All eyes have been on the ‘magnificent seven’ over the past year or so as this small handful of stocks powered ahead of their peers. But with so much attention on these mega-cap names, the even greater outperformance by smaller stocks went unnoticed by most investors.
Some 197 small-cap stocks in the US and UK actually outperformed the magnificent seven’s average return of 111% last year, according to AJ Bell, despite most investors putting this small bundle of shares on a pedestal for their exceptionalism. Dan Coatsworth, investment analyst at AJ Bell, says the data “shows that clever stockpicking can still help investors to do better than the big names hogging the limelight”.
Out of sight, out of mind
Yet investors have largely ignored smaller companies in recent years due to their poor returns. The MSCI Global World Small Cap index was in negative territory for most of the past three years. It is up 6.7% in total over the period, but it only began making positive returns at the start of this year. Rob Morgan, chief analyst at Charles Stanley, thinks this recent uptick in performance will continue.
“It makes sense to keep a foot in the big-tech camp but ensure a portfolio is diversified across other areas to ensure it is flying on more than one engine,” he says. “Smaller companies, both here in the UK and across the globe, stand out as an opportunity to diversify without compromising on future returns.
“Smaller firms have, on average, underperformed in recent years, but it is not necessarily due to lack of growth. It’s that they have more debt, which in a world of rising interest rates is a problem. As interest rates start to come down, there could be welcome relief for such businesses and a more positive environment for confidence and growth.
“It could also change the narrative around the all-conquering magnificent seven so that investors take a second look.”
Indeed, the number of small-caps in the US and UK beating the magnificent seven is up this year. As the growth of the tech giants slowed to 38.8%, 548 smaller companies outperformed them in 2024.
This could represent the “green shoots of a revival” for small caps, according to Darius McDermott, managing director of FundCalibre, who points out that they typically outperform the larger end of the market. And after a prolonged period of significant underperformance, this could be the return to norm small-cap investors have been waiting for.
He says: “Historically, small caps have outperformed large caps over the long term, benefiting from their agility and greater growth potential. Although they’ve faced macroeconomic headwinds in recent years, we believe the market is poised for a rebound, particular as risk appetite returns and borrowing costs ease over the rate-cutting cycle.”
Read the rest of this article in the October issue of Portfolio Adviser magazine
