Amid market volatility, experts see opportunities in small and mid-cap equities
June 25, 2025
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4 min read
Recent market dynamics, including significant volatility and a growing disparity in the valuation of small to mid-cap (SMID) and large companies globally has created attractive opportunities for investors willing to look beyond the market's biggest companies to seek more robust returns.
Global stock markets, including the Australian bourse, are currently undervaluing a significant number of small, rapidly expanding companies that possess immense growth potential. This follows a huge influx of investors’ money into large companies in recent years, most of all large tech stocks in the US, boosting their values. However, it is innovative and fast-growing small and mid-cap companies that will likely deliver the most handsome returns to investors over time.
Moreover, with a greater number of mergers and acquisitions (M&A) expected this year, that will likely support valuations for smaller companies, according to these three experts.
Tim Murphy, Co-CEO of Genium Investment Partners, a boutique asset consultant and research ratings house, says an increasing interest in small caps stocks over the past year has been driven in part by the "almost unprecedented gap" between the valuation of large and small caps globally. The correcting of this gap over time suggests good opportunities for investors over the medium to longer-term.
“On top of that valuation gap opportunity, we also see a fundamentally more diverse opportunity set within SMID equities. Certainly, we think that is where the best relative opportunities are,” says Mr Murphy.
“From a Genium perspective we've been allocating money and adding exposures over the course of the last 12 months to small caps across the board, both globally and domestically.”
Mr Murphy points to a notable trend during recent market pullbacks; small caps have, somewhat unusually, outperformed large caps in a ‘risk off’ environment. He attributes this partly to the increasing concentration of investment in large-cap companies, which is now likely to be reversed as concentration in large caps diminishes.
Opportunities in Australian SMIDs
In terms of the Australian market, Lucas Goode, a Portfolio Manager at IML, which specialises in Australian quality and value equities, says greater flows into large caps has left smaller caps behind, particularly those outside the S&P/ASX 100.
While this dispersion can be frustrating, Mr. Goode views the SMIDs opportunity as offering ‘future alpha’, in that fundamentals will eventually be recognised by the stock market and the valuation gap will close.
“You can only stretch the rubber band so far and it will snap back, because fundamentals always win out. And I think that's been exacerbated now when you do have these market disruptions like Liberation Day. Indeed, the current volatility can be thought of as ‘an active manager's friend’,” says Mr Goode.
“It really is happy hunting ground for us at the moment. If you look at the ASX as a whole, the market is fully priced. But that is driven by the banks and some large cap tech companies. Once you get below that level, we see several high-quality industrials with good earnings growth, great competitive positions, strong management teams, trading at single-digit to low double-digit price-to-earnings ratios with attractive yields.”
Mr Goode likes healthcare stocks such as Integral Diagnostics and Australian Clinical Labs, noting that a Labor majority government could be positive for public health spending. TPG Telecom also appeals for its defensive qualities and potential capital return while Austal’s large order book is attractive and the defence company was until recently trading at a discount to its Net Tangible Assets (NTA), which is a good example of the kind of mispricing found outside the large-cap universe.
SMIDs valuations will catch up
However, quality companies will not stay cheap forever, as pricing will eventually catch up to fundamentals, Mr Goode says. With lower interest rates too, more M&A activity is likely, which could push up SMID valuations and add to shareholder returns.
“Quality doesn’t stay cheap forever; M&A activity has been accelerating over the last 18 months and with that ongoing, some SMIDs will become likely future M&A targets,” he says.
From a global perspective, Chris Wallis, CEO and CIO of Vaughan Nelson Investment Management, says his investment focus is on companies earning a positive return on capital but which are undervalued. Wallis focuses on stocks which meet at least one of three criteria: undervalued earnings growth, undervalued asset, or undervalued dividend yield. His approach combines top-down macro factors with bottom-up stock selection.
“Importantly, the current market environment, characterised by valuation disparities and volatility, appears to favour the approach of patient, fundamentally-driven active managers in the SMID space,” he says.
“We think the market will reward patient investors. Essentially, all we do is trade time for value. We seek 50% returns over a three-year period with only 10 or 15% downside,” says Mr Wallis. That downside protection is provided by a strong emphasis on capital allocation and avoiding value traps.
Despite their label, global small and mid-caps are not really small at all. The global SMID cap index (MSCI ACWI SMID) has nearly 7,500 companies, and their market capitalisation ranges between US$100 million to US$65 billion, with an average of US$12.8 billion. That makes them attractive, according to Mr Wallis.
“These are established businesses and there's nothing speculative in this space. SMIDs also offer a very high return on assets (ROAs), with high single-digit ROAs, provided by very profitable businesses that can self-fund their own growth,” he says.
“Still, the sheer size, and diversity, of the global small and mid-cap market makes it much more difficult for investors to pick stocks. That’s why high quality, in-depth stock research is so important. Many companies are under-researched, and not well understood by the market in general. Active fund managers, like Vaughan Nelson, are best placed to find companies that have been mispriced by the market, and which are likely to perform better in the medium to long term.”
The data backs up the outperformance of SMIDs, which are often described as the ‘sweet spot’ in the company life cycle; their growth prospects are stronger than those of more mature businesses. As the table below shows global SMIDs have significantly higher returns on a historical basis, without much more volatility.
