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Is it time to take another look at UK smaller companies?

A difficult decade has left UK smaller companies looking attractively valued, but what could turn that value into opportunity? At the recent AIC Showcase, Cassie Herlihy, deputy fund manager for The Henderson Smaller Companies Investment Trust, looked at the catalysts that could change the picture and the opportunities she is finding within the market.

Growth at a reasonable price (GARP)
GARP investors seek companies offering consistent-earnings growth that is higher than the broader-market level while excluding companies with high valuations.

Growth investing
Growth investors search for companies they believe have strong growth potential. Their earnings are expected to grow at an above-average rate compared to the rest of the market, and therefore there is an expectation that their share prices will increase in value. See also value investing.

Interest rates
The amount charged for borrowing money, shown as a percentage of the amount owed. Base interest rates (the Bank Rate) are generally set by central banks, such as the Federal Reserve in the US or Bank of England in the UK, and influence the interest rates that lenders charge to access their own lending or saving.

Macroeconomic indicators
Statistics that provide an indication of the performance and health of an economy, such as economic growth, inflation and unemployment.

Mergers and acquisitions (M&A)
Transactions that bring together two businesses. A merger involves the combination of two businesses, while an acquisition occurs when one business buys another.

Outflows
The movement of money out of an investment fund, typically when investors redeem or withdraw their investments.

Re-rating
Occurs when investors are willing to pay a higher price for shares, usually in anticipation of higher future earnings. In terms of bonds, a re-rating can be assigned when the bond issuer’s ability to service and repay its debt improves (credit quality). Also see de-rating.

Small-cap stocks
Companies with a valuation (market capitalisation) at the smaller end of the market scale.

Valuation metrics
Metrics used to gauge a company’s performance, financial health, and expectations for future earnings, e.g. P/E ratio and ROE.

Value investing
Value investors search for companies that they believe are undervalued by the market, and therefore expect their share price to increase. One of the favoured techniques is to buy companies with low P/E ratios or P/B ratios. See also growth investing.

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For me, the key takeaways have to be it’s been a really tough decade for UK small caps. You could probably say it’s a lost decade. You would’ve been better investing elsewhere.

UK small caps are therefore very, very cheap. But again, we’ve been saying that for many years now. Being cheap in itself isn’t enough. We need to be thinking about what are the catalysts that can really move the needle here.

Firstly, from a macro perspective, you know, I think there is still an argument that there could be improving macro indicators going through 2027. Perhaps we will see the interest rates coming through from a cutting perspective, and maybe we’ll see more political stability.

More importantly, I think is the flow dynamic. If we just see a stemming of the outflows from this part of the market, that should be enough to underpin the valuations from here. And then you’ve got the continuing takeovers in M&A in the space. This shines a light on how undervalued this part of the market is.

So there’s no silver bullet, there’s no easy answer. It’s a combination of these things coming together that should help to drive a re-rating of this part of the market.

I’ve always looked at UK smaller companies, and the exciting thing is that there’s fantastic businesses. But to your point of why now, I’ve said that UK small caps are cheap, and we want that to all change because all ships will rise.

However, from my perspective, I’m a growth investor, but at a reasonable price, so I don’t want to overpay for these assets. So for me, there’s quite a unique investment opportunity where there’s kind of lots of company that fit my quality growth criteria, but there’s also increasingly more companies that fit my valuation criteria as well.

So from my perspective, the investment universe is much richer than it was in the past.

It’s actually my first time attending this conference, and what I would say is I’m absolutely blown away by the sheer number of people that have come out on what is a very blustery October day. But it’s more than the number of people. For me, it’s the level of engagement that we’ve seen from the people sitting within the audience.

From a UK small cap perspective, we’ve seen persistent outflows from the sector, from institutional investors who have been allocating away from our part of the market for one reason or another.

So for me to have the opportunity to stand up to speak to an engaged audience who are looking at the nuances of this part of the market and taking a long-term view, I think that’s a fantastic opportunity to potentially fill the gap that’s being left by these institutional investors who are leaving the space.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.

 

Before investing in an investment trust referred to in this article, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser. Please refer to the AIFMD Disclosure document and Annual Report of the AIF before making any final investment decisions. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change.

 

Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

 

The information in this article does not qualify as an investment recommendation.

 

There is no guarantee that past trends will continue, or forecasts will be realised.

 

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Before investing in an investment trust referred to in this document, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser. This is a marketing communication. Please refer to the AIFMD Disclosure document and Annual Report of the AIF before making any final investment decisions.
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