Opportunities

• Lower Analyst Coverage & Market Inefficiencies: Globally, SMID caps are covered by an average of only 3 brokers versus 16 for large caps, with over 40% of SMID caps receiving no coverage at all. The significant reduction of global equity research analysts over the past decade has increased market inefficiencies, with fewer earnings revisions and less coverage of mid-cap stocks, creating opportunities for active managers to identify mispriced securities.

• Industry Research Gap: Beyond company-specific analysis, there is a significant lack of industry research on SMID caps, creating opportunities for investors willing to conduct comprehensive industry analysis across competitors, suppliers, and customers.

• Valuation Discrepancy: SMID caps currently trade at a record discount to large caps (15.8x P/E vs. large cap 29.0x P/E), despite offering similar earnings growth potential (5.8% vs. 7.3% large cap growth), representing a potential mean reversion opportunity.

• Diversification Benefits: The SMID cap universe is significantly larger and more diverse than large caps, with over 7,600 stocks where the top 10 represent less than 2% of the index (versus 30% concentration in large cap indices).

Risks & Areas of Concern

• Higher Volatility: SMID caps do generally exhibit greater average volatility and are less liquid than large caps and also might be sold off by investors in a risk-off secbario meaning that allocations need to be sized appropriately. However, relative valuations can also have a mitigating impact - see below.

• Cyclical exposure: Many SMID cap companies are more leveraged to the global economy and can therefore have greater perceived downside in recessionary scenraio.

• Company-Specific Risk: SMID caps often have fewer avenues for growth and are more vulnerable to company-specific events like poor earnings reports or management decisions.

Portfolio Implications

• Adding 20% to the Antipodes Global Opportunities Fund to a typical index overseas equity portfolio would:

  • Reduce overall US equity and MAG 7 (as an approximation for large US tech) by a around 5% (of the international equity allocation

  • According to consensus estimates it would reduce the aggregate portfolio 1 Year Forward Price/Earnings multiple from around 18x to 16x.

• We estimate that the long term expected return is around 3-4% higher than that of the market and this allocation would could increase the portfolio expected return by around 0.5% per annum.

• While, in theory, an allocation to smaller companies should increase risk 'through the cycle', valuation support can have the opposite effect. Over the last few months a 20% allocation would actually have reduced overall portfolio volatility and drawdown slightly.

• If you would like us to conduct similar analysis for your model, SMA or client's portfolio please contact us below.

Economic Scenario Expectations

• Continued Economic Growth

  SMID caps with strong business models and reinvestment opportunities would likely outperform, particularly those benefiting from structural growth trends (for instance, streaming TV advertising where SMID caps companies like Roku and Magnite are well-positioned).

• Mild Recession

  Companies with multiple ways of ‘winning’ and with strong business resilience would weather a downturn better, though more cautious position sizing would be warranted. A diversified approach amongst SMID caps would provide better downside protection.

• High Inflation & Rising Rates

  Companies with pricing power and low leverage would be favoured. SMID caps trading at historically reasonable multiples (15.8x average P/E) may be less vulnerable to further multiple compression compared to large caps (29.0x P/E).

• Severe Economic Downturn

  A SMID cap allocation with proper position sizing based on company resilience and margin of safety would help minimise the impact of underperforming holdings. Maintaining sector diversification rather than crowding into similar risk exposures would be crucial.

Conclusion

SMID caps provide greater opportunity gaps than large caps through lower analyst coverage, industry research inefficiencies, and misunderstood change dynamics. Active management focused on deep industry research, company resilience, and valuation discipline could exploit these inefficiencies to deliver superior risk-adjusted returns.

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