Coldplayed, verb
- Emotionally disappointed from being caught up in high hopes, only to be let down
- Being unintentionally exposed while cheating in public
Trouble. It’s been a tough week for people having affairs at concerts. A few key themes have risen to the surface in the process. One, there may actually be such a thing as bad publicity after all. Another, key person risk is real for more than just companies starting with “T” and ending with “esla”. But when looking past the Jumbotron sized elephant in the room, what is also highlighted is an ongoing chronic reality for investors that size may no longer matter the way it used to.
Let’s ignore the players and instead focus on the stage. Astronomer, a company that I had never heard of until just over a week ago (undiscovered), is a company that helps its client firms move and manage their data automatically and reliably so that they can run AI models and make better strategic decisions. Their clients include well known names such as Apple, Ford, Marriott, Uber, and Autodesk. While it is still unprofitable and scaling to date, it is posting triple-digit year-over-year revenue growth with an expected path to profitability within the next two years (high growth). Prior to recent headline stealing events and perhaps even after, this company is a typical up-and-comer that likely would appeal to the investor seeking to build a portfolio roster with the “next big thing”. But here’s the problem. You can’t directly own this company, because it’s not publicly traded. And it probably won’t be for at least the next two years if not longer (assuming it can shed the recent bad publicity).
The story of Astronomer (the company, not the Coldplay concert attending former CEO and head of HR) is not unique. And it continues to increasingly plague the mid-cap and small cap areas of investment markets that used to call companies like this home.
There was a time not that long ago when companies that had high growth potential would tap the public markets by listing shares of their company on the NYSE or the NASDAQ in order to raise capital to fund their next great phase of growth (remember the IPO boom of the late 1990s among others?). These companies would enter the small cap indices like the Russell 2000 and rise their way through the ranks hopefully to S&P 500 large cap greatness. For example, when Amazon went public back in May 1997, it boasted a market cap of $438 million which at the time was square in the middle of the typical small cap space. Today, it ranks as the fourth largest company in the world with a $2.4 trillion market cap including a brief stint as the largest company in the world back in 2019. Another example, a company you might have heard of named NVIDIA debuted in January 1999 with a market cap of $626 million. Small cap. Today? The largest company in the world with a more than $4 trillion market cap.
Today, the notion of “finding the next Amazon or NVIDIA” simply does not exist in any realistic way. Why? Because legions of companies like Astronomer with attractive business models and impressive growth are not going public. Instead, they are staying private for much longer. Why? Simple. The access to capital is cheaper and abundant in the private equity space, and as an owner you can remain focused on long-term strategic growth without having to answer to the short-term pressure of quarterly earnings expectations from the average Joe investor in the public market place. By the time you and your private equity supporters decide to take your company public, in many cases these companies are entering the market already in the mid-cap or large cap space. As one of many examples, specialized cloud provider CoreWeave recently entered public markets with a $23 billion market cap. Welcome straight into the big leagues. This among other reasons helps explain why we had more than 7,500 publicly traded companies in the U.S. at the end of the 1990s but only have just over 5,500 today.
This ongoing trend of the companies with leading growth potential staying private for longer (what was at one time 6-7 years on average is now as much as 11-12 years on average) has increasingly gutted what was once the higher octane area of the market in mid-cap and particularly small cap stocks, as the shiniest stars that used to help drive the higher than average returns from the space for so many decades no longer reside in this area of the market.
Consider the investor freshly coming out of the financial crisis in 2010. Disciplined and with a long-term view, they open up their Ibbotson SBBI yearbook and confirm once again the following based on returns from 1926-2009 (84 years is a solid long-term time period for reference):
- Large Cap Stocks: Annual Return 9.8%, Standard Deviation 19.6%
- Small Cap Stocks: Annual Return 11.9%, Standard Deviation 32.0%
Small cap stocks are indeed more risky than large caps (much higher standard deviation). But an investor over 84 years of history was compensated for this higher risk in pursuing the likes of the next Amazon or NVIDIA with more than two percentage points of annual returns, which if compounded over long-term periods of time adds up to a lot of extra money.
But much to the Coldplayed investors dismay starting in 2010, such has been the experience since through June 2025:
- Large Cap Stocks: Annual Return 13.7%, Standard Deviation 14.5%
- Small Cap Stocks: Annual Return 9.8%, Standard Deviation 19.8%
Small caps over the last fifteen years have delivered four percentage points less in annual returns with considerably higher risk. Ugh.
Unfortunately for small caps and mid-caps to a lesser extent, this phenomenon is not only a byproduct of more companies staying private for longer in the private equity space, but a number of other fundamental factors that include the following for those that remain in the publicly traded space:
- Slower relative growth
- Less ability to scale globally and access growth abroad
- Higher interest rate sensitivity
- Higher cost of capital
- Greater labor costs and supply constraints
- Margin compression
- Reduced liquidity, market coverage and institutional interest
These are all relatively negative competitive forces for the broad mid-cap and small cap stock spaces that are not likely to diminish anytime soon. If anything, they could become more pronounced as we continue through the remainder of the decade and beyond.
Clocks. For all of the reasons cited above, it is reasonable to justify a reduced weighting to mid-cap and small cap stocks relative to large cap stocks in a broad asset allocation model portfolios. But this does not mean that the mid and small cap space should be abandoned altogether.
The category still likely to have its bursts of relative outperformance, particularly given deeply discounted relative valuations and periodic macroeconomic tailwinds (lower interest rates, emphasis on onshoring/reshoring domestic production).
Moreover, just because the category may have relative disadvantages from a broad brush stroke perspective, selected and more targeted attractive total return opportunities will still emerge from this area of the public market place. The key is a focus on active managers with the demonstrated skill and expertise to uncover these more curated and targeted opportunities going forward.
Bottom line. The U.S. investment landscape has shifted from a size perspective since the Great Financial Crisis. The reward of higher annual returns for the risk of owning smaller company stocks has given way to large cap return dominance along with lower risk, and these trends may continue for the foreseeable future. This helps justify a reduced allocation to mid-caps and small caps in asset allocation portfolios. With that said, more targeted outsized return opportunities along with short-term periods of relative outperformance will continue to exist in the space, supporting a continued, more specialized allocation at a lower overall weight.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Investment advice offered through Great Valley Advisor Group (GVA), a Registered Investment Advisor. I am solely an investment advisor representative of Great Valley Advisor Group, and not affiliated with LPL Financial. Any opinions or views expressed by me are not those of LPL Financial. This is not intended to be used as tax or legal advice. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Please consult a tax or legal professional for specific information and advice.
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