UK smaller companies: Is the tide finally turning?

By James Yardley on 26 August 2026 in UK

UK smaller companies offer investors access to dynamic businesses across a variety of fast-growing markets, and the potential for attractive long-term returns – the trouble is that the past decade has been dominated by negative headlines as Brexit, Covid and the fall in markets in 2022 have all contributed to greater uncertainty.

Two trends have led to significant outflows from the asset class in recent years. We’ve seen a collapse in demand from UK pension funds, which have increasingly allocated to global portfolios, and we’ve also seen a decline in demand from retail investors. The UK stock market has seen outflows of $160 billion since 2016, with a disproportionate share coming from UK small and mid-cap funds*.

The old football saying is that “it is the hope that kills” and that has most definitely been the case for this asset class, which always seems to end up in the eye of the storm. Yet periods like this often create an important question for long-term investors: when sentiment becomes overwhelmingly negative, are markets still pricing businesses correctly?

We have already started to see some potential signs for greater optimism. In the past 12-18 months, interest rates and inflation have fallen (although this has slowed down due to the Middle East crisis) while we also saw a rotation away from the world’s largest economy in 2025, with UK equities outperforming their US counterparts.

Compelling valuations

In a world where many global markets look expensive relative to their own history, UK small-caps remain incredibly cheap. Figures from Unicorn Asset Management place them at between 30-50% below their long-term PE averages**; these are ludicrous, multi-decade low valuations.

IFSL Marlborough Special Situations manager Eustace Santa Barbara says the value available in the UK smaller companies arena is arguably unrivalled. He says that despite being at the forefront of fields including aerospace, chemicals, construction, defence, energy, engineering, finance, healthcare, infrastructure, life sciences and medicine, many businesses remain modestly priced – often remarkably so.

An important point to note is that the FTSE SmallCap index now has a yield of 3% — 0.8% higher than the FTSE 100***. This typically signals that small-cap share prices have fallen to unusually cheap levels relative to the cash dividends they pay, presenting a rare value and income opportunity.

Why this opportunity may not last forever

Pessimists will rightly say the UK discount has been persistent since Brexit, but there is a feeling that the negative noise around UK smaller companies is reaching a crescendo. International buyers and private equity businesses are taking notice. The FTSE index is seeing a steady decline in the number of constituents, while there has been very little IPO activity to replace these losses.

In the past five years, 77 small and medium-sized London-listed companies were acquired. These companies were bought at a near 50% premium on average – but the important point is that the pool of companies remaining is getting smaller and any change in sentiment could see valuations rise even faster.

The M&A activity has seen the team at Unicorn delve into a market they believe still has plenty of valuation opportunities.

JPMorgan’s Georgina Brittain cites the sale of Manchester-based engineering group Renold. Although they got a 100% premium, she felt it was still cheap and an indictment of the current