The Unconventional Appeal of Small Caps for Unconventional Times
David Swensen, the late and legendary CIO of Yale’s endowment (1985-2021), knew a thing or two about navigating uncertainty. His approach to investing wasn’t about chasing the flavor of the month, but about long-term vision and the power of diversification into sectors and asset classes most wouldn’t consider. Swensen was a pioneer, championing unconventional investments like hedge funds, real estate, and private equity long before they became mainstream. And his returns spoke for themselves: an annualized gain of 13.7% per annum, outperforming the average endowment (as measured by Cambridge Associates) by 3.4% per annum.
Fast forward to today, with earnings season in full swing and a US election less than two weeks away that’s sure to rattle the markets, the need for unconventional thinking has never been clearer. Headlines this past week have been quick to spotlight the fading small-cap rally, citing economic soft spots and rising interest rates as reasons to avoid. But that’s only part of the story. Historically, small caps have been the underdog that rises during periods of recovery. They’re scrappy, nimble, and have the flexibility to pivot faster than their much larger counterparts.
To be sure, some small caps have delayed going public over the past 12-24 months due to market uncertainty and the upcoming election. However, this delay has created a significant window of opportunity especially for investors who know where to look. As private equity allows some to grow behind the scenes, publicly traded small caps may be undervalued gems waiting for the right moment to shine.
As Swensen emphasized, measuring success isn’t about one year’s returns, but the long game. In times like these where a potentially contentious election looms and uncertainty reigns in the markets, now is the time to embrace the unconventional. Small caps may not be everyone’s cup of tea, but for those willing to steep their bags a little longer, they could become the unexpected favorite in a well-diversified portfolio.
