More Foreign Investors Are Turning to Small Caps for US Exposure

As institutional investors continue to pursue greater exposure to the US economy, an increasing number of foreign investors are turning to small- and mid-cap companies as a more cost-effective means of gaining direct market access.

Schroders strategists noted that more institutional investors are seeking exposure to the US because its economy emerged from the pandemic with greater strength than most other economies around the globe, with consumer spending continuing to drive growth.

In addition, the strong labor market and potential policies under the next Trump administration aimed at supporting domestic growth suggest that investing in the US could remain beneficial.

However, US equities are considered an expensive asset class, especially as large-cap stocks are at a premium. This has prompted more foreign insitutional investors to turn to small- and mid-cap stocks as a more affordable alternative for accessing that market.

In addition to being more cost-effective, small- and mid-cap companies offer distinct advantages as many large-cap US companies compete globally, making their revenues more reliant on the global economy.

In contrast, small- and mid-cap companies often have customer bases that are either entirely or predominantly based in the United States, offering investors more direct exposure to the US economy.

This strategy is especially advantageous now, as small- and mid-cap valuations have been discounted relative to large caps for several years. Schroders strategists noted that this trend is expected to continue, as the recovery in M&A activity and IPOs is likely to persist into 2025, and inflation is now at levels particularly favorable for small caps.

In addition, Wall Street is forecasting a bigger rebound in small-cap earnings, starting in Q4 2024 and through much of 2025, many small-cap companies are set to play a key role in driving the AI revolution and the ongoing growth of the service sector further supports small and mid-caps, which predominantly operate in this space.