Fidelity: Looking beyond US mega-caps: A different take on US equities

US equities continue to benefit from resilient economic growth, robust corporate earnings and accelerated investment in artificial intelligence. Yet concerns around concentrated market leadership, elevated valuations and a more uncertain interest rate environment suggest that investors may need to look beyond familiar large-cap names for the next phase of market leadership and opportunity.

Key points

• Strong earnings continue to support US equities, but persistent inflation, higher financing costs and concentrated market leadership are raising the importance of valuation discipline and stock selection.
• Small and mid-cap companies offer access to a broader and less researched opportunity set, with valuations remaining at a significant discount to their large-cap counterparts.
• One year after the launch of Fidelity’s Fundamental Equity ETF range, the Fidelity US Fundamental Small-Mid Cap UCITS ETF provides an actively managed route into this under-researched part of the US market.

The US economy continues to demonstrate considerable resilience. Consumer spending, healthy corporate balance sheets and AI-related investment have supported economic activity, while recent earnings growth has extended beyond large-cap technology companies. This provides a broadly constructive foundation for US equities going forward.

However, in our view, the conditions to enable further gains are becoming more demanding. Inflation remains persistent and, with rates once again rising, the borrowing environment may stay restrictive for longer than previously expected. Higher energy prices and geopolitical uncertainty add to the pressure, potentially raising companies’ financing costs and the hurdle for equity valuations. Against this backdrop, markets are increasingly distinguishing between businesses that can translate investment into cash flow and those whose valuations rely more heavily on future expectations.

This is particularly relevant in the context of AI. Investment in semiconductors, data centres, networking, power infrastructure and software continues to support earnings across the broader technology ecosystem. The opportunity is also starting to extend into industrials, advanced manufacturing, financials and, more broadly, those companies who are able to leverage AI to improve current - not future - productivity and revenue streams. Yet the path is unlikely to be uniform. As the investment cycle develops, evidence of earnings delivery and successful monetisation should become more important than thematic exposure alone.

At the same time, market leadership remains highly concentrated. Mega-cap technology companies continue to represent a substantial share of the broad US market, leaving many investors exposed to a relatively narrow collection of companies and return drivers.

Why look further down the market capitalisation spectrum?

Given the broadly constructive backdrop and the potential for further gains across the market, the answer to managing the emerging risks is not necessarily to reduce US equity exposure. Rather, the current environment strengthens the case for accessing the market more selectively and across a wider capitalisation spectrum.

Small and mid-cap companies have spent several years in the shadow of mega-cap equities. Investor positioning in this segment remains subdued and valuations are close to multi-decade lows relative to large-caps, although this has shown signs of bottoming out over recent months. US smaller companies also tend to be more domestically oriented, which may leave them less directly exposed to global macro disruption and geopolitical uncertainty. 

Relative performance of small vs large-cap indices

Past performance is not a guide to the future.

Source: Fidelity International/Bloomberg, September 2026. Data retrieved from Bloomberg as at 31 July 2026.

The relative gains of small and mid-caps since the start of 2025 are due to a range of specific factors, but in general, the headwinds that previously weighed on the segment are beginning to fade. Smaller companies were particularly exposed to the sharp increase in borrowing costs during 2022 and 2023, but many have now absorbed a substantial part of that adjustment, and future rate hikes will likely have a lessened impact. In contrast, some larger companies face the prospect of refinancing old low-cost fixed-rate debt in a higher rate environment, creating a potentially meaningful increase in interest expense.

Labour-cost pressures have also moderated. US wage growth has declined materially from its 2022 peak, reducing pressure on margins. Over time, greater use of AI and automation could provide an additional productivity benefit, particularly for more labour-intensive businesses.

As investors get to grips with a market that retains equity upside potential, but has become more complex, looking further down the capitalisation spectrum in the US could offer compelling opportunities. And if sentiment becomes more challenged, this area could offer greater levels of resilience than large-caps - as many investors are already underweight and valuations are at a relative discount, there would be less selling pressure. Overall, depressed valuations, improving fundamentals and light investor ownership could create a more attractive risk and reward profile than headline perceptions suggest.

