Investors Eye European Small Caps as Hidden-Gem Strategy Gains Traction

European small-cap companies with narrow product focus and dominant local positions are drawing renewed investor interest as potential long-term growth investments, according to portfolio managers at JPMorgan Discovery Trust.

The trust, known by the ticker JEDT, seeks out what it calls "hidden gems" — firms with superior products, strong capital returns and the potential to grow over extended periods. Jack Featherby, portfolio manager at the trust, cited German oven maker Rational AG as a model: its Icombi oven is widely used by restaurants and caterers around the world and the stock has risen more than 800% since 2005 despite volatility in recent years.

Featherby said the trust favours companies that either lead a single global product category or hold dominant market share in a domestic market. Those firms, he said, can earn excess returns and grow consistently because they are more in control of their competitive environments. "If you go into a restaurant kitchen or food truck, many will have a Rational oven," he said, noting the firm's under-penetrated addressable market and strong capital returns.

JEDT's selection framework balances valuation, business quality and shorter-term operational momentum to judge where the market is heading. The trust has used that framework to maintain positions in defence firms that performed strongly in 2025, but Featherby said recent price rises have prompted a reduction in the portfolio's exposure as valuations have become "quite steep."

With defence stocks repriced by investor demand, JEDT is increasingly looking to electrification as the next structural growth theme in Europe. Featherby described the energy transition as "the real long-term driver" for the region, spanning electrification of transport, industry and infrastructure and driven by environmental forces that will require sustained public and private spending.

"It needs trillions of dollars' worth of investment, and the nature of infrastructure is that you can't build these things overnight," he said. "You can't build it all in a year, it's going to take a very long time," which creates a lengthy runway for companies exposed to that transition.

The trust has sought exposure across the electrification value chain. One example is German engineering firm Bilfinger SE, which JEDT holds as a beneficiary of industrial clients' shifts away from traditional energy sources. Featherby said large German firms are contracting engineering companies such as Bilfinger to support work on green energy projects.

Featherby also emphasised the defensive qualities of many small caps in the current market. He said managers find clarity when meeting the leadership teams of these firms because many still focus on doing a narrow set of activities very well. That micro focus, he argued, can make small caps relatively insulated from the concentration of investor flows into a small number of global mega-cap themes such as artificial intelligence.

"People think the only way to invest is in AI, but they are investing in a market with record high valuations in the world's most global companies," he said. "We're in a world where de-globalisation is not a cool word to say… de-globalisation is better for domestic companies, so it should be better for small caps."

The trust's approach illustrates a broader trend among some institutional investors to hunt for value and durable cash-generation outside the high-flying technology and defense sectors. By combining companies with dominant niche products and domestic market strength with targeted exposure to structural themes such as electrification, JEDT aims to capture long-term growth while managing near-term valuation risk.