Catherine Yoshimoto
Confusing headlines on US small caps
Recent US small-cap headlines have a familiar rhythm. When small caps lag the broader equity market, the story is “small cap is broken”. When small caps start to rebound, the story often shifts to “small cap is back, but only the better smaller companies”.
In some recent advisor-facing commentary, that second narrative is frequently paired with a benchmark debate: is the Russell 2000® Index “lower quality” because it includes a meaningful share of unprofitable companies? And are other competing indexes “better” because they apply a quality screen, such as company profitability, to constituents?
This is a useful moment to separate two different questions that are often mixed up to the detriment of understanding. First, what does the benchmark represent? Second, what characteristics do you want to tilt toward within that benchmark’s opportunity set? Those are not the same decision—and investors should consider the two questions separately.
What the Russell 2000 is built to represent
At a high level, the Russell 2000 is designed to represent the investable US small-cap segment, drawing from the whole US equity universe.
To get into that universe, a company must meet certain standards. It needs US nationality, its shares must trade on an eligible exchange, and it must pass minimum share price, market capitalization, free float and voting rights thresholds.
To build the Russell indexes, we then rank stocks in the eligible universe by market cap. In our framework, the Russell 3000® Index represents the broad market, the Russell 1000® Index represents the large-cap cohort and the Russell 2000 represents small caps. Each segment is defined by transparent, easy-to-understand rank and cut-off rules, rather than discretionary selection.
The design choice matters for advisors because it answers a basic client question cleanly: “What part of the market does this benchmark measure?”
As a representative small-cap benchmark, the Russell 2000 is meant to reflect the small-cap market as it exists. That includes companies that are earlier in their business lifecycle, reinvesting heavily, in cyclical troughs or simply not yet profitable.
When you see statistics like “around 40% of Russell 2000 constituents are unprofitable” it is easy for that to sound like a flaw in the index. Another way to read it is more neutral and more accurate. It is a description of the investable small-cap market at a point in time.
It goes without saying that investors who had insisted on a profitability screen in earlier decades of the Russell 2000’s life would have missed out on some of the great US equity growth stories in history.
Russell’s US equity indexes added fast-growing (but not initially profitable) tech stocks like Microsoft, Amazon, Netflix, Alphabet and Google up to a decade before competing US equity benchmarks.
Why “unprofitable” shows up in small cap, even in bull markets
Let’s dig into the last point further. Small-cap universes naturally include more companies that are earlier stage, more levered to the economic cycle and more dependent on capital markets for funding than large-cap universes. Profitability is not evenly distributed across the market-cap spectrum, and it changes through the cycle.
Eliminating unprofitable companies may be a sensible investment choice, but it’s a blunt portfolio construction tool. A profitability screen does not tell you why certain companies were unprofitable, how dispersed their losses were, whether they are concentrated in specific sectors—and, most importantly, what the prospects for those companies are.
The US equity market is the world’s deepest and largest because it is open to corporate ventures. Investors have a long history of funding start-ups with equity capital, rather than bank loans or debt, as in other markets. Some of those start-ups have failed. Others have repaid early investors very handsomely.
What if I want only profitable small caps?
Of course, some investors and advisors may want to superimpose a quality screen on the US small-cap segment, rather than going for a broad benchmark like the Russell 2000. Our recently designed Russell 2000 Earnings Leaders index allows index users to apply a quality lens to small caps, one that emphasises profitability and operational strength.
The key point is not that one index approach is inherently “right” and the other is “wrong”. The point is that they are measuring different things. One is a US small-cap benchmark. The other is a strategy index that draws from the small-cap benchmark universe.
A profitability screen may work well if investors buy into quality at the right time. It can also introduce selection effects that make performance comparisons hard to interpret without context, because you are no longer comparing the same opportunity set.
Market representation should be the starting point in conversations
For advisors, client communication should start with reframing the conversation from “unprofitable companies” to a definition: benchmark or index?
The Russell 2000 is a benchmark that’s designed to represent small cap as a market segment. If you want to emphasize quality within small cap, you can do that through an intentional quality-tilted strategy, but the benchmark itself is meant to define the segment, not pre-filter it.
That is also why rules-based transparency matters. When small-cap leadership shifts or profitability cycles change, a benchmark build on rules-based market representation gives advisors a consistent reference point. The small-cap segment is consistent, even when the narrative around that segment changes.
A timely governance note for 2026
There is also an operational story worth remembering as 2026 progresses. The Russell US Indexes reconstitution will move from an annual to a semi-annual frequency this year, with reconstitution in June and December (rather than in June alone). This will help our indexes maintain accurate representation in a more dynamic market environment, while preserving disciplined governance.
Bottom line
The Russell 2000’s inclusion of unprofitable companies is not a bug in the index. It is a consequence of representing the investable small-cap market as it exists. When “quality” narratives circulate, the advisor opportunity is to clarify the difference between a benchmark’s job (define the market segment) and a strategy’s job (tilt within that segment). There’s a need in most advisors’ client conversations to discuss both benchmark and strategy – but it’s a good idea to keep those discussions separate.
Disclaimer
© [2026] London Stock Exchange Group plc and its applicable group undertakings (“LSEG”). LSEG includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. “FTSE Canada”, (4) FTSE Fixed Income LLC (“FTSE FI”), (5) FTSE (Beijing) Consulting Limited (“WOFE”), FTSE EU SAS ("FTSE EU"). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, FTSE FI, WOFE, FTSE EU and other LSEG entities providing LSEG Benchmark and Index services. “FTSE®”, “Russell®”, “FTSE Russell®”, “FTSE4Good®”, “ICB®”, “Refinitiv”, “WMR™” “FR™” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of LSEG or their respective licensors.
FTSE International Limited is authorised as a Benchmark Administrator and regulated in the United Kingdom (UK) by the Financial Conduct Authority ("FCA") according to the UK Benchmark Regulation, FCA Reference Number 796803. FTSE EU SAS is authorised as Benchmark Administrator and regulated in the European Union (EU) by the Autorité des Marches Financiers (“AMF”) according to the EU Benchmark Regulation.
All information is provided for information purposes only. All information and data contained in this publication is obtained by LSEG, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical inaccuracy as well as other factors, however, such information and data is provided "as is" without warranty of any kind. No member of LSEG nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or LSEG Products, or of results to be obtained from the use of LSEG products, including but not limited to indices, rates, data and analytics, or the fitness or suitability of the LSEG products for any particular purpose to which they might be put. The user of the information assumes the entire risk of any use it may make or permit to be made of the information.
No responsibility or liability can be accepted by any member of LSEG nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any inaccuracy (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of LSEG is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of LSEG nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this document should be taken as constituting financial or investment advice. No member of LSEG nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset or whether such investment creates any legal or compliance risks for the investor. A decision to invest in any such asset should not be made in reliance on any information herein. Indices and rates cannot be invested in directly. Inclusion of an asset in an index or rate is not a recommendation to buy, sell or hold that asset nor confirmation that any particular investor may lawfully buy, sell or hold the asset or an index or rate containing the asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index and/or rate returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index or rate inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index or rate was officially launched. However, back-tested data may reflect the application of the index or rate methodology with the benefit of hindsight, and the historic calculations of an index or rate may change from month to month based on revisions to the underlying economic data used in the calculation of the index or rate.
This document may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of LSEG nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of LSEG. Use and distribution of LSEG data requires a licence from LSEG and/or its licensors.
