Recovery and reshoring – potential boons for global small caps

Is the current environment supportive for small cap investing in 2025?

Generally the macro backdrop is supportive. It is probably one of GDP recovery and reducing inflation, and hence interest rates are falling. Interest rates falling is good for small caps; anything that would encourage risk – and small caps are perceived to be more risky by investors – would generally be good for small caps.

How impactful is the trend of deglobalisation and onshoring to small caps?

If we look at the global small cap index (the MSCI World Small Cap Index), which is the index from which we select stocks, that index is overweight both industrials and materials. Those are two areas of the market that we think will benefit enormously from reshoring. It has to be said that if President Trump does put tariffs on goods globally, then we think that would also be very good for 66% of our index, which is US small cap, where you will have a swap of economic growth from one particular area to another. So we think that effectively tariffs accelerates reshoring.

Given recent tech market uncertainty, do you see a reallocation opportunity for small caps

I think one of the important things to think about when you are investing globally, is the correlation between individual assets. The correlation between large cap and small cap has been falling over recent years. Basically what that means is if large cap were to fall substantially, it is not necessarily the case that small cap would fall as much.

And also, I think if you look at the top end of the market over in the US, you can see that the business models are changing. Having largely been intangible asset-driven companies, the likes of Microsoft, Meta, Alphabet are all investing in data centres. Data centres are hard tangible assets, and the return profile you make on hard tangible assets is not normally as good as you make on intangibles.

So I think again there is a valuation argument between the two. It is undoubtedly the case that global small caps are materially underpriced relative to their large-cap brethren. And then if we look at the very top seven companies in the US, which have obviously driven markets, that discrepancy is even wider.

Is there a region where you are seeing particularly strong opportunities?  

I think if we look globally at small caps, as we said, 66% of the index is US. US small caps are slightly more expensive than the rest of the world. But I think that because of President Trump’s potential activities in reshoring, so you may see corporate rates over in the US fall. That would be very good for US small caps, because that would enhance their cash flows materially. And small caps generally speaking pay a higher rate of interest on any borrowing than large cap. So I think that the wind is in the sail of US small cap.

I think if we look at Japanese small cap, the moves there for the companies to take cash off the balance sheet and reinvest it elsewhere, or rather give it back to shareholders, mathematically will increase the return profile of that market. So that is good.

And then I think if we look at Europe, there are some transitory reasons for believing that the valuation multiple has been depressed by fear. And possibly some of those reasons get removed over the next 12 months. I also think that European small caps per se are largely domestic orientated, so any tariffs coming into the European market, hopefully wouldn’t hit them too hard.

Glossary:

Balance sheet: A financial statement that summarises a company’s assets, liabilities and shareholders’ equity at a particular point in time. Each segment gives investors an idea as to what the company owns and owes, as well as the amount invested by shareholders. It is called a balance sheet because of the accounting equation: assets = liabilities + shareholders’ equity.

Correlation: How far the price movements of two variables (eg. equity or fund returns) move in relation to each other. A correlation of +1.0 means that both variables have a strong association in the direction they move. If they have a correlation of -1.0, they move in opposite directions. A figure near zero suggests a weak or non-existent relationship between the two variables.

GDP (Global domestic product): The value of all finished goods and services produced by a country, within a specific time period (usually quarterly or annually). When GDP is increasing, people are spending more, and businesses may be expanding, and vice versa. GDP is a broad measure of the size and health of a country’s economy and can be used to compare different economies.

Large caps: Well-established companies with a valuation (market capitalisation) above a certain size, eg. $10 billion in the US. It can also be used as a relative term. Large-cap indices, such as the UK’s FTSE 100 or the S&P 500 in the US, track the performance of the largest publicly traded companies, rather than all stocks above a certain size. Mega caps are the largest stocks of all.

MSCI World Small Cap Index (USD): An index of almost 4,000 stocks that captures a range of small cap companies across 23 developed market countries.

Onshoring/reshoring: The process of businesses bringing production or operations back to their home country.

Overweight: Having a relatively large exposure to an individual security, asset class, sector, or geographical region than a relevant benchmark, such as an index.

Small caps: Companies with a valuation (market capitalisation) within a certain scale, eg. $300 million to $2 billion in the US, although these measures are generally an estimate. Small cap stocks tend to offer the potential for faster growth than their larger peers, but with greater volatility.

Valuation multiples: Financial measures that evaluate a financial metric as a ratio of another (eg. share price to earnings per share). It is used to help measure a company’s value and compare it to other businesses.