While UK equity funds have generally been out of favour in recent years, the past nine months has seen a rally in UK mid and smaller company stocks.
Since October 2023, which Jonathan Brown, smaller companies fund manager at Invesco, says he regards as the “bottom” of the market, the UK mid-cap index has risen by 30 per cent and the small-cap index by 26 per cent.
Since the start of 2024, the FTSE All Share is up 7 per cent, but Victoria Stevens of the Liontrust Economic Advantage team, which runs both small and all-company mandates, says the data indicates small caps still “stand out” in terms of being cheap, and trade at a 31 per cent discount to the intrinsic value of the companies.
This compares with an 18 per cent discount for the FTSE 100, while US smaller companies trade at a 20 per cent premium.
Brown says he is in no doubt that a change in “sentiment” is responsible. “Last October we started to get better inflation data and that started the market thinking about rate cuts and that set the market off. We initially got exposure to this by increasing the level of gearing on our investment trust and running a very low cash level within our open-ended fund.”
Peter Dalgliesh is chief investment officer at Parmenion, and he began adding to UK and US smaller company funds at the end of the first quarter of this year, a move he says he made on "the back of historically cheap valuations, light ownership with investors herded into mega caps, and a belief that lower rates would lead to a narrowing of the underperformance as any softening of global growth would be modest and short lived.
"Arguably we were a little early, but the arguments remain valid in our opinion, and having come through a reasonable period of elevated rates, those small caps that have demonstrated resilient earnings growth are well placed to capture the recovery as and when global growth improves”.
Simon King, chief investment officer at Vermeer Partners, says: “We increased our exposure to UK small cap about six months ago when valuations had reached another new low. General UK pickup and new government have improved backdrop since then so despite the rally we think there is still further to go.”
Darius McDermott, managing director at Chelsea Financial Services, says: “We are firm believers in the long-term outperformance of small caps.
"As we all know that has not been the right call in developed markets over the past three or so years. The valuation opportunity is clear, they are cheap on a PE basis versus their long-term history and they are also cheap versus large cap.
"I am pleased to see the beginning of recovery and interest in the asset class. We have been adding to small cap via funds like Chelverton UK Equity Growth and Montanaro UK Smaller Companies Investment Trust (when the discount widens).”
