62%
of small cap fund assets are passive, up from 40% a decade ago
-40%
small cap valuation discount vs. large caps, bottom 4th percentile since 1990
A Russell 2000 ETF holds every company in its index regardless of whether it trades at five times earnings or fifty. It cannot overweight the cheap ones. It cannot underweight the expensive ones. It buys the whole bucket.
For companies below the index threshold, the effect is more extreme. The active capital that might have discovered them has not been replaced. It has simply gone elsewhere.
-40%
$1T+
The shift from active to passive investing is one of the most consequential structural changes in the history of capital markets, and its consequences have not been distributed evenly. In August 1996, twenty years after the launch of the first publicly available index fund, passive vehicles held 6% of US-domiciled equity mutual fund and ETF assets. By end of May 2024, that figure had grown to nearly 60%.
In the small cap segment specifically, the concentration is sharper still. As of August 2024, 62% of small cap fund assets are held in passive vehicles, up from 40% a decade earlier. Active equity funds overall suffered more than $1 trillion in net outflows in 2025, the eleventh consecutive year of redemptions and the steepest of the cycle. The investor base that historically existed to identify, research, and price small cap companies has been systematically replaced by vehicles that, by mandate, cannot perform that function.
The rise of passive in small caps
Share of small cap fund assets in passive vehicles, 2014–2024
Source: Osterweis Capital Management, citing Morningstar / Morgan Stanley Wealth Management, data through August 31, 2024.
The mechanism is straightforward and worth stating precisely. A Russell 2000 ETF holds a position in every company in its index weighted by market capitalisation. It cannot overweight the cheap ones. It cannot underweight the expensive ones. It does not analyse fundamentals. It does not initiate coverage, build models, or take a view. When it receives inflows, it buys the whole index. The price of any individual constituent is, to a passive fund, entirely irrelevant.
For companies inside index thresholds, this at least means there is a steady and substantial ownership base. For companies below the index threshold (the sub-$300 million universe where most of the valuation distortion sits), the situation is more extreme. These companies are not in the passive bucket at all. The active capital that might have discovered them, researched them, and paid fair value has not been replaced. It has simply gone elsewhere.
The data on passive ownership share also understates the true picture. Chinco and Sammon, writing in the Journal of Financial Economics in 2024, estimate the true passive ownership share of the US market at approximately 33% of all equity, roughly double the ~16% figure reported by the Investment Company Institute, once closet indexing and de facto passive behaviour by nominally active managers is accounted for. The active investor base that once dominated small cap ownership is smaller than any standard metric suggests.
The small cap valuation discount relative to large caps stood at -40% at the end of 2024, against a historical median of -5%. Research Affiliates places this in the bottom 4th percentile of all observations since 1990. On a forward price-to-earnings basis, small caps trade at approximately 14x against large caps at 20x, a 30% premium commanded by large caps. Wellington Management documents that the current cycle of small cap underperformance has now lasted thirteen years, against a historical average cycle length of twelve years.
Small cap valuation discount vs. large caps
Forward P/E comparison and historical context, end-2024
Sources: Research Affiliates, 20255; Wellington Management, 2024. Historical median -5% vs current -40% discount. Bottom 4th percentile since 1990.
The conventional counterargument to a structural explanation is cyclical: prior discount cycles of similar depth have always reverted. Active managers eventually notice the gap, deploy capital to exploit it, and prices recover. Mean reversion has been documented consistently across decades of small cap data.
Three things are structurally different in this cycle.
First: the correction mechanism has been displaced.
Prior small cap discount cycles were corrected by active investors: deep value managers, small cap specialists, and event-driven funds that took meaningful positions in overlooked companies and held them until prices recovered. That capital base has been the precise segment of the market that passive investing displaced first and most completely. Active equity fund outflows are not a cyclical phenomenon: they are structural. The investor who would have bought these cheap small cap companies has been replaced by an investor who, by design, buys the S&P 500 regardless of price.
Second: academic evidence now directly links passive ownership to impaired price discovery.
