Small caps: An opportunity hiding in plain sight
European investors have largely overlooked small caps. We look at what sets the US and European segments apart, from their sector mix to their valuations, and the range of ETFs now available to access them.
Small cap equities represent approximately 11%1 of the global equity opportunity set and may be a valuable component of a diversified equity allocation. Smaller companies often trade at lower valuations, are significantly less concentrated than large cap indices and have at times outperformed large caps, though the pattern varies markedly by region and period. They also tend to be more domestically focused and cyclical, offering a potentially closer link to underlying economies.
Despite these merits, ETF flows suggest that European investors have largely overlooked this important segment of the market.2 While widely used benchmarks such as the MSCI ACWI, S&P 500, and MSCI Europe provide broad market exposure, none of them is designed to offer access to small cap companies.
Meanwhile, the range of ETFs providing access to small caps has expanded significantly in recent years. Investors can now choose from traditional index market-cap weighted strategies through factor-based approaches and systematic enhanced solutions to high-conviction fundamental active portfolios. In our view, small caps may be particularly well suited to active management, as the asset class remains relatively under-researched,3 which may create opportunities to add value through security selection.
More direct economic exposure
The old adage that "the market is not the economy" remains true, but some equity segments provide a closer reflection of domestic economic conditions than others. This is particularly evident within small caps. Russell 2000 constituents generate approximately 75–80% of their revenues domestically, compared with 59% for the S&P 500. Similarly, domestic revenues account for 64% of MSCI Europe Small Cap revenues versus 46% for MSCI Europe.
This domestic bias can benefit investors for different reasons across regions. In the US, small caps may provide more direct exposure to domestic economic strength and AI-driven investment activity. In Europe, their lower reliance on foreign revenues may help insulate earnings from trade disruptions and broader geopolitical fragmentation.
Cyclical exposures with regional drivers
Small cap indices typically exhibit a more cyclical sector profile than their large cap counterparts, reflecting greater exposure to economically sensitive industries and lower allocations to defensive segments of the market. However, the nature of this cyclical exposure differs meaningfully between the US and Europe.
In the US, small caps may provide a more direct way to participate in economic resilience and investment-led growth. Relative to large caps, the Russell 2000 offers greater exposure to Industrials, which may benefit from ongoing infrastructure investment and AI-related capital expenditure. Health Care, while traditionally perceived as defensive, is the largest sector in the index, but a significant portion of that exposure is in biotechnology companies, which may add to cyclicality and could benefit from broader AI adoption. Meaningful exposure to Financials may also support performance in an environment characterised by elevated interest rates and solid economic growth.
European small caps exhibit an even more pronounced tilt towards Industrials and Materials. In Europe, this positioning may benefit from increased fiscal spending directed towards defence, infrastructure development, and the energy transition. At the same time, lower exposure to Financials and greater exposure to Real Estate relative to European large caps increase small caps’ sensitivity to monetary policy moves. Investors seeking to manage this risk may consider smart beta or active strategies, which can alter sector positioning.
Overall, the cyclical nature of small caps remains a potential tailwind as global growth has proven resilient despite geopolitical uncertainty and restrictive monetary policy. That said, a sustained rise in interest rates or a further escalation of geopolitical tensions could act as headwinds for cyclical exposures and weigh on relative small cap performance.
Addressing market concentration
A common characteristic of small cap equities across regions is their potential to help mitigate a widely discussed investor concern: market concentration. In a world where a handful of companies account for an increasingly large share of major equity indices and drive a significant portion of index returns, small caps offer exposure to a broader opportunity set with less reliance on any single company. While concentration risks are most frequently discussed in the context of the US market, small caps can provide meaningful diversification benefits on both sides of the Atlantic.
Valuation gap
Small caps currently trade at a discount to their large cap counterparts, which could narrow over time. While valuation multiples were not a major driver of equity returns during much of the first half of the decade, as investor attention remained focused on technology leaders, market leadership has broadened in 2026 and we believe fundamental factors have become increasingly important in differentiating performance.
When evaluating small cap indices, it is important to recognise the heterogeneity of the asset class. The Russell 2000 Index includes a significant portion of businesses that have yet to reach profitability, particularly in the Biotechnology and Technology sectors, potentially distorting the valuation picture at the index level.4 While these companies may carry higher risk, they may also offer growth potential and can be attractive acquisition targets for larger industry participants.
Is the small cap premium coming back?
The small-cap premium may be re-emerging, although the recovery remains uneven across regions. In the US, the rebound has recently been more pronounced, supported by resilient economic growth, improving earnings prospects, and growing investor interest in opportunities beyond the Magnificent Seven. US small caps have outperformed large caps so far in 2026, after lagging them on average over the previous two decades (Figure 5). It is still too early to determine whether this marks a lasting change, although US economic momentum may offer support.
In Europe, by contrast, the near-term performance of small caps has been less convincing. Weaker economic momentum, lingering geopolitical uncertainty, and a more challenging earnings backdrop have weighed on investor sentiment towards the segment. Nevertheless, the longer-term evidence points to a small-cap premium in European equity markets, where small caps outperformed large caps by an average of 4.4 percentage points a year between 2003 and 2025.
Accessing small caps through ETFs
Small caps are not a single trade. The US and European segments differ in what they hold, what drives them and how they are priced, and the long-run return evidence differs too. That argues less for a blanket allocation than for a deliberate choice about region and about implementation, and the range of vehicles now available makes that choice a practical one.
The small-cap universe is increasingly accessible through a diverse range of investment approaches:
Index market-cap weighted
ETFs tracking broad indices allow access to comprehensive and diversified index exposures. These include:
Systematic enhanced
Enhanced strategies may suit investors seeking excess returns through modest benchmark deviations: