Beyond the giants: Finding growth in smaller companies

With global equity markets dominated by a handful of mega-cap technology names, opportunities may be emerging where fewer investors are looking. We believe small- and mid-cap (SMID) companies, still underrepresented in many portfolios, have the potential to combine attractive valuations, solid fundamentals, and, in many cases, stronger earnings and revenue growth than their large-cap peers. In our view, this is where SMID companies can offer diversification and may present an opportunity for investors with a long-term horizon. 

Limited research coverage of the SMID segment also creates market inefficiencies, which gives active managers the opportunity to identify potential opportunities that may be under-researched or undervalued before they gain broader recognition.

Similar to emerging-market equities relative to developed-market ones, global SMID stocks have experienced a long and almost uninterrupted streak of underperformance versus large caps since after the Global Financial Crisis (GFC), leading to very low valuations whose disconnect from companies’ fundamentals appears quite extreme today (see chart 1). The last time relative valuations were at comparable levels was around the year 2000. In the subsequent decade, from 2001 to 2011, SMID companies – measured by the MSCI ACWI SMID Index¹ – generated an average annual return of 6.25%, significantly outperforming large caps, as represented by the MSCI ACWI Index², which returned 2.19% per year.

Several legitimate factors have at least partially supported the relative performance trajectory observed since the GFC and contributed to today's valuation gaps. In a global economy increasingly shaped by intangible assets and the strategic importance of data accumulation, the high cash flow-generating technology oligopolies – particularly in the US – have been able to consolidate market power and capture a growing share of total revenues in a “winner-takes-all” dynamic, enabled by a relatively benign competition and anti-trust regulation. This race for scale and the rising returns that accompany it in a data network-driven economy, has been a key driver of the valuation premium (i.e., structurally higher P/E multiples) now attached to the “Magnificent 7,”³  and, more broadly, to mega- cap companies (defined as those with a market capitalization above USD 200 billion).

However, any prolonged dynamic provokes its own imbalances and excesses, often setting the stage for a reversal. The stock market has developed to be dominated by a small group of large-cap companies, creating potential risks for investors relying on passive index exchange-traded funds (ETFs). As of the end of January 2026, the top 10 stocks account for roughly 40 percent of the S&P 500 Index’s weight and contribute more than 50 percent of its trailing 12-month earnings growth, while SMID indices are broadly diversified, as shown in chart 2. This concentration appears to be peaking, as investors increasingly question whether the substantial capital expenditure (capex) commitments by cloud hyperscalers, such as Microsoft and Amazon, will translate into sustainable long-term returns.

A rotation into SMID stocks might already be underway. A Bloomberg index tracking the “Magnificent 7” has seen a year-to-date decline of 6.8% as of February 27, 2026, while SMID equities, as measured by the MSCI ACWI SMID Index, have gained 9.1% over the same period (all in US dollars).  A sustained shift in sentiment could prompt an even sharper reversal of passive fund flows concentrated in a handful of dominant stocks, with potential implications for broader market performance.

In the short term, the pressure on investors to diversify away from the most crowded segments of the market, combined with solid earnings perspectives for SMID-cap companies, may act as the best catalysts for a reallocation of flows from mega/large caps to smaller companies. Based on the median of Bloomberg consensus estimates, SMID-cap companies are expected to deliver stronger EPS growth over the next three years than large caps, while maintaining more conservative balance sheets with lower leverage relative to equity (see chart 3).

Breaking free: Diversifying beyond just US tech

The desire to diversify across markets and industries is obviously another – perhaps at this time the main – driver of these reallocation flows. Often overlooked, SMID companies can provide differentiated exposure across geographies, sectors, and structural themes compared with large-cap indices. SMID indices also tend to have greater representation in Europe and emerging markets, alongside relatively lower exposure to the US.

At the sector level, technology typically carries a smaller weight, while areas such as materials, utilities, and industrials are more prominent – sectors closely aligned with structural themes including infrastructure development, robotics and automation, and the reshoring of production amid evolving geopolitical dynamics.

Over the medium term, a more distinct, structural dynamic may also be at work. Many of the key trends driving the transformation of the global economy both reflect and also fuel the emergence of innovative business models often originating from smaller companies. These characteristics lead to a rich universe of fast-growing businesses, with total addressable markets expanding at a much faster pace than the broader economy. 

SMID companies at the heart of structural trends

Structural megatrends, such as technological innovation, demographic changes, the emergence of a multipolar world, and sustainable value creation, are increasingly influencing capital allocation strategies. These powerful forces are moving investor focus from short-term trading toward long-term opportunities. From these megatrends, we have identified six investable themes that we believe are particularly poised to benefit SMID companies.

