But still no catch-up! Despite a positive performance of 8.3% in the first two months of the year, the MSCI Europe Smid Cap Index (small and mid caps) was unable to narrow the underperformance gap with the MSCI Europe Large Cap Index (large caps) (+11.4%). European small and mid caps have rarely underperformed over such a long period (since 2023) in the memory of any manager. The MSCI Europe Smid Cap Index continues to lag behind and to suffer from investor disenchantment. And yet…
As the saying goes, past performance is no guide to future performance. Over the last four years, the MSCI Smid Cap Europe Index has underperformed the MSCI Large Cap Europe Index by more than 40%.
However, in the past, it was small and mid caps that took the cake and outperformed large caps. In the decade from 2011 to 2020, the MSCI Europe Smid Cap Index has outperformed the MSCI Large Cap Europe Index by more than 15%.
Of course, historically, rising interest rates have never been very favourable for the stock market, and particularly for small and medium-sized enterprises. In 2022 and 2023, the underperformance may be justified by the sharp rise in interest rates in the period after covid. Even if these small and medium-sized businesses are no more indebted than larger ones, with the exception of the property sector, it is true that their access to finance is more complicated because they are considered to be more fragile, have a less robust business and often have less capacity to meet the banker’s requirements. As a result, borrowing conditions are tighter.
But for over a year now, the story has been reversed. The ECB prints a rate cut at each of its meetings, with probably a sixth in the pipeline as inflation figures continue to fall (2.4% in February compared with 2.5% in January in the eurozone). But to no avail, the underperformance of small and mid caps persists. Logically, they should benefit more from this downward trend in interest rates, as it will be easier for them to find finance.
Pascal Riegis , co-head of Fundamental Equities and in charge of the ODDO BHF Avenir range at ODDO BHF , is sounding the alarm and betting that this bad patch will end with a recovery based on a number of arguments.
EPRs also behind schedule
Today, in a large and diversified universe, the world of small and medium-sized businesses has every chance of making a comeback. “The normalisation of financial conditions, an economic rebound, a flurry of M&A activity, and the adoption of AI by small and mid caps all promise growth over the coming quarters,” explains the manager.
Pascal Riégis’ analysis of the undervalued situation Pascal Riégis is unambiguous in terms of the price/earnings ratio (PER), which is easier to understand for mid-caps.
“After several years of underperformance relative to large-caps, European mid-caps are now significantly outperforming their larger peers. The historic premium that the market attributed to their superior earnings growth has disappeared. In December 2024, according to Bloomberg, the price/earnings ratio (P/E) of European mid-caps is 13.4x. This ratio appears low both in absolute terms but is also below its historical average since 2010 (18.3x) and that of large-cap equities (14.0x), according to our analysis (whereas it is generally higher than that of large-caps).”
The sector’s premium over large caps is justified by its greater growth potential. Often focused on market niches, small and mid caps are more agile than larger companies when it comes to reorienting their business towards a new activity. In addition, decision-making processes are faster. Starting small, they offer the potential for higher and faster earnings growth, often in double figures for the best companies.
With these characteristics, in the past the market capitalised these small and mid caps 15-20% more than the market.
Outlook for 2025
There are still many uncertainties for 2025 (political and economic situation in France and Germany, US tariff hikes, the war in Ukraine, etc.). “This valuation already implicitly seems to take account of some of these risks,” emphasises Pascal Riégis. Then, alongside these uncertainties, there is the certainty that the asset class remains significantly undervalued and neglected by investors (with the exception of venture capital managers – see below).
A continued or perhaps even accelerated reduction in interest rates, improved economic growth, pan-European investment programmes, etc. are also catalysts that should revive this asset class, whose performance remains unflattering. After years of disappointing returns (in absolute terms and at low valuations), their stock market rebound is potentially significant.
Finally, there was another significant upward driver. More and more often, the world of ‘small/mid caps’ is in the news on stock market mornings in the form of mergers and acquisitions. And this type of event has been on the increase in recent months. Attracted by their low valuations, venture capital firms are often at the helm. This phenomenon also highlights the fact that the European small and mid-cap market is full of nuggets.
Manager of the same fund for 22 years
Pascal Riegis is a small and mid-cap specialist and stockpicker who has been at the helm of the ODDO BHV Avenir Europe CR-EUR fund for over 22 years. The fund has generated an annualised return of 7.7% since its creation in May 1999.
In a broad and diversified universe, the world of small and mid caps has every chance of making a comeback. Thecaution of institutional investors in a market segment (with the exception of venture capitalists) considered to be rather volatile and risky seems less and less justified in the face of an increasingly glaring discount.
