Over the last several years in which large-cap has dominated relative performance, a narrative has emerged that higher active share is synonymous with underperformance and/or unnecessary risk. We found ourselves asking if active share is still relevant in small-cap portfolios and how an investor can determine whether a portfolio is truly actively managed?

Active share is a simple way to show how different an investment portfolio is from the index it is measured against. It looks at both which stocks the portfolio owns and how much it invests in each one, then gives a score from 0% to 100%. A score of 0% means the portfolio is identical to the index; 100% means it has no holdings in common with the index. A 50% score means that half of the portfolio, by weight, differs from the index. In short, the higher the active share, the more the portfolio departs from its benchmark. Active share does not show whether the portfolio will perform better or worse—only how different it is.

Funds and ETFs that seek to mirror an index typically have low active shares. While there are no hard and fast rules, a score of 60% or higher is generally thought to qualify a portfolio as being actively managed. In fact, the terms “closet indexer” and “benchmark hugger” are now used to describe funds that are ostensibly actively managed but whose holdings and position weightings stick very close to their benchmark, making them more like an index fund than an actively managed portfolio.

Active ETFs typically have higher active shares, though they can range widely depending on their investment criteria. Perhaps in response to the proliferation of both quantitative strategies and active ETFs, Morningstar now categorizes active portfolio approaches in two broad categories: ‘Active-Systematic’ includes strategies that use defined rules, quantitative models, or systematic processes that select securities and choose weightings without tracking an index. The second category is ‘Active-Discretionary,’ in which the strategies use fundamental analysis, judgment, and discretion to select stocks and construct the portfolio. (Morningstar classifies these funds using a large language model trained to categorize strategies based on the investment objectives described in fund prospectuses.)

Why do we think active share is important in the small-cap world? It starts with the fact that large-cap stocks have led the U.S. equity market over most of the last 15 years, giving passive large-cap strategies, whether in ETFs or index funds, impressive records of success. This trend has somewhat understandably led to even actively managed large-cap funds morphing into benchmark huggers, particularly as mega-cap stocks accounted for the lion’s share of large-cap returns. Our friends at Furey Research Partners recently pointed out, for example, that the median Active share for large-cap mutual funds is 57%.

However, the same Furey study notes that the median active share for small-cap mutual funds is 94%. We think this makes sense for a couple of reasons. Active share is also likely to be higher in small-cap funds because they typically benchmark against the broader Russell 2000 Index.

So while deviating from benchmarks like the S&P 500 Index and Russell 1000 Index has carried a significant performance penalty in the increasingly concentrated large-cap market of the last several years, small-cap managers operate in a vastly different environment. A related observation is that higher active share has not shown the same consistently negative correlation to performance as it has in large-cap funds. Simply put, a higher active share in a small-cap fund has not automatically implied underperformance. Of course, it also does not imply outperformance. Its value is solely as a measure of how a portfolio differs from its benchmark. And unlike the large-cap market of the last several years, it has often been an advantage within small-cap to deviate more decisively from small-cap indexes like the Russell 2000.

Small- and Large-Cap Are Very Different Markets

Royce was one of the first asset managers to think about small-cap as a professional asset class, a broad and diverse universe where one could find companies trading at attractively cheap share prices that also boasted rock solid fundamentals and strong long-term growth potential. The long-term success of several of our Funds became a proof point that the small-cap universe was home to far more stocks than risky, highly volatile and/or speculative companies.

We have also learned over the years that small-cap differs from large-cap, not only in terms of the size of the investable universe, liquidity, and volatility but also in overall performance patterns. To highlight the varying patterns that small- and large-cap have displayed over time, the chart below shows the growth of $10,000 from the inception date for both the Russell 2000 and Russell 1000 Indexes through 9/30/26:

Small- and Large-Cap Have Different Historical Performance Patterns
Growth of $10,000 for the Russell 2000 and Russell 1000 Indexes, 12/31/78-9/30/26

Past performance is no guarantee of future results.

An examination of sector and industry weightings and contributions over the last 5- and 10-year periods further underscores the differences between the two asset classes. (Contribution to Return is a performance attribution metric that measures how much each sector and industry added to or subtracted from an index’s overall return during the 5- and 10-year periods shown, taking into account both performance and the respective sector and industry weights in each index.)

Russell 1000: Total Return of 84.4% for the 5 Years Ended 9/30/26

Past performance is no guarantee of future results.

Russell 1000: Total Return of 306.1% for the 10 Years Ended 9/30/26

Past performance is no guarantee of future results.

Russell 2000: Total Return of 36.0% for the 5 Years Ended 9/30/26

Past performance is no guarantee of future results.

Russell 2000: Total Return of 155.5% for the 10 Years Ended 9/30/26

Past performance is no guarantee of future results.

These tables reveal not just differences among the top contributors at the industry and sector levels but also the wide divergence in the average weightings of each top-contributing sector and industry. Index rebalancing differs as well, allowing for more variation from year to year in the Russell 2000 as larger constituents graduate, and new entrants appear. As one might expect, the Russell 1000 had much higher levels of concentration in its top contributors. In addition, the Russell 2000 has a much higher weighting in Industrials but appreciably lower weightings in its other top-contributing sectors and industries.

We think that these differences argue for taking a differentiated and active approach in the effort to achieve benchmark-beating long-term outcomes. We would offer four Royce funds as an additional example: a core offering, a value fund, a growth fund, and a specialized small-cap subset (a micro-cap portfolio in which we would expect the choice of asset class to be reflected in higher active share):

Average Annual Total Returns as of 9/30/26 (%)

Past performance is no guarantee of future results.

Conclusion

As long-time small-cap specialists, even we were surprised by the differences in the large- and small-cap performance at the sector and industry levels. More importantly, we continue to believe that active share is highly relevant in the small-cap universe in a way it is not currently within large-cap portfolios. The overwhelming majority of actively managed small-cap funds use the Russell 2000 (or one of its style indexes) as their benchmark, which encompasses a wide range of companies with varying characteristics. The breadth and diversity of this universe naturally lend themselves to relatively higher active shares among actively managed portfolios. We think it’s also important to repeat that these measures reflect the degree to which a portfolio differs from its benchmark, not the quality of its investment decisions or its potential to outperform.

Ultimately, these findings underscore the importance of choosing a manager who practices disciplined stock selection in small-cap investing, rather than simply favoring active management or opting for a passive ETF or index fund. If one believes as we do that active management matters, then the choice of a manager is critical. We invite investors to choose wisely.

Important Disclosure Information