Höfler, Schlag, and Schmeling, in research presented at the SFS Cavalcade 2024 and funded by the German Science Foundation, find using the full CRSP/Compustat sample that stocks with high passive ETF ownership show significantly stronger price reversal patterns than those with low passive ownership, consistent with the interpretation that high passive ownership reduces stock liquidity and price informativeness.
Jiang, Vayanos, and Zheng, writing in the Review of Financial Studies in 2024, develop a theoretical framework in which the growth of passive investing makes active investors more risk-averse, specifically reducing their willingness to correct mispricings in individual stocks as the passive share grows. Brightman and Harvey, in "Passive Aggressive: The Risks of Passive Investing Dominance" (May 2025), conclude that "escalating passive dominance reinforces a feedback loop in which passive inflows perpetuate price trends, active managers underperform, and capital shifts further into passive strategies."
An earlier UCLA Anderson working paper using mutual fund holdings data finds that passive fund trading generates significant price reversals in subsequent quarters, while active fund trading generates return continuations, direct evidence that passive capital moves prices away from fair value rather than toward it.
Third: the active managers who remain in small cap are demonstrably skilled, and still losing assets.
Morningstar's Active/Passive Barometer for December 2024 reports a 26% ten-year success rate for active small cap managers against their passive peers, substantially above the 7% success rate for active large cap managers. Active small cap investing works. The data is clear. Yet passive has still captured 62% of small cap fund assets. The migration of capital to passive is not primarily a response to active skill failure in small caps. It is a structural preference for low costs and simplicity that is indifferent to where active management actually adds value.
The index construction dynamic compounds the problem further. Dimensional Fund Advisors documented in 2024 that on average between 2010 and June 2023, approximately 25% of the Russell 2000 was composed of the largest 1,000 stocks in the Russell 3000. Companies that graduate out of small cap indices take passive capital with them. Companies that fail to meet index thresholds attract no passive capital at all. The index boundary functions as a hard floor on institutional attention.
By the numbers
33%
True US passive ownership share, double the ICI headline figure of ~16%, once closet indexing is accounted for (Chinco & Sammon, JFE 2024)
Passive vs. active: small caps
62% of small cap fund assets are now passive (vs. 58% large cap, 44% mid cap)
Active small cap funds: 11 consecutive years of net outflows through 2025
Russell 2000: ~25% composed of large-cap stocks from Russell 3000 on average
Sub-$300M companies: excluded from index thresholds entirely
Key source
Chinco & Sammon, Journal of Financial Economics, 2024
Osterweis / Morningstar, Aug 2024
American Century / Morningstar, Oct 2024
The Structural Argument
The implication is that the structural discount in sub-$300 million public companies will not be corrected from within the public market. It will be corrected, company by company, by transactions (acquisitions, going-private deals, or partnership structures) that remove these companies from the public market and unlock the value that passive investing has indefinitely deferred.
Altuva was built to be the counterparty for precisely this transaction: a listed, board-friendly platform that partners with management to unlock value that the market has structurally decided not to price.
The passive revolution has been enormously beneficial for the investors who own large cap index funds. For the companies that sit below the index threshold, it has produced something different: a permanent underclass of public companies, generating cash, operating profitably, and carrying fundamental value that the market, by structural design, has stopped paying attention to.
That persistent inattention is where Altuva operates.
The equilibrium
14x
Forward P/E for small caps vs. 20x for large caps, a 30% discount persisting without the active investor base that would historically have closed it
Where Altuva operates
Sub-$300M listed companies, below index threshold, no passive ownership
No analyst coverage, no institutional base, no active capital targeting them
Discount structural, not cyclical. The correction mechanism has been removed
Altuva partners with boards to unlock value that the market has stopped pricing
Where Altuva
Operates
The 13-year duration of the small cap underperformance cycle is not evidence that reversion is imminent. It is evidence that the mechanism that would produce reversion has been structurally reduced.
Active equity funds experienced $1 trillion in outflows in 2025 alone. The supply of patient capital willing to take positions in overlooked sub-$300M companies has declined in every year since 2015.
The discount will not be corrected from within the public market. It will be corrected transaction by transaction.
