Following more than a decade of underperformance, fund managers believe small-cap equities are finally showing signs of a revival.
In the first half of 2026, smaller companies started outpacing large caps, driven by historically cheap valuations and managers hunting for value.
Nish Patel, manager of The Global Smaller Companies Trust, explained: “Small caps have endured a difficult period over the past 14 years, as investors have overwhelmingly favoured large-cap growth companies, particularly in the US technology sector. However, we are now beginning to see early signs that this dynamic may be changing.”
He said that in the first six months of the year, small caps have typically outperformed larger companies by around 5% and the magnificent seven by around 16%.
“We believe this could mark the beginning of a new cycle for the asset class,” he said.
But for investors looking to capitalise on this rotation, managers say there is a crucial distinction between the broader global market and the specific, sentiment-driven discounts found in the UK.
Global tailwinds
On a global scale, the case for small caps is anchored in historic market concentration and a changing economic cycle.
Patel said that smaller companies are currently trading at around one standard deviation below larger companies on a price-to-earnings basis and historically, when valuations have reached these levels, it has “often marked the beginning of long periods of outperformance for small caps”.
“We saw that in the 1970s following the ‘nifty fifty’ period, and again after the dot.com bubble in 1999, when investor attention became heavily concentrated in a relatively small number of large companies,” he said.
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“In both cases, valuations for small caps reached similarly depressed levels before the asset class went on to outperform for many years afterwards.
“Today, we believe we are seeing a similar setup emerge. Valuations for smaller companies remain historically attractive relative to large caps, despite many businesses continuing to deliver strong earnings growth and operational resilience,” he added.
“If history repeats itself, this could mark the beginning of another significant long-term cycle for global small caps.”
Global small-caps also offer a hedge against a changing macro environment – and Patel believes the market is entering a more inflationary environment over the longer term driven by deglobalisation, geopolitical change and a new commodities cycle.
“Historically, these conditions have tended to favour value stocks and smaller companies,” he said.
The UK discount
While global small caps are benefitting from broader economic shifts, UK smaller companies remain cheap simply because they have suffered from years of poor investor sentiment.
Amisha Chohan, head of equity research at Quilter Cheviot, said that when it comes to valuations, UK small caps currently stand out among the crowd.
“Years of investor outflows, concerns over the domestic economy and a challenging higher interest rate environment have left many quality UK businesses trading at discounts that look difficult to justify given the quality of earnings that lie beneath,” she explained.
Unlike the global market, this discount is heavily driven by local politics and a lack of confidence.
“The reality is that a large number of UK-listed smaller companies are generating healthy and growing earnings, yet they continue to be dogged by persistent challenges with the UK economy, political situation and capital markets,” Chohan added.
Katen Patel, manager of the JPMorgan UK Small Cap Growth and Income trust, said that what has changed in recent years is the valuation opportunity.
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“UK small and mid caps remain very attractively valued relative to their own history, UK large caps and other major markets,” he said.
The most glaring evidence of this UK-specific undervaluation is playing out through corporate action as buyers swoop in to take advantage of the cheap prices.
“International businesses and private equity investors continue to target UK-listed businesses because they can see value that the public market is overlooking,” Chohan said.
Stocks to keep an eye on
Because the UK market is so heavily influenced by sentiment, experts say that capturing this value requires careful stockpicking.
Patel said: “The biggest challenge is separating durable business improvement from short-term market noise. Small and mid-cap share prices can move sharply on macro headlines, interest-rate expectations, Budget speculation or changing sentiment towards the UK.”
To navigate the volatility, he focuses on companies with their own demand drivers, regardless of the economic background. He explained the breadth of the UK market, spanning from AIM businesses to the lower end of the FTSE 250, allows active managers to find niche leaders.
“Quartix is subscription-based vehicle tracking systems that help small and medium-sized businesses monitor fleets. With around 330,000 vehicles already connected to its platform and further scope to grow internationally, it has a scalable model in a fragmented market,” he said.
He also highlighted Applied Nutrition, a company benefitting from the long-term shift towards health, fitness and wellbeing, which manufactures the majority of its products in-house to control quality and costs.
“These companies operate in very different sectors, but they share the traits we look for: visible demand, strong financial foundations, disciplined management and the ability to grow from a relatively small base,” he concluded.
