U.S. small cap equities are coming off the strongest start to a year in more than three decades. At the same time, the Russell Indexes’ first 2026 reconstitution took effect at the end of June, with a second one scheduled for December.
What was once an annual rebalance is now happening twice a year; a shift that arrives at an especially interesting moment for smaller stocks. Small and microcap stocks have led all of U.S. equity of late, with the small cap Russell 2000 Index’s 41% return over the last year ending June 30 nearly doubling the 22% returns of the large cap Russell 1000.
Even more impressive, the Russell Microcap Index is up 59% over the same period. The strong performance run from small and microcap stocks has contributed to this summer’s annual reconstitution having a larger impact on investor exposure relative to the Microcap Index compared to recent years, and we believe smaller stocks are still in the early innings of a favorable market environment.
Incredibly, the Russell Microcap Index’s weighted average market cap peaked at $2.5 billion in June, which is larger than where the small cap Russell 2000 was just a decade ago. For those unfamiliar, the Russell Microcap Index is comprised of the smallest half of the Russell 2000 Small Cap Index (the smallest 1,000 stocks) plus a few hundred additional smaller ones. Meanwhile, the Russell 2000 hit an all-time high of $8.6 billion weighted average market cap in June. This is larger than several stocks in the S&P 500 Index, the standard-bearer for large-caps.
For advisors and their clients, the clear message is that the microcap and small-cap universes you may have shied away from a decade ago are completely different as we hit the midpoint of 2026, and they have the benchmarks to prove it.
Stock Constituent Shakeup
During last month’s Index reconstitution, the small cap universe parted ways with many high-flying stocks while simultaneously welcoming a significant number of new entrants. Notably, the Russell Microcap Index added 252 new stocks. This was the largest cohort of new entrants into the Microcap Index in nearly half a decade. It also marks a roughly 50% increase over last summer’s influx of new stocks. The Index also waved goodbye to 154 securities, resulting in a net increase of nearly 100 constituents, which counters the argument that the pool of small, public stocks is dwindling.
Meanwhile, the Russell 2000 moved back toward its standard 2,000 constituent target, with 244 new entrants (throughout the year, the name count drifts down mainly due to M&A). Roughly one-third of those new entrants are stocks from the Microcap Index moving into the Russell 2000, with the rest a blend of IPOs, a few dozen that have moved from large cap, and a variety of stocks that have gained eligibility for inclusion since the last reconstitution took effect. Perhaps most importantly, particularly for those advisors who are increasingly concerned about overexposure to artificial intelligence, the technology sector is slated for reduced representation, while both financials and consumer discretionary are experiencing modest increases.
Post-Reconstitution Outlook for Microcap
Particularly encouraging is the underlying quality of the new microcap entrants, as a larger proportion of newcomers boast positive earnings compared to those leaving the Index. Consequently, the Microcap Index experienced a meaningful improvement across key fundamental metrics, including a roughly 4% increase in both return on equity and operating margins, with reduced leverage across the Index.
Most Microcap Index constituents will once again be profitable companies as well, while valuations are declining across the board. Better companies and cheaper multiples make for an appealing combination and an environment that should bode well for the active managers who specialize in small and microcap stocks.
Why the New Semiannual Schedule Matters
In recent years, several small and microcap stocks grew so quickly they created an immediate and distortive impact on their respective indexes. Increasing the frequency of index reconstitutions helps combat this anomaly. Semi-annual updates allow fast-growing stocks to “graduate” into the proper index more quickly, resulting in a more accurate representation of the stock universe each index is meant to capture. This provides both asset managers and advisors with clearer, more consistent exposures when passively investing, and more accurate benchmarking when actively investing in small and micro stocks.
The semi-annual reconstitution schedule also allows new entrants into the indexes at a faster pace, further enhancing the integrity of the small and microcap indexes. Historically, several public companies could meet the market cap criteria for inclusion but were ultimately excluded from the indexes because they did not meet one of the other criteria (float, nationality determination and share price are common reasons). Now, companies will have a faster path to inclusion as they address the criteria that need attention.
While SPACs and “blank check” companies are excluded from the Russell Indexes, companies that go public via a SPAC are eligible but can temporarily be stuck in index purgatory as they await the next reconstitution. Having an additional reconstitution date in December brings these companies into the indexes half a year earlier than they previously would have been.
Diversify with Better Benchmarking
Clearly, these are not the small and microcap stocks of years past, and it is heartening to see the key indexes against which these categories are benchmarked making changes to keep up with the times. This reconstitution acts as a healthy pruning, paring stocks that don’t represent the small-cap universe anymore and creating room for emerging companies. The result is a more expansive, representative index for investors and money managers.
For advisors with clients clamoring for diversification (or perhaps for those advisors clamoring to get their clients to diversify), all these facts could make this the right time to take a fresh look at the role small and microcap stocks can play in a portfolio.