The capital structure of public equity investing has bifurcated in a way that is structural rather than cyclical. The large cap end of the market is overowned by passive vehicles that reinforce valuation premiums regardless of fundamental merit. The small cap end (and particularly the sub-$300M universe below index thresholds) is underowned by the only type of investor capable of correcting the discount.
Passive investing created this condition gradually, over two decades, as flows migrated from active managers who priced individual securities to index vehicles that do not. The academic evidence on the consequences (reduced price informativeness, impaired liquidity, persistent mispricing) has accumulated to a point where the structural nature of the gap is no longer contested.
What the market will not price fairly, Altuva partners with boards to unlock. That is the only mechanism available to the companies that passive investing left behind.
Sources & Footnotes
American Century Investments, "Passive Investing & Stock Prices: Myth vs. Reality," October 14, 2024. Citing Morningstar data: passive mutual funds and ETF assets grew from 6% of equity fund assets in August 1996 to nearly 60% by end of May 2024.
americancentury.comOsterweis Capital Management, "Small Cap Investing: Act on Active, Pass on Passive," September 26, 2025. Source: Morningstar, Morgan Stanley Wealth Management Global Investment Office, data through August 31, 2024. "Currently, 62% of small cap funds are passive, compared to 40% in 2014."
osterweis.comLarry Swedroe, "Active Managers Keep Losing as Passive Investing Grows," Substack, February 13, 2026. "Active equity mutual funds experienced more than $1 trillion in outflows in 2025, the 11th year of net outflows and the steepest of the cycle."
larryswedroe.substack.comAlex Chinco (Baruch College) and Marco Sammon (Harvard Business School), "The Passive-Ownership Share Is Double What You Think It Is," Journal of Financial Economics, Volume 159, 2024, Article 103875. True passive ownership share estimated at ~33% of US market via reconstitution-day volume methodology.
sciencedirect.comResearch Affiliates, "Small Caps, Big Opportunities: Investing Beyond Large-Cap Stocks," 2025. "At the end of 2024, the valuation discount of US small caps relative to a portfolio of US large- and mid-cap stocks stood at -40%. This is a deep discount relative to the historical median level of -5%, standing in the bottom 4th percentile since 1990."
researchaffiliates.comWellington Management, "A Turning Point for US Small Caps," April 2024. Forward P/E: small caps 14x vs. large caps 20x. Thirteen-year underperformance cycle, against a historical average cycle length of approximately 12 years (range: 6 to 16 years).
wellington.comPhilipp Höfler, Christian Schlag, and Maik Schmeling (Goethe University Frankfurt / CEPR), "Passive Investing and Market Quality." Presented at SFS Cavalcade 2024. Funded by German Science Foundation (DFG). "Stocks with high passive ETF ownership have much stronger reversal than those with low passive ETF ownership, which lends credence to the view that PO reduces stock liquidity and price informativeness."
aeaweb.orgThummim Cho, Jiang, Vayanos, and Zheng, "Passive Investing and the Rise of Mega-Firms," Review of Financial Studies, Volume 38, Issue 12, 2024. Documents active investors becoming too risk-averse to correct overvaluation as passive share grows.
academic.oup.comChris Brightman and Campbell Harvey, "Passive Aggressive: The Risks of Passive Investing Dominance," May 2025. As summarised by Alpha Architect, "Passive Investing Dominates, But Are There Risks?", July 25, 2025.
alphaarchitect.com"Active vs. Passive Investing and the Efficiency of Individual Stock Prices," UCLA Anderson Working Paper. "Passive fund trading has a negative impact on stock liquidity, while active fund trading generates return continuations." Trading by passive funds generates significant price reversals during subsequent quarters.
anderson.ucla.eduMorningstar, "Measuring the Performance of Active Funds Against Their Passive Peers," Active/Passive Barometer, December 2024. "Just 7% of [large-cap active funds] survived and beat their average passive rival over the decade through December 2024. That fell well short of the 22% and 26% success rates for active mid- and small-cap managers, respectively."
morningstar.comDimensional Fund Advisors, 2024 study. Cited in Alpha Architect, July 2025. "On average from 2010 through June 2023, roughly 25% of the Russell 2000 Index was composed of the largest 1,000 stocks in the Russell 3000 Index."
alphaarchitect.com
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