An overlooked fund trend delivering big gains

For many years various asset allocators have pointed to the fact that the US stock market has a lofty price tag versus other regions.

Another concern that’s generated plenty of column inches is rising levels of concentration risk. Seven companies, the so-called Magnificent Seven stocks, account for 39.3% of the entire market capitalisation of the S&P 500 index compared to around 12% a decade ago. In turn, the index is heavily exposed to a narrow group of businesses and themes, particularly artificial intelligence (AI). 

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Given the price that investors pay is a crucial component of prospective long-term returns, this has led some investors to take risk off the table and look towards better value areas. Over the past year to 18 months, the pivot to other markets is in part explained by many regions outperforming the US.

Since the start of 2025, a period that includes the notable sell-off that occurred last March and April amid concerns over US tariffs as well as the more recent pick-up in volatility this year on the back of Middle East tensions, the S&P 500 index has returned 19.3%. 

While such a return isn’t to be sniffed at, other regions have fared better, with the MSCI Emerging Markets Index up 55.2%, the MSCI Europe ex UK Index up 34.8%, the MSCI Japan Index up 33.3% and the FTSE All-Share up 33.0%. All figures are in sterling and sourced from FE Analytics to 27 May 2026.

However, as more experienced investors can testify, while stock markets becoming more turbulent can cause a short period of queasiness, it can also bring opportunity.

Moreover, while US shares in aggregate are carrying more premium valuations, it’s important to avoid tarring the entire region with the same brush.

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One key trend that’s played out since US tariff risks passed into the rear-view mirror is the strong performance of value-focused strategies and US smaller companies, with some funds specialising in that style or area of the market even outperforming the return the MSCI Emerging Markets index produced of 65.6% from 21 April 2025 to 27 May 2026. 

In contrast, over this period the S&P 500 returned 46.9%.

Past performance is not a guide to future performance.

US smaller company recovery

Topping the table, the iShares Edge MSCI USA Value Factor ETF (LSE:IUVL) “seeks to capture undervalued stocks relative to their fundamentals”. However, investors need to be cognisant that its top holding – Micron Technology (NASDAQ:MU) – has done a lot of the heavy lifting. 

Over one year, the memory chip firm has seen its share price soar by 950%, benefiting from the AI boom that’s supercharged chip demand at NVIDIA Corp (NASDAQ:NVDA), one of its biggest customers. Micron now accounts for a very big single-stock position of 21.8% in this ETF.

Also in the list are two funds, BlackRock US Dynamic and Artemis US Select, that have most of their portfolios in larger companies. Gaining an edge over US indices over this period will have been driven by successful stock picking.

However, what stands out is that five smaller company funds feature in the above table. Each has outperformed tracker funds following the ups and downs of the Russell 2000 index. To give one example, the Xtrackers Russell 2000 ETF (LSE:XRSU) is up 54.4%.

The key to the rally is low valuations, influenced by the fact that US smaller companies have for many years been overshadowed by their larger peers, particularly the Magnificent Seven.

It’s a trend, though, that investors are overlooking. Investment Association (IA) data shows that US smaller company funds have endured a year of consistent outflows, totalling £1.4 billion (to March 2026).

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Moving back to valuations. Research published last summer by Fidelity showed that as of June 2025 US small caps were in their cheapest quintile versus large caps since 1990. Fidelity said this increases the historical odds of small caps outperforming large caps over the next five to 10 years.

Nish Patel, manager of The Global Smaller Companies Trust (LSE:GSCT), observes that the “long winter” for smaller companies stretches back over a decade, noting that “investors have overwhelmingly favoured large-cap growth companies”.

However, Patel says that when valuations are at such a low point “history suggests that when these cycles begin to turn, they can last for many years”.

In common with our own home market, US smaller companies tend to have more of a domestic footprint than the behemoths at the top end of the S&P 500 index.

However, one notable difference is that US smaller companies are much larger than those here in the UK.

Olivia Micklem, co-manager of Artemis US Smaller Companies, appeared in our Insider Interview series last year, saying: “For us, that’s typically businesses with a market cap of below $10 billion (£7.7 billion). 

“What we are really trying to find are those businesses that can create a strong competitive moat, have a really strong competitive advantage, but also a really strong profitability profile, and the opportunity to maybe expand their margins and grow their cash flows over time, using that to reinvest in the business or return that cash to shareholders and grow over time.”

Its top three positions are infrastructure firm Primoris Services, transport and logistics firm J B Hunt, and Coherent, which develops, manufactures, and markets lasers among other things. 

The fund is a concentrated approach of 48 holdings, but risk is widely shared with its top 10 weightings ranging from 3.1% to 4.2%.

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Both Neuberger US Small Cap Intrinsic Value and First Eagle US Small Cap Opportunity have more holdings, 94 and 231 positions respectively.

Neuberger US Small Cap Intrinsic Value looks for companies below a market cap of $5 billion that are trading at a “material discount to their intrinsic value”.

Meanwhile, First Eagle US Small Cap Opportunity describes its approach as one that “focuses on characteristics such as inefficiently valued assets, turnarounds, accelerating growth and overlooked leaders”.

Bill Hench, head of small caps and portfolio manager at First Eagle Investments, makes the case for why recent strength in this part of the market can be sustained. Among the “bright beacons still on the horizon” is an expected earnings upswing. “For the first time in several years, earnings for the Russell 2000 are projected to outstrip those of the S&P 500 index for at least the next two years,” Hench said.

He also notes that AI-driven growth can allow certain smaller companies to scale at a faster pace. Hench said: “AI may enable some small-cap companies - including suppliers to infrastructure and data-centre construction - to expand their customer bases without incremental spending on research and development, underpinning both top-line growth and margin expansion. 

“Healthcare and consumer goods companies could conceivably see even greater benefits from AI through enhanced development of premium products that drive pricing power.”

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Ultimately, time will tell whether this is the start of a trend that has longer legs, but not up for dispute is that due to their size, smaller companies have higher potential for growth. As the late Jim Slater said, “Elephants don’t gallop.”

This part of the market is also less intensively researched by analysts, giving investors and fund managers who do invest in smaller companies greater chance to gain an edge.