The Global Smaller Companies Trust: Finding opportunities beyond narrow market leadership

• Narrow AI-led market leadership has left many smaller companies behind, creating opportunities in quality businesses where valuations have fallen despite resilient fundamentals
• Smaller-company earnings grew around 40% year-on-year in the second quarter, with strength extending beyond AI into industrials, power, energy, materials, defence and aerospace
• Attractive valuations are creating opportunities across global smaller companies, from overlooked software and IT services businesses to companies in the UK, Japan and Emerging Markets

After an extended period of large-cap and US technology dominance, Nish Patel, Fund Manager of The Global Smaller Companies Trust, believes increasingly narrow market leadership is creating opportunities in businesses and sectors that have been left behind, while attractive valuations and strong earnings provide a supportive backdrop for smaller companies.

Finding opportunities beyond the AI winners

“Markets remain narrow, with capital concentrated in semiconductors, power and other beneficiaries of AI investment. We have exposure to those areas, but the concentration has also created opportunities in sectors that have been left behind.

“Quality smaller companies have been particularly out of favour, including in software and IT services. That suits our contrarian quality-value approach: we are finding businesses where fundamentals remain strong but valuations have fallen because investors have taken a broad-brush view of an entire sector.

“CACI International is a good example. It has been caught up in the wider weakness in IT services, but its underlying business continues to perform well, with exposure to areas including defence, electronic warfare and anti-drone technology. We have also found opportunities in vertical software, where high-quality businesses are trading at valuations we would not normally expect to see because investors have moved away from the sector.

“We saw market leadership broaden during parts of the summer before narrowing again in September. A more sustained broadening would be supportive for a diversified smaller-company portfolio, but in the meantime the dispersion within markets is creating opportunities for bottom-up stockpickers.”

Stronger fundamentals beneath the surface

“The fundamental backdrop is also encouraging. Second-quarter earnings growth among smaller companies was around 40% year-on-year, supported partly by the AI infrastructure build-out but also by strength across industrials, power, energy, materials, defence and aerospace.

“At the same time, valuation dispersion between smaller and larger companies is at levels last seen around the technology boom of 1999–2000 and following the Nifty Fifty era of the early 1970s – both periods of highly concentrated market leadership.

“Following the late-1990s technology boom, smaller companies went on to outperform for around a decade. History will not necessarily repeat itself, but we believe we could be in the foothills of a recovery that has the potential to last for several years.”

Opportunities across global markets

“The opportunity is not confined to one market. Smaller companies provide access to businesses across a much broader range of regions and sectors than the US mega-cap technology companies that have dominated global indices.

“That does not mean we are negative on the US. It continues to offer some of the strongest fundamentals and the Trust has a significant position there. However, we are finding particularly attractive valuations elsewhere.

“In the UK, companies can generate 50% or 60% of their revenues from the US yet trade at a substantial discount because they are listed in London. That allows us to access similar underlying economic exposure at a very different valuation.

“Japan is interesting for different reasons. Corporate governance reform and changes to capital allocation are creating potential catalysts, particularly among smaller companies where many of those changes are taking place.

“Emerging markets are also a significant overweight for us, with opportunities also surfacing as the focus on shareholder value and capital allocation spreads into markets including South Korea, Thailand and Malaysia.”

A greater focus on catalysts

“We remain bottom-up investors rather than making wholesale portfolio changes in response to macro events. But valuation alone is not enough, which is why we have increased our focus on identifiable catalysts that can close the gap between price and value over the past two years, whether that is a buyback programme, activism or a change in management.

“Alongside tighter sell discipline, we have reduced the number of holdings in the Trust from 213 to around 130 over the past two years, allowing us to focus more closely on the opportunities where we have the strongest conviction.

“With market leadership remaining narrow, strong earnings beneath the surface and significant valuation dispersion across sectors and regions, we are finding plenty of compelling opportunities across the small-cap market. If the broadening we saw over the summer resumes, we believe that could provide a further tailwind for the asset class.”