For the past few years, UK equities have remained in the doldrums, with the MSCI United Kingdom index achieving just over half of the total return of its All-Country World counterpart during the past five years, according to data from FE Fundinfo.
The problem intensifies further down the cap spectrum, with the MSCI United Kingdom Small Cap index returning less than half of the broader UK index again, with gains of 13.9% over five years versus 36%. And, while global small caps have underperformed the global multi-cap index by 17 percentage points, they have still managed to achieve a total return of 50.7%, meaning they have more than tripled any gains seen in the UK.
The headwinds looming over the UK are complex and multi-faceted, and smaller companies are typically perceived as being more sensitive to economic concerns than their larger peers.
But this is a common misconception, according to Abrdn’s Andrew Paisley. “Most investors think smaller companies underperform in a recession. In most cases, they are correct,” he says. “However, what’s less well-known is that small caps usually exit recessions quicker than assumed – outperforming large caps. This rebound can begin as early as three months into an economic downturn.” He explains this happens because markets tend to price in an economic recovery before it actually happens.
Ryan Lightfoot-Aminoff, investment trust research analyst at Kepler, agrees that UK small caps often outperform after periods of difficulty. His research shows that, since 1955, every negative year the Numis Smaller Companies index has suffered has been proceeded by three positive years, with an average return of 84.4%.
“Current valuations of UK smaller companies offer further validity to their investment case,” he adds, with the FTSE Small Cap index currently trading on a priceto-earnings multiple of 9x. According to data from Schroders, whenever the smallcap index has traded below a P/E of 10x, the average return over the following 12 months has been 36%, and over the next 24 months, this figure increases to 60%.
And if valuations and historical performance data (which of course is no guide to future returns) offer no solace to investors, given just how tricky the UK’s backdrop is to navigate at the moment, some more bullish UK small-cap investors suggest we could even be at the start of a performance ‘supercycle’.
Readers can make their own minds up as to whether this is on the cards or not but, for now, they can read more insights into UK smaller companies on page 20.