Small caps have proven resilient this year despite a difficult macroeconomic environment, and they can provide value and diversification
Despite being frequently disregarded, small-cap stocks have the potential to reward patient investors in the long run.
"Aberdeen UK Smaller Companies Growth Trust co-manager Abby Glennie stated that small caps provide a unique blend of growth, diversification, and attractive valuations. "We've also experienced global market periods where a few mega caps have dominated markets due to prevailing tech themes, but maybe now is the time for market strength to spread out. Or at the very least, as investors grow more apprehensive about the artificial intelligence (AI) trade, their allocations should diversify beyond mega caps."
Glennie pointed out that despite the Middle East conflict, which on paper might have appeared to be a significant obstacle for smaller companies, small cap stocks have fared remarkably well this year.
Up until July 31, 2026, the MSCI World Small Cap Index returned 13.8 percent, surpassing the 10.3 percent gain of the core MSCI World Index.
Watch the entire video here. Glennie stated, "We aren't seeing risk-off market performance in the way many would expect." "Smaller companies are trading at substantial discounts to their historical valuation levels, which contributes to this driver."
Describe small-cap stocks.
A small cap stock is defined by investment bank Saxo Group as having a market capitalization (market cap) of between £250 million and £2 billion.
This is not how everyone classifies small caps. Instead of using an absolute number as a threshold, the major index provider, MSCI, divides stocks into size categories based on the proportion of each country's investable market that they cover.
"MSCI looks separately at each developed market, such as the US, Japan, UK, and Australia, when constructing the MSCI World Small Cap Index," stated Lynn Hutchinson, Raymond James' head of index and ETF solutions. Approximately 85% of each nation's investable stock market may consist of large and mid-cap companies. The MSCI then creates a single, market cap-weighted index by combining the small cap stocks from every nation.
However, when considering small caps, the £250 million to £2 billion range is generally a good guideline.
With rare exceptions, small-cap stocks are less globalized than larger stocks due to their smaller size. For instance, they might be more connected to their home country's economy than larger-cap stocks.
Why make small-cap investments?
Particularly in the current climate where momentum investing has concentrated many portfolios into the biggest stocks in the world, small caps can provide diversification.
According to Glennie, "small caps provide exposure to a much broader range of businesses, sectors, and growth drivers." In this sense, small cap benchmarks and portfolios are typically quite diverse, not dominated by a small number of stocks or a single overarching theme."
They also have the potential to yield larger returns, but there is a catch: you may need to be ready to endure volatile times.
According to Angeline Ong, a senior investment analyst at trading platform IG, "small caps shouldn't be treated with fear but with healthy curiosity."
Currently, small caps provide investors with good value as well. According to data from investment research firm Morningstar, the MSCI World Small Cap Index's average trailing price/earnings (P/E) ratio as of July 2026 is 18.4, while the MSCI World Index's is 23.1.
Do small caps in the UK offer good value?
Good value is especially available in the UK's small cap sector. Morningstar reports that it is trading even lower at only 15.6 times trailing earnings.
"We see opportunities across global small caps, but the UK remains especially compelling on valuations," Glennie remarked. "Smaller businesses in the UK have been neglected by investors for a long time, and the asset class has not been well-liked.
Glennie went on, "This has left valuations significantly below both their own history and many international peers." In the meantime, a lot of UK-listed small businesses make money abroad, providing investors with access to global expansion prospects at a lower cost due to their prominent UK listing."
All UK stocks, regardless of market capitalization, are significantly undervalued. However, the economic storms of 2026 have not affected its small caps. The FTSE AIM All Share Index, which includes the nation's smallest stocks, increased by 6.4 percent in 2026 through August 25, while the FTSE 250 index, which is composed of mid-cap stocks, increased by 10.6 percent.
Glennie stated, "While macroeconomic uncertainty still exists, this isn't holding back the asset class in the way many market participants might fear." "A number of excellent UK small caps continue to produce strong cash flows, maintain strong balance sheets, and deliver strong earnings growth. They also continue to support shares through share buybacks."
The dangers associated with small-cap investing.
Small caps can be more volatile than larger stocks, as the MSCI emphasizes. They may also be less liquid, which can increase the cost of trading them.
"You could be caught offside and end up nursing quite large losses if you haven't done your homework and your due diligence," Ong stated.
According to Ong, a lack of liquidity may prevent you from selling a position you wish to get out of as soon as possible because there aren't enough buyers on the other side.
"If you want to get in and out quickly, you might not have the flexibility with small caps," she warned.
How to purchase small-cap stocks.
Selecting the small-cap stocks you wish to invest in can be tempting, especially since many of them may be companies you are already familiar with.
However, small cap investing risks may be increased by this strategy. Glennie stated, "Wed suggests small cap investing is best approached through a portfolio holding, rather than direct individual equities." This is due to the advantage of risk-adjusted returns that come with a managed portfolio; however, the risk level is significantly higher at individual stock levels, so that approach might only be appropriate for a particular kind of investor."
The iShares MSCI World Small Cap UCITS ETF (LON:WLDS) and the Vanguard FTSE Global Small-Cap UCITS ETF (LON:VSML) are tracker funds that replicate some of the major small cap indices.
The Invesco Global Smaller Companies Fund and the Janus Henderson Horizon Global Smaller Companies Fund are two active funds that track global small caps.
Edinburgh Worldwide (LON:EWI) and The Global Smaller Companies Trust (LON:GSCT) are two investment trusts that concentrate on small caps.
You could choose Aberdeen UK Smaller Companies Growth (LON:AUSC) if you want to concentrate on UK smaller businesses. Investment platform AJ Bell (LON:AJB) and construction companies Morgan Sindall (LON:MGNS) and Galliford Try (LON:GFRD) are among the top holdings as of July 31.
Ong emphasizes the significance of sticking to businesses, or at least industries, that you are extremely familiar with if you decide to choose your own small-cap stocks.
She remarked, "It's not like buying Microsoft." "You must truly understand what you're purchasing."
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