Definitions matter. We learn this in elementary school, if not before, as we are tested on our ability to connect vocabulary words to brief descriptions. Then, the definitions feel absolute, unambiguous, and concrete. However, as we develop and progress into reality, we realize that definitions are relative, ambiguous, and abstract in many instances of life. This situation is the case and, therefore, the plight of the investment advisor.

While this subject could take many forms and pursue different avenues, we will focus on Equity allocations within portfolios.

First up: equity capitalization.

If you flip open to page six of an “Investments” textbook in college, there’s a fair chance the authors have begun discussing market capitalization. With that, they’ve begun discussing what classifies a stock as large cap, mid cap, or small cap. The textbook definition for these classifications is: large-cap companies have $10+ billion market capitalizations, mid-cap companies have market capitalizations between $2 billion and $10 billion, and small caps are those under $2 billion.

In 2025, as the market darlings have surpassed $3 trillion in market capitalizations, with a few surpassing $3.5 trillion, we can hardly say that a $10 billion company is in the same league as a $3+ trillion company. While colloquially, we separate some companies by categorizing them as mega caps, most advisor software, built with end-clients in mind, simplifies equity capitalization to large, mid, and small.

So, how should we interpret equity capitalizations, and why does it matter?

It matters because not all funds (mutual funds, ETFs, SMAs, etc.) are allocating within the same parameters, and these differences around definitions impact portfolio construction.

To understand equity capitalizations, we must examine how the index and providers define them. The variations in definitions are similar to those in coffee shops – where one might call a size large, another calls it venti, and where one says medium, another says grande. But how big is a large one? And what's the difference between a venti and a grande? Beware: unlike ordering in a coffee shop, market capitalization is an inherently murky topic - there are overlaps of capitalization within the definitions provided by S&P and Russell. The S&P indices employ a committee-based approach for selecting its constituents, requiring companies to meet specific criteria. There is, therefore, an implicit quality factor built into the indices. In contrast, the Russell and CRSP indices use a rules-based methodology based primarily on market capitalization. While not a major index provider, Morningstar provides the bulk of fund data for advisor software, in which their classifications are used.

These definitions and categorizations result in the below indices from S&P, Russell, and CRSP. The broadness of the indices is not only exemplified by the number of constituents but by the market capitalization as well. For example, the large cap indices: The S&P 500 has an average market cap of $349 billion, and the smallest company in the index has a market cap of $11.6 billion. The Russell 1000 has an average market cap of $265 billion, and the smallest company has a $2.4 billion market cap. The CRSP US large cap index has an average market cap of $362 billion, with the smallest company having a market cap of $554 million.

As portfolio managers, allocating across indices or strategies benchmarked to indices is crucial. Unfortunately, software systems often simplify information for our end clients, leading to the adage "what gets measured gets managed." We must stay informed about the differences between these indices, understand how these allocations affect our clients' portfolios, and recognize their impact on performance statements. We've experienced a very narrow market in recent years but now might be the right time to consider broader, less concentrated exposures for your clients.

Jared M. Orr, CFP® is a Portfolio Strategist at an asset management company.

Editor: Greg Filbeck, CFA, FRM, CAIA, CIPM, PRM, Samuel P. Black III, Professor of Finance & Risk Management, Penn State Erie, mgf11@psu.edu