap Complete by roughly 8%. This is one of the widest annual gaps since the early 2000s, as shown in Table 2.
Table 2: Comparison of returns, Russell 2000, Russell Small Cap Complete and S&P 500 indices
|
Return
year |
2014
|
2015 |
2016 |
2017 |
2018 |
2019 |
2020 |
2021 |
2022 |
2023 |
2024 |
2025 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
S&P
500 |
13.69
%
|
1.38% |
11.96
% |
21.83
% |
-4.38 |
31.49
% |
18.40
% |
28.71
% |
-18.11 |
26.29
% |
25.02
% |
17.88
% |
|
Russell
2000 |
4.89%
|
-4.41
% |
21.31
% |
14.65
% |
-11.01 |
25.52
% |
19.96
% |
14.82
% |
-20.44
% |
16.93
% |
11.54
% |
12.81
% |
|
Russell Small Cap Complete
|
7.40%
|
-3.41
% |
16.59
% |
18.27
% |
-9.21
% |
28.04
% |
32.88
% |
12.64
% |
-25.49
% |
24.81
% |
17.14
% |
12.67
% |
Source: Morningstar Direct
©2026 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
This cycle is different than when small caps shined during economic recoveries.
The real story unfolded within the small-cap universe itself. Starting around 2019, high-quality small caps (companies with strong profitability, solid balance sheets and disciplined management) began losing ground to lower-quality peers
The numbers tell the story. In 2025, small-cap stocks without earnings in the Russell 2000 gained roughly 42% year-to-date, nearly three times the index’s overall return of 14%
Meanwhile, the highest-quality names (those in the top 20% of the Russell 2000 based on return on equity) underperformed significantly (roughly 8.7% to the index’s 14%), leaving quality-focused managers trailing despite strong fundamentals.
This disconnect between price and profitability underscores a market driven by speculation rather than discipline. While low-quality names have led the charge recently, history suggests fundamentals eventually matter. Quality tends to win over the long term.
What fueled the rally
The surge in low-quality small caps didn’t happen in isolation. It was driven by a perfect storm of market dynamics. Retail investor momentum surged as meme-stock culture made a comeback, drawing speculative flows into high beta (or high volatility) names. At the same time, AI hype dominated headlines, pushing investors toward companies with little more than a promise of future growth. Falling interest rates and easier financial conditions amplified risk-taking, making speculative bets more attractive than disciplined investing.
In this environment, fundamentals were largely ignored. Earnings, balance sheet strength and return on equity mattered less than narrative and volatility. Investors chased “lottery ticket” stocks, prioritizing short-term gains over long-term sustainability. This regime tends to be short-lived. Once financing costs and earnings discipline matter again, quality historically outperforms. For example, after the dot-com bubble burst in 2000, low-quality tech stocks collapsed, while quality companies recovered and led performance over the following decade
How global and international small caps behave
We’ve closely discussed the state of the small cap industry in the US markets, but it’s also important to consider small cap indices across other regions.
Internationally, small cap indices tend to behave similarly to U.S. small caps. In part this is because U.S. companies represent roughly 65 to 75% of global equity benchmarks. This is shown by how US companies make up the majority of two global indices: 65% of MSCI ACWI (an index which captures large and mid cap representation across countries with developed and emerging markets) and 72% of MSCI World (an index which captures large and mid cap representation across countries with developed markets). At the same time, the international small‑cap universe is far broader than the U.S.. Non‑U.S. markets contain more than five times as many small‑cap companies as the U.S., offering greater diversification potential
International small caps have also historically shown lower correlations to U.S. large caps than either U.S. small caps or international large caps. In our opinion, this makes them a unique return source within a broader small‑cap allocation
Canadian small cap performance
During our analysis, we found that Canada stood out. Canadian small cap indices have consistently outperformed their U.S. and global counterparts in recent trailing returns, largely due to sector composition. Heavier weightings in materials and energy, sectors that surged during the latest cycle, helped drive this outperformance. Refer to Table 3.
Table 3: Trailing returns (CAD), MSCI World Small Cap vs Russell 2000 vs S&P/TSX Small Cap Indices
|
Return year |
6 month
|
1 year |
2 year |
3 year |
5 year |
|---|---|---|---|---|---|
|
Small Cap Index |
12.32% |
14.79% |
16.63% |
15.48% |
9.21% |
|
Russell 2000 |
15.38% |
7.52% |
14.37% |
14.18% |
7.66% |
|
Cap Index |
33.19%
|
50.16% |
33.58% |
23.20% |
15.33% |
Source: Morningstar Direct
©2026 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
Where we stand today
The current state reflects a market driven by momentum rather than discipline.
Low-quality names outperformed because they offered exactly what speculative investors wanted: high beta and the potential for outsized returns. This speculation overshadowed fundamentals, creating a market where price movements were disconnected from earnings reality.
Today, valuations for many of these companies remain inflated relative to their profitability. Meanwhile, quality-focused managers that emphasize strong balance sheets and sustainable growth have underperformed. Many profitless names still trade at elevated price-to-sales multiples, leaving investors exposed if liquidity fades or earnings disappoint.
The majority of top-performing small-cap stocks in 2025 were in three typically volatile industries:
- Biotech
- Junior miners
- Crypto currency
For example, one of the top performers, Diginex (within the Information Technology sector), returned 683.1% in 2025
While this trend has rewarded risk-takers in the short term, history suggests fundamentals eventually reassert themselves. Quality stands the test of time.
Canada Life’s small-cap product shelf
Canada Life has seven small- and mid-cap offerings in both mutual fund and segregated fund products across different regions, Canada, U.S., and Global. Each strategy is managed by portfolio managers with vast experience in the small-mid cap space.
|
Fund |
Canada Life Shelf
|
Sub-advisor |
|---|---|---|
|
|
|
|
|
Canada Life Global Small-Mid Cap Equity Fund |
|
|
|
|
Segregated fund
|
|
|
Canadian Small-Mid Cap |
|
|
|
|
|
|
|
|
|
Mackenzie Financial Corporation and Mackenzie Investments Corporation |
|
|
|
|
Looking ahead
We believe fundamentals will matter again because market cycles tend to reward discipline over time. As economic conditions normalize and earnings regain focus, quality companies are positioned to lead. Catalysts such as stabilizing interest rates, improved corporate profitability and a shift away from speculative excess should favor businesses with strong balance sheets and sustainable growth drivers.
At Canada Life we stand firmly behind our sub-advisors and their conviction in quality mandates. While short-term noise has rewarded risk-taking, our approach remains rooted in long-term principles. We invest in companies with proven profitability, competitive advantages and disciplined management.
We remain confident that as fundamentals reassert themselves, these managers are well-positioned to aim towards delivering long-term results.
Investment manager research (IMR): Our role in selecting best-in-class managers
Canada Life offers a full and diverse suite of funds across every major asset class. We truly believe that no single asset manager is an expert in every asset class. That’s why we use a multi-manager, best-in-class approach that draws on several management styles, investment philosophies and risk management strategies from around the world. Canada Life’s best-in-class approach gives you, the advisor and investor, access to a broad global network of specialized investment managers from around the world who offer deep expertise within their specialized areas of portfolio management.
The IMR team selects and oversees the best-in-class sub-advisors for Canada Life’s mutual and segregated fund shelves. With more than 100 years of combined experience in wealth management, the IMR team uses a rigorous and objective governance process to select, continuously monitor and evaluate sub-advisors on our shelf.
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