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Equities

Mid caps are the new small caps

February 26, 2026 - 5 min
Dan Hughes
Dan Hughes
Vice President, Distribution / Business Development – Vaughan Nelson Investment Management

Key takeaways

  • Structural changes – such as regulatory shifts and the expansion of private equity – have slowed the flow of young companies entering public markets, reducing the historical replenishment cycle that once supported strong small cap performance.
  • Companies are staying private much longer, reshaping the investable universe. Late stage private equity has become the primary funding source for many growing companies, leading them to go public at a much later stage and often skipping the small cap phase entirely.
  • As higher quality companies enter public markets directly as mid caps, we see the mid cap segment gaining relative quality.

Conventional wisdom has long held that investing in small-capitalization stocks typically rewards investors with excess returns. Generally speaking, the historical record supports this principle, as small caps have outperformed large caps over most extended market periods. However, structural changes have emerged in the small-cap universe that imply the returns of the past may not extend to the future.

The small-cap universe has traditionally been fertile ground from which relatively young, promising companies can raise capital. The public markets have typically offered depth, liquidity and valuations at a considerable premium not easily found in the private market. These benefits have outweighed the demands placed on public companies: reporting requirements, quarterly scrutiny, and often steady pressure from investors to meet growth and profitability targets.

Over the past two decades, regulatory changes and a significant expansion of private equity funding have altered the cost-benefit profile of public equity. As companies remain private longer, the small-cap universe suffers a decline in the replenishment cycle. Historically, a steady influx of new companies has been instrumental in continually invigorating the small-cap universe with opportunities; however, the inflow of new public companies has slowed markedly.

Furthermore, the composition of the IPO market changed. From 1980 to 2000, small firms represented 61% of all IPOs. Between 2001 through 2025, only 43% of IPOs comprised small companies.

Fewer small companies are going public

The private market has stepped in to fill the funding requirements of small companies. The mechanism by which a growing number of small companies is funded shifted from the public market to late-stage private equity.

Moreover, companies are now staying private longer. In 2025, the median age of a venture-backed company going public was 12 years, twice as long as in 2000 (six years).

Private markets are supporting late-stage growth

Implications

Investors seeking the absolute returns generated historically by the small-cap universe may be well served to pursue a barbell approach: Allocate to late-stage private equity and to mid-cap public equity in lieu of small-cap public equity. Dedicating capital to late-stage private equity allows investors to gain access to those growing, valuable small companies now delaying their access to the public markets. Allocating to mid-cap public equity provides the investor access to growing companies when they enter the public market as mid-cap companies after bypassing the small-cap public-company stage altogether.

The mid-cap space has traditionally offered a more attractive risk-return profile than the small-cap universe due to superior-quality companies (e.g., higher return on assets, better earnings growth). As the more alluring companies enter the public markets as mid caps, the mid-cap space will likely increase in quality relative to small caps, and the return differential may widen further. Because of these dynamics, public market investors should expect mid caps to outperform small caps in the current environment. As a result, we categorize the present phenomenon as “mid caps are the new small caps.”

Investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.

The views, information, and/or opinions expressed in this commentary are solely those of the individuals involved and do not necessarily represent those of Vaughan Nelson and its employees. Vaughan Nelson does not verify and assumes no responsibility for the accuracy of any of the information contained in the commentary. The primary purpose of the information, opinions, and thoughts presented in this commentary is to educate and inform. This commentary does not constitute professional investment advice or services, and any reliance on the information provided is done at your own risk. Past performance is not an indication of future performance. Securities discussed in this commentary may be held in the Vaughan Nelson strategies.

NIM-02172026-wtdz6v8k

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