Global small and mid caps: the overlooked middle child of equities

For much of the past 15 years only one trade has mattered in global equities – US large caps. Over time US mega-cap tech companies grew and grew and, like giant planetary bodies, they pulled more and more capital into their orbits. Investors grew richer and richer and more and more money flowed in until US exceptionalism became an unquestioned truth. Towards the end of 2024, the US stock market made up more than 60% of global market capitalisation¹, its highest point in more than 40 years².

Things have changed in 2025. The global macro-economic and geopolitical landscape has gone through its most intense period of change in decades. Unquestioned truths are being questioned. Mega cap tech has lost its lustre and many investors are considering alternatives. So far in 2025, global equities have out-performed US equities, and the Magnificent 7 have significantly underperformed the broader S&P 500³.

While some investors are turning to European equities or emerging markets, or switching asset classes to fixed income, one area which hasn’t attracted as much attention is global small and mid-cap equities (global SMIDs). Global small-mid caps have historically outperformed large caps⁴, with similar volatility and income yield⁵, however their share prices have underperformed significantly for much of the past five years as the Magnificent 7 swept all before them. Right now they are considerably cheaper than large caps, but with similar growth prospects.  Also, with a universe of more than 7,000 stocks there is a much greater opportunity for investors and active managers to outperform.

This paper examines the overall attractiveness of global small-mid caps for investors, as well as whether now may be a good time to allocate to this asset class.

Global small-mid caps have out-performed large caps, until recently

If you invested $10,000 in global SMID caps (MSCI ACWI SMID) in January 2001, by the end of March 2025 your investment would have grown to $52,148. Whereas $10,000 invested in the comparable global large cap index (MSCI ACWI) over the same timeframe would have grown to $40,121 – a difference of $12,027

Growth of $10,000

Source: Morningstar Direct, from Jan 2001 to March 2025, indices are the MSCI ACWI SMID (global SMID caps) and MSCI ACWI (global large caps). Past performance is not a reliable indicator of future performance.

Of course, returns can change significantly depending on the start and end dates selected, rolling returns over the same period give a better indication of how often global SMIDs outperform global large caps (rolling returns split the period into multiple monthly increments of the same time period).

Over the 24-year period global SMIDS outperformed global large caps:

• 63% of the time for 3-year rolling returns
• 66% of the time for 5-year rolling returns
• And 65% of the time for 10-year rolling returns

Source: Morningstar Direct, from Jan 2001 to March 2025, indices are the MSCI ACWI SMID (global SMID caps) and MSCI ACWI (global large caps). Past performance is not a reliable indicator of future performance.

Greater opportunity for investors to out-perform

Every investor and active manager seeks an ‘edge’. A way to out-perform the benchmark and the competition. Active managers have different methods of doing this – whether it’s through assessing companies by quality, value and growth prospects or assessing how macroeconomic factors will cause different companies or sectors to outperform. Whatever their method, or combination of methods, active investment managers try to find companies that they think have been mispriced by the market, and so are likely to perform better in the medium to long term. These mispriced stocks are indicators that the market is operating ‘inefficiently’, as in a totally efficient market everything would be priced correctly.

In an index filled with companies that are household names like Apple, Amazon, Microsoft and Tesla finding an edge and beating the competition is hard. Most global and US large cap managers hold similar stocks and hug the benchmark pretty closely. They look for an edge in the weighting these stocks have in their portfolios, or by buying and selling at the right time.

Whereas in the global SMID cap index (MSCI ACWI SMID) there is a much greater opportunity to out-perform. The SMID index has nearly 7,500 companies spread across the world, subject to an incredible array of different market forces and economic conditions.

The sheer size, and diversity, of the global small and mid-cap market makes it much more difficult for investors to develop high quality, in-depth stock research. This means that many companies are under-researched, and not well understood by the market in general. This is illustrated in the chart below which shows that there are more than twice as many analyst recommendations per stock for companies in the large cap index compared to the small-mid cap index. This information asymmetry creates an opportunity for astute active managers to add value through rigorous bottom-up research.

Analyst recommendations by stock

Source: Bloomberg, April 2025. Numbers are based on median analyst coverage per stock.

The sweet spot between risk and growth

While many of the US megacaps have thrilled investors with their impressive growth in recent times, this kind of growth rate from very large companies is highly unusual. While it’s easy for a small company to double in size, high growth rates tend to become progressively harder to achieve the bigger companies become. This leads investors looking for high growth to hunt down promising small caps. Yet while small caps can rocket up in growth, they can also drop equally quickly.

Despite their moniker, global small-mid caps are not small companies at all. The market capitalisation of the index ranges from around $100 million to $65 billion, with an average of US$12.8 billion. This is part of what makes them so attractive according to Vaughan Nelson CIO and CEO Chris Wallis:

“I think one of the biggest advantages, and you can just look historically at the results, these are not necessarily, ‘small companies’ right? These are established businesses - there's nothing speculative in this space. It's also a very high ROA (return on assets) universe, high single-digit ROAs, very profitable businesses that can self-fund their own growth. More importantly, you don't get the big state-owned enterprises in here or the large financials that have accumulated a lot of bad paper, or the large businesses that can't reinvest and grow in here. You're really getting the future leaders and it's borne out in the data.”

Small- mid caps are often at that sweet spot in the company life cycle where their growth prospects are still exciting but they are larger, more mature businesses that are less volatile and risky than true small caps. As the table below shows global SMIDs have significantly higher returns on a historical basis, without much more volatility.