A deeper opportunity set for active investors

The case for looking further down the capitalisation spectrum is also about the breadth of the opportunity. The US small and mid-cap universe contains more companies, receives less sell-side research coverage and exhibits greater dispersion in earnings expectations and stock returns than the large-cap market.

This can create a fertile hunting ground for fundamental research. Over each of the past 18 calendar years, the average performance of the top quartile of stocks in the Russell 2500 Index has exceeded that of the top quartile in the S&P 500 Index. This consistency illustrates an often-overlooked feature of the asset class: while small and mid-caps may experience periods of weaker index-level performance, they continue to generate a deep pool of high-conviction winners for investors that have the tools to identify them.

Average performance of top quartile (by count) for US small and mid-cap and US large-cap stocks

Past performance is not a guide to the future.

Source: Fidelity International, Bloomberg as of 31 July 2026.

Combining fundamental conviction with a systematic framework

The Fidelity US Fundamental Small-Mid Cap UCITS ETF was designed to capture these inefficiencies through a high-conviction active investment approach. The investment process brings together insights from a range of Fidelity Investments portfolio managers, drawing on different investment styles and perspectives across the firm’s research platform.

A proprietary framework aggregates these views to identify stocks where the underlying managers have the greatest conviction. Portfolio construction then combines this fundamental insight with a disciplined, systematic process which efficiently manages any unintended style or sector exposures.

The resulting portfolio provides access to a range of research-led ideas while reducing reliance on any single portfolio manager. Its semi-transparent ETF structure is also designed to protect proprietary investment insights, an important consideration in less liquid and less intensively researched areas of the market, and helping to ensure efficient trade pricing.

Within a broader equity allocation, the strategy can help diversify exposure away from mega-cap stocks, increase participation in domestically oriented areas of the US economy and create access to company-specific growth opportunities that may not be well represented in large-cap indices.

One year of broadening the opportunity

Since the Fundamental Equity ETF range was launched over one year ago in September 2025, it has remained aligned with its objective of capturing the breadth of opportunities across the US small and mid-cap universe. Despite periods of volatility, the strategy has delivered strong outcomes, outperforming the Russell 2500 Index since inception.

In terms of performance drivers, the portfolio has benefited from exposure to companies positioned to capitalise on rising AI-related capital expenditure, particularly across memory, semiconductors, and digital infrastructure. These have been among the highest-conviction ideas identified by the underlying portfolio managers and, as a result, have featured prominently among the ETF’s largest active positions. Lumentum has been the standout performer since inception, supported by surging demand for its datacom lasers and optical transceivers as hyperscale providers accelerated investment in AI infrastructure. Seagate, a non-benchmark holding, also generated strong returns, benefiting from a sustained increase in demand for high-capacity hard disk drives linked to the AI investment cycle.

One year on, we have already witnessed a variety of sentiment shifts towards the US market which has underscored the importance of research-powered investing. The past year has provided an early illustration of how active management and disciplined stock selection can uncover differentiated opportunities beyond the largest US companies. With market concentration elevated and valuations increasingly dispersed, looking further down the capitalisation spectrum may help investors build broader and more balanced US equity exposure.

Rolling 12-month performance

Past performance is not indicative of future results.

Source: Fidelity International, Bloomberg. Rolling 12 month returns (%) in USD, retrieved as at 03 September 2026. Basis: nav-nav, income reinvested in relevant base currency (USD); returns shown net of fees.

Important information

Investment objective - The Fidelity US Fundamental Small-Mid Cap UCITS ETF aims to achieve long-term capital growth by actively investing in a portfolio primarily made up of equity securities of companies with small-to-mid market capitalisations domiciled, or exercising the predominant part of their economic activity, in the United States.

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