Three reasons to be excited about UK small caps

According to AXA’s Henry Lowson small caps continue to offer a premium growth opportunity over the medium term.

Three reasons to be excited about UK small caps

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The first reason for this view springs from the growing confidence on display within the market more broadly as a result of the improved economic backdrop and the strengthening of corporate balance sheets. This, along with an improving financing opportunities available have meant that merger and acquisition activity that has already picked up in the larger caps has begun to filter down to the smaller cap space.

“M&A activity is another key driver of small cap performance and that is something that has been lacking over three to four years. There were no bids last year, but this year the fund has already been the beneficiary of a number of takeover proposals.”

The second reason suggested by Lowson for a positive view of the sector is that UK small caps remain structurally under owned. The graph below demonstrates the point, as it shows the performance of assets under management within the space if performance is stripped out.

According to Lowson, while there is no way to know exactly where that money has gone, the broad thesis is that much of the move is on the back of a shift to more global mandates.

But, as he points out, although UK small caps are perceived to be very niche, a closer look at the sector demonstrates that you can actually get a rather good geographical earnings split from UK companies.

Lowson’s third reason way it is a good time to be a small cap fund manager is the diminishing amount of research available on small cap stocks.

“The a lack of research has always been a factor within small caps, but I think particularly due to the regulatory changes and the commission payment changes currently underway, smaller companies have become less commercial for investment banks to cover and therefore there isn’t the research out there. That means you can find undervalued companies not because they are poor but because they are unknown.”

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