The US Small-and Mid-Cap Moment: How markets dynamics are aligning for smaller companies

Over the long term, small- and mid-cap companies outperform large caps. Yet it is this prospect of generating excess returns that offsets the excess risk associated with the higher volatility of this asset class.

Nevertheless, in recent years, it has been large-cap technology stocks (FAANG, Magnificent 7) that have driven the sharp rise in US stock markets, leaving the small- and mid-cap segment lagging behind.

However, after several years of dull performance, the stars seem to be aligning once again, with a convergence of factors that appear conducive to a return of the asset class to favour: attractive valuations, constructive monetary and government policies.

Discover more about our approach!

Valuations whose attractiveness can no longer be ignored

Historically, small and mid-cap equities have commanded a valuation premium over their large-cap peers. This valuation premium is justified by their superior growth prospects. However, this trend has now been reversed. The current 12-month forward P/E on the S&P 500 (large cap) is 22.3x (24.67x trailing), which compares to a 16.11x (17.69x trailing) multiple for the S&P 400 (mid-caps) and a 15.15x (17.04x trailing) P/E ratio for the S&P 600 (small caps)[1].

The current discount represents much more than a temporary market disruption; it is outside historical ranges and has only been this low during periods preceding a significant return to the mean, such as just before the tech bubble burst.

This unprecedented compression of valuation multiples occurred even as small- and mid-cap companies posted more than respectable earnings growth. Yet between 2015 and 2025, while small companies posted earnings growth of 143%, their share prices rose by only 85%. The same trend was seen for medium-sized companies, with profits up 134% and share prices up 104%. Conversely, large-cap stocks soared to new heights (+200%) despite recording only 110% growth in profits.

It is this gap between fundamental performance and market valuation that, in our view, creates fertile ground for a return to favour for this asset class.

Monetary policy: from a drawback to an opportunity

Smaller companies generally rely more on external financing, particularly through short-term and/or variable-rate loans, which makes them more sensitive to interest rate fluctuations.

In this context, the Federal Reserve's expected change in stance could act as another supporting factor for this market segment.

Lower financing costs should enable small and mid-cap companies to invest in growth opportunities, improve their margins, and participate in merger and acquisition activity, which is expected to accelerate. Lower rates also boost management confidence and reduce the cost of capital, creating a positive environment for business development.

Government policies favourable to the domestic economy

The America-first agenda of the Trump administration creates multiple tailwinds specifically benefiting domestically-focused companies. SMID cap companies derive approximately 80% of their revenues in the US compared to 59% for large caps, positioning them to benefit disproportionately from policy initiatives. Reduced international competition and market share gains through higher tariffs on imports, making them less competitive, bolstered by potential reshoring opportunities, could propel SMID cap growth.

Deregulation represents one of the most powerful catalysts for small-cap performance. Regulation has been an effective moat for larger companies that have the resources to navigate compliance efficiently. Reducing the regulatory burden should disproportionately help smaller companies that have been constrained by compliance costs and increase faster product approval.

The One Big Beautiful Bill Act provides additional support through tax relief measures: the policies collectively improve the competitive position of domestic-focused smaller companies that are typically less equipped to avoid taxes compared to large companies with sophisticated tax mitigation strategies. In general, the Trump administration's policies could reduce the effective corporate tax rate to as low as 12%, the lowest in US history.

Approaching this market from a quality growth perspective

BL American Small & Mid Caps has been exploiting the potential of this market for almost 10 years through an active, fundamental, purely bottom-up and long-term approach.

Our universe covers both small- (500mn to 7.5bn USD) and mid-caps (7.5 to 30bn USD). 

Given the historical outperformance of US mid-cap stocks, we believe it makes sense to give them a prominent place in our portfolio, focusing our investments on high-quality, high-growth stocks. It is surprising that these companies are often overlooked, given that they are in the most interesting phase of their development cycle, combining both growth and a certain maturity in their business model. Smaller companies also have a certain appeal but are generally riskier.

We target companies with a transparent and understandable business model that is highly profitable and protected by sustainable and measurable competitive advantages, quantified by significantly higher levels of return on capital employed, operating margins and free cash flow. In our view, sustainable competitive advantages are the foundation for long-term value creation. 

Once these companies have been identified, we ensure not to overpay them by being very disciplined in our buying and selling policy, which allows us to control both expected returns and volatility.

The final portfolio is concentrated around our main convictions (40 to 60 positions) with a balance between high-growth stocks (50% to 75% of the portfolio) and more mature companies (20% to 40%). Additional diversification is reached through opportunistic investment in more value opportunities (max. 15%).

The objective is to build a portfolio with an attractive long-term risk/return ratio. Since its launch, the Fund (gross of fees)[1] has delivered an annualised return of 11.9% with volatility of 16.1% compared with an annualised return of 11% and volatility of 19.2% for the MSCI US SMID 2200 NR (and an annualised return of 10.1% a volatility of 20.1% for the Russel 2500 TR), making it one of the least volatile funds in its category.

Conclusion

The convergence of multiple positive factors creates a potentially unique opportunity in SMID cap equities. The combination of extreme relative valuations, supportive Federal Reserve policy and favourable political developments suggests this could mark the beginning of a sustained & strong period of SMID cap performance.

For investors seeking to diversify away from the concentration risks of large-cap indices while capturing superior risk-adjusted returns, the case for increasing allocations to US SMID cap equities represents both a tactical opportunity and a strategic necessity.

Author: Henrik Blohm, Lead Fund Manager, US Small- & Mid-Caps @ BLI – Banque de Luxembourg Investments

Main associated risks: risk of capital loss, equity market risk, discretionary management risk, concentration risk, liquidity risk, currency risk.

Disclaimer: Marketing communication. Please read the prospectus and the KID of the Product mentioned before making a final investment decision. These documents are available free of charge on request by post (BLI - Banque de Luxembourg Investments, 16, boulevard Royal, L-2449 Luxembourg) or by e-mail (info@bli.lu). BLI will be able to advise you of the languages in which each of the Documents is available. A summary of investors' rights is available on the BLI website

(https://www.banquedeluxembourginvestments.com/en/bank/bli/legal-information).

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Finally, BLI points out that it may decide at any time to cease marketing the Product subject to compliance with the applicable legal and regulatory provisions.

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