Choosing small-cap stocks can be challenging, but if done correctly, they can yield disproportionate returns
Your portfolio may see growth from small-cap stocks. However, they are unpredictable and challenging to choose.
Small caps, however, are currently popular. Wimpey Taylor (LON:TW. was the second-most-bought stock on Interactive Investor for do-it-yourself investors in August, even though it was a part of the FTSE 250 and had a market value of less than £3.05 billion.
On September 23, the Russell 2000, a measure of small-cap stocks in the United States, reached a new high of 2,488. The index's 15.6 percent gain over the previous three months beat that of its large-cap cousin, the SandP 500, which increased 10.5 percent during the same time frame.
Lale Akoner, global market analyst at eToro, stated that a rare run of upward earnings revisions has supported the small-cap indexes' surge. With interest expenses at their lowest level in more than a year, declining financing costs are a major fundamental driver of the performance. Smaller businesses that depend primarily on short-term debt stand to gain the most as markets price in additional Fed cuts, according to Akoner.
Additionally, the One Big Beautiful Bill's fiscal support could make £150 billion available to the U.S. S. households from 2026, supporting small businesses that are sensitive to consumer demand, like retailers, restaurants, and home builders," Akoner continued.
There are many reasons to think about investing in global small caps at the moment, but I recently wrote about why growth-oriented investors might want to look at UK small caps.
Knowing which ones to choose is the difficult part.
The qualities that a small-cap stock should have.
The problem with investing in small-cap stocks is that they're not a particularly strong asset class.
"We've always maintained that smaller businesses are generally of lower quality," says Baillie Gifford's global small cap investment specialist Bill Chater.
He is a member of the team at Edinburgh Worldwide (LON:EWI), an investment trust that focuses on international small cap and private companies, so this may sound controversial coming from someone with his job title. However, Chaters argues that the skill of investing in small-cap companies lies in identifying the most promising small businesses, which have the potential to grow into tomorrow's big caps.
In contrast to their ultimate market potential, he states, "We want to look for individually outstanding companies that are immature."
Chater and his group consider four criteria when choosing small-cap investments with this potential.
Establishing a competitive advantage that grows over time; solving a big problem (which could be addressing a significant market opportunity or creating a new market around their solution); and the caliber of the management team, with a focus on founder-leaders rather than experienced CEOs; and scalability, or the potential for the solution they are developing to reach new heights. Despite his focus on growth investing, Chater adds that he never loses sight of valuation as a crucial consideration.
He says, "You want to buy a business when it's relatively cheaply valued, hold it for a while, and then sell it when it's worth more." Generally speaking, Chater and the EWI team search for businesses that they can reasonably envision doubling in value in the worst-case scenario.
How to make investments in small-cap companies worldwide.
Even experts have trouble selecting small-cap stocks that will eventually grow into mid- or large-cap stocks.
"It isn't always about making the right investment," Chater says. "It involves identifying a select few unique businesses and then approaching them with precision.
Therefore, if you are in charge of your own investments and do not have access to the depth of research that Chater and similar teams have, it might be prudent to invest in an investment trust or fund to contract with small cap experts to pick stocks for you.
As of September 26, 2025, the average investment trust in the universe of AIC's global smaller companies is currently trading at a 12p1 percent discount. At the moment, EWI is trading at a 7 percent discount. Smithson Investment Trust (LON:SSON) and Herald Investment Trust (LON:HRI) are two other small-cap investment trusts that are trading at smaller discounts than the sector average.
Another option for investing in small-cap stocks is to take a passive approach. Investing in smaller-cap US stocks, the Invesco Russell 2000 UCITS ETF (LON:RTYS) tracks the Russell 2000 index. The HSBC MSCI World Small Cap Screened ETF (LON:HWSS) is an alternative for accessing global small caps. It integrates ESG metrics and tracks the MSCI World Small Cap Selection Screens Index.
However, keep in mind that passive strategies like these amount to "owning the asset class," which Chater would rather avoid in favor of a smaller selection of small-cap stocks with strong convictions.
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