Investments

European small caps: ready to outperform the benchmark?

Posted by MoneyController on 11.06.2024

In recent years, the performance of small caps in Europe has so far, on average, been lower than that of larger capitalisation companies. Is it possible that current conditions could favour growth of small caps even above the market benchmark?

Unfavourable conditions for small caps

As Francesco Lavecchia, Morningstar's Research Editor in Italy, points out, small caps have underperformed mid and large caps in Europe. There are more than one reason for this. Lavecchia mentions in this regard some remarks by Geoffroy Goenen, Head of Fundamental European Equity Management at Candriam. Given that small caps are more sensitive to interest rates (they are more oriented towards the ‘growth’ segment than the ‘value’ segment), it is not surprising that the central banks' restrictive monetary policy has weighed negatively on their valuations.

Small caps amid traumatic events and below-average liquidity

Goenen also points out that some recent traumatic events, such as the war between Russia and Ukraine, as well as the energy crisis aftermath, had a further impact on small-cap stocks: many investors decided to sell, since these were less liquid securities than those with a larger capitalisation. Not only that: Lavecchia mentions an analysis by Laurent Chaudeurge, manager of the BDL Convictions fund: Chaudeurge believes that the outflow from active funds in the direction of passive funds also tends to make active managers increase their exposure to mid- and large-cap stocks.

What can push small caps to outperform?

Nevertheless, Goenen explains that small caps have weathered what appears to have been the most difficult economic period and are now showing accelerating earnings. If one also adds to the profits (a) the interest rate cut and (b) the undervaluation of the sector (relative to the benchmark and other capitalisations), it is possible then that small caps have room to grow. And that they are trading at a discount, Lavecchia writes, is also pointed out by Deutsche Bank strategists, who also speak in some cases of a possible ‘relative outperformance (...) in the double digits’.

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