We believe SMID companies may be positioned to capitalize on these transformative trends, offering compelling growth opportunities. Operating in specialized niches, they are often closely aligned with emerging structural themes, including rapid advancements in AI, innovation in automation and robotics, and opportunities linked to the growing need for critical minerals. Unlike larger, more diversified corporations, SMID stocks are typically "pure plays," providing investors with more direct exposure to specific sectors and themes.

M&A booms as disruption fuels the hunt for innovation

Rising tariffs, a more fragmented trade environment, and the disruptive impact of AI across entire industries are prompting companies to reassess their strategies for growth and expansion. In response, M&A activity has accelerated as businesses seek to acquire new capabilities in order to stay competitive. Unlike other macroeconomic trends that resemble past market cycles, AI represents an entirely new challenge for boardrooms and M&A professionals.

As larger companies look to strengthen their competitive positioning, they are increasingly targeting smaller firms with niche, cutting-edge technologies aligned with key structural trends. This surge in M&A activity has not only driven up valuations for smaller companies but has also created opportunities for shareholders to benefit from acquisition premiums, whether through public or private market deals.

Over the past year, M&A activity has accelerated to its second-highest level on record in terms of transaction volume, with a noticeable increase in premiums paid and transactions involving companies valued at under USD 10 billion. This trend echoes patterns observed in the late 1990s and early 2000s, reflecting renewed investor confidence and highlighting the growing importance of smaller firms in shaping the future of industries.

List of latest SMID company takeovers

ServiceNow - Armis: (USD 7.75 billion / Cyber security)
Thoma Bravo - Darktrace: (USD 5.3 billion / Cyber security)
Rio Tinto - Arcadium Lithium: (USD 6.7 billion / Battery materials)
Pfizer - Metsera: (USD 10 billion / Obesity)

Our approach: Investing at the intersection of structural themes and SMID

Built on our long-standing experience in managing smaller caps with high exposure to megatrends, the Vontobel Fund II – Global Small & Mid-Cap Opportunities employs a focused investment process to identify and invest in companies operating at the crossroads of transformative structural themes and the SMID universe. The fund targets companies with market capitalization within the boundaries of the MSCI ACWI SMID Index, which spans over 7,000 stocks globally. From this broad index, the fund narrows its focus using a top-down approach, selecting companies whose business activities align with six key thematic areas leveraging large language models to define relevant companies. This process results in a refined universe of approximately 1,500 stocks, from which a concentrated portfolio of around 150 high-conviction investments is constructed.

To be sure, investing in SMID companies can also involve a set of risks that can make them more volatile than their large-cap counterparts. They tend to be generally more dependent on the economic cycle, and also often have lower average trading volumes, which can lead to faster share price movements and larger swings, especially during periods of market turmoil or around company-specific events, such as earnings results or other market-moving news. They also tend to receive less analyst coverage, which can contribute to limited available information or reduced visibility among investors. This last characteristic can be viewed as the symmetric downside of a greater opportunity to generate sizable outperformance based on proprietary research, in our view.

Six thematic areas driving SMID opportunities

1. Foundational technologies: Focuses on the critical building blocks of the digital economy, including AI infrastructure, computing, software, and cybersecurity.
2. Critical infrastructure: Targets essential infrastructure underpinning economic and societal resilience, such as power and grid infrastructure, social infrastructure, water and agriculture, and national security-related industries.
3. Robotics & automation: Captures the adoption of automation across industries, including factory automation, autonomous vehicles, humanoid robotics, and drone technologies.
4. Healthcare innovation: Invests in transformative healthcare solutions, spanning digital health, precision medicine, preventive care, and surgical robotics among others.
5. NextGen consumer: Addresses evolving consumer behavior through exposure to digital commerce, differentiated brands, financial innovation, and gaming.
6. Energy transition: Focuses on the shift toward a lower-carbon economy, including transition materials, renewable energy, low-carbon solutions like gas or hydrogen, and energy storage technologies.

Conclusion

We believe the Vontobel Fund II – Global Small & Mid-Cap Opportunities is uniquely positioned to capitalize on these six transformative themes by focusing on high-quality SMID companies that are aligned with structural megatrends. With their strong growth potential, undervalued opportunities, and direct exposure to emerging trends, we believe these companies offer investors a compelling opportunity to diversify and benefit from the next wave of innovation and economic growth.