Everyone hates small and mid-cap stocks right now. Their performance has badly lagged those of their larger counterparts in recent months.

Seen as more vulnerable to the vagaries of the economy and without the scale and financial strength to withstand higher borrowing costs, investors have been abandoning them in their droves. The chart shows how the MSCI World Small Cap index has been lagging the broader MSCI World index over the last six months.

The same pattern has been repeated domestically with the FTSE 250 and FTSE Small Cap trailing behind the large cap FTSE 100.

This exodus from smaller companies and the apparent reasoning behind it ignores three important points. One, not all of them are created equal. Some have perfectly respectable balance sheets and generate healthy amounts of cash flow. Second, because they are smaller, a decent number of businesses will still be able to grow against an uncertain economic backdrop by taking market share. Finally, because they have been so unloved, valuations are looking attractive.

Investment bank Berenberg sums up the valuation gap between larger and smaller firms: ‘On a 12-month forward PE basis, the S&P 600 small-cap relative to the S&P 500 has only been cheaper 8% of the time in the last 30 years. Similarly, the STOXX 200 small-cap and mid-cap indices relative to large-cap have only been cheaper 3% and 2% of the time in the last 20 years. In the UK, the FTSE 250 trades at a 30-year median dividend yield high relative to the FTSE 100 – UK mid-caps have never been cheaper relative to large-caps on this basis.’

Naturally, there are risks with small caps. The chance of outright default is undoubtedly greater, the ability to buy and sell shares freely and without a large spread between your purchase and sale price can be constrained and it can be harder to find out information about them.

This presents a compelling case for investing in small caps through funds and relying on the expertise of a professional stock picker. They can uncover the underappreciated gems which occupy the small cap universe. We highlight just such a vehicle, investment trust BlackRock Throgmorton (THRG), in our Great Ideas section this week.

That is not to say there is anything to stop you from investing in smaller companies yourself as part of a broader investment portfolio. Some people like to make these ‘satellite’ investments which can be added on top of a more stodgy and solid portfolio of core holdings.

It’s important to do your research though. Read the annual report, check the balance sheet. If the business is consumer facing even sample its products or services yourself or see how its offering is rated online.

Shares (and others) hold investor evenings and webinars where you get the chance to hear from and quiz senior executives from small and mid-cap firms. You can find details of upcoming events of this nature here.

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