Source: Morningstar Direct; 1 January 2001 – 31 March, 2025. Indices used are MSCI ACWI SMID NR USD (SMID caps), MSCI ACWI NR USD (large caps)

Greater diversification benefits

One side effect of the success of megacap tech is that US and global indices have become increasingly concentrated. There are three main ways this is occuring: more concentrated in the US, more concentrated in fewer stocks, and more concentrated in the technology sector. It has also resulted in US large cap indices becoming more similar to the global indices.

At the end of March 2025, 65% of the global large cap index was based in the US, versus 53% for the global SMID index, with the remainder spread more evenly across the world. The top 5 stocks in the global large cap index (5 of the Magnificent 7) made up more than 15% of its total market capitalisation, whereas in the global SMID index it was a paltry 1.2%. Of course, part of the reason the top 5 SMID stocks make up a much smaller part of the index is due to its sheer size. There are around 7,500 companies in the index, giving investors an incredibly diversity of stocks to choose from.

The diversity of stocks in the SMID cap index becomes easier to visualise when we look at individual industry sectors. For example, the small-mid cap benchmark is far less concentrated in tech than the large cap index (11% vs 23%) and the companies are more evenly spread in each industry, more closely representing the diversity of companies available in the global economy⁶. 

Source: msci.com, as of March 31, 2025. Indices are the MSCI ACWI SMID (global SMID caps) and MSCI ACWI (global large caps). Past performance is not a reliable indicator of future performance.

There is a much larger percentage of the SMID cap index in industrials and there also many industry sub-sectors in the SMID index which are not represented in the large cap benchmark at all. For example the largest US Auto Components manufacturer, Aptiv, has a market capitalisation of U$17.8 billion⁷ making it too small for many large cap managers to own. This scenario is replicated many times across multiple industries where the dominant players are mid-caps, leaving many large-cap funds simply unable to invest in many industries.

A clear way of demonstrating the greater diversity of the SMID cap index is by looking at the underlying ‘factors’ which impact each company, but which they do not have control over. Broadly speaking, factor exposure can be thought of as a measure of diversification within a benchmark or portfolio - fewer factors means less diversification.

The diagram below shows how the factors affecting the global large cap index and global SMID index have changed over time. While the Global Large Cap space has become less diversified over time, the SMID space has remained relatively stable and much more diversified.

Factors impacting Global Large Caps and Global SMID Caps over time

Source: Axioma, monthly data from March 2010 to March 2025. Indices are the MSCI ACWI SMID (global SMID caps) and MSCI ACWI (global large caps).

The unintended concentration of the large cap indices makes them less diverse, and so more risky for passive investors, who are not controlling the weight of each stock, sector or geography within their portfolios. It is also quite common for large cap portfolios to have a similar makeup to their benchmarks and so have a lot of overlap with both passive index ETFs and other active large cap managers. Whereas when you move into the SMID index the sheer scale of opportunity available means that focused portfolios of small-mid cap stocks often have no common names between them. This greater diversification gives active investors a much greater ability to pick stocks with very different business drivers, or factors, in the SMID cap universe compared to the large cap universe.

Why consider global small-mid caps now?

We appear to be in a period of great global change. Ray Dalio has called it a ‘once in a lifetime breakdown in the global order’. Global economic and trade rules are being rewritten as the framework that has been in place since WWII is reworded. According to Chris Wallis, this is part of a longer-term structural change he calls ‘The Great Rebalancing’.

“The Great Rebalancing began at the end of 2021 and we believe it's going to continue. What I mean by that is we're changing the flow of goods, trade and capital and changing the drivers of economies locally. Countries like the US that are used to overconsuming and using foreign capital to do so and then have that foreign capital recycled back into their assets, meaning Nvidia and US Treasuries and everything else, are going to have to get used to things reversing and going the other way. Capital is going to go home, and I believe we are just at the start of this.”

If Chris is correct and current trends continue then we are likely to see capital flow from US large caps to smaller companies around the globe over the medium to long term.

Global SMID caps have underperformed recently and valuations are attractive

While historically global SMID caps have delivered stronger returns than global large caps, the situation has reversed in recent years. Global SMIDs have lagged large caps over the last four years as the chart below shows.

Source: Morningstar Direct, February 2021 to March 2025. Indices are the MSCI ACWI SMID (global SMID caps) and MSCI ACWI (global large caps). Past performance is not a reliable indicator of future performance.

This performance gap has become more pronounced since early 2023 as the large cap indices, buoyed by the mega-cap tech stocks, surged further ahead of global SMIDs. While large caps are now looking expensive on a historical basis, SMIDs are much better value, but with similar growth prospects and better income prospects.

Source: Factset, 31 March, 2025. Global large caps is MSCI All Country World and Global SMID Caps is MSCI All Country World Small Mid. Past performance is not a reliable indicator of future performance.

Macro environment likely to suit active managers

With great change often comes great upheaval, and this has been clearly evident in global share markets. This heightened volatility creates greater opportunities for investors to buy high quality businesses at discount prices according to Chris Wallis:

“We're moving into an environment where volatility is going to be your friend and active managers should be able to take advantage of it. You use the volatility like a backboard in basketball, right? You play against it. As everybody else is panicking, give them some cash. And if they want my shares at too high a price, I'll give them those too, right? I think we're very much in an environment that's suitable for active management. I'm pretty happy, I'm having fun again.”