Global smaller companies: the diversification deliverers

If you want to protect your portfolio from war, energy shocks, disruption by AI and concentration risk in market indices, you're not alone. This list of worries is long enough to give even the most committed bull cause to reflect.  

Now for the hard question: what represents a 'defensive' investment in 2026? A consumer staples business with globally recognised toothpaste and deodorant brands? Or one of the Magnificent Seven, with their prodigious cashflows and (formerly) iron-clad balance sheets? Or perhaps being 'defensive' simply means owning a claim on a gold bar sitting quietly in a Swiss vault.  

We acknowledge that many investors regard economically sensitive smaller companies as part of their 'risk' bucket. But perhaps an allocation to some of the world's modestly valued, growing but under-owned smaller companies has something to offer the defensively minded. This statement is not meant to provoke. Instead, it reflects a recognition of three interrelated factors.  

First, the world looks different in 2026 than it did when many of us formed our ideas of what constitutes a 'defensive' asset. Second, SmartGARP®, our stock-screening system, suggests that the fundamentals of some smaller companies are compelling, particularly when compared to the large US companies that dominate market-cap weighted indices. Third, diversification remains the only free lunch on offer in financial markets. 

To the detriment of traditionally ‘defensive’ assets, the world has changed 

The tariffs President Trump announced on Liberation Day were emblematic of an ongoing move away from globalisation and towards fragmentation. In these conditions, attributes that were once helpful for mega-cap multinationals, such as their globally diversified revenues and international, just-in-time supply chains, now appear to be liabilities. Smaller companies, by contrast, tend to focus on their domestic markets. That offers shelter at a time where trade tariffs can double overnight. It is no coincidence that the small-cap Russell 2000 index has outperformed the large-cap S&P 500 index since Liberation Day.  

Deglobalisation, however, is not the only way the environment has shifted against of some of yesterday's defensive stalwarts: 

• Government bonds – Ballooning debt-to-GDP ratios across the developed world are eroding the safe-haven status once enjoyed by government bonds. 
• Magnificent Seven – The vast sums being committed to AI infrastructure are transforming the business models and balance sheets of the US technology giants. Meta, Alphabet, Microsoft and Amazon are, along with Oracle, expected to deploy $4 trillion of capital expenditure over the next five years. To help pay for it, Alphabet borrowed $32 billion from the bond market earlier this year; Amazon borrowed over $50 billion.¹ 
• Consumer staples – To rediscover their lost growth, consumer staples companies are undergoing drastic corporate re-engineering, spinning off slower growing divisions and reversing debt-fuelled mergers.  
• Pharmaceutical companies – In exchange for a reprieve from punitive trade tariffs, Pfizer, AstraZeneca and Novo Nordisk agreed to lower their drug prices in the US and invest in domestic production. 

SmartGARP highlights attractive valuations in the global smaller companies market 

Clearly, smaller companies are not immune to wider turmoil in financial markets. But we believe that some of the characteristics SmartGARP points us towards – such as companies with below-average valuation multiples, above-average free cashflows and attractive dividends – provide our portfolio with a margin of safety should there be a deterioration in sentiment or a compression in multiples.  

On a price-to-earnings (P/E) basis, our portfolio of small caps traded on 9.9x at the end of March versus a P/E of 17.0x for the MSCI AC World index². This does not reflect any lack of growth in the stocks we own; earnings forecasts for our holdings are being revised up by more than for the market as a whole. Our portfolio offers a free cashflow yield of 9.9% versus 3.4% for the all-cap index³. As shareholders, we receive some of that cash directly, through a 3.9% dividend yield (as opposed to 1.9% for the MSCI AC World index⁴) and share buybacks. 

Smaller companies can bring instant diversification to most portfolios 

Diversification may be "the only free lunch in investing", but it has slipped down the menu in recent years. The comfort zone for many investors has been to be long in the US, long in mega caps and long in growth. Funds that track capitalisation-weighted indices are exposed to the same themes. And, until relatively recently, that was a winning formula. 

But now? A handful of mega-cap technology stocks exercise outsized influence over the success (or not) of market-cap-weighted indices. Given the quantum of political and economic uncertainty, does having 63% of your equity portfolio⁵ exposed to the US – as anyone tracking MSCI AC World Index does – make sense? Or might it be more attractive to have a diverse pool of opportunities?  

At 34%, our strategy's allocation to the US⁶ is meaningful but prudent. We currently have overweight allocations in companies with hard assets in the industrials, basic resources and oil & gas sectors; we have relatively little invested in technology or healthcare. As a result, our portfolio has little in common with other global equity funds or any benchmark index. We can’t offer a single silver bullet to protect your assets in an uncertain world. But allocating part of your portfolio to a carefully selected portfolio of smaller companies might offer the next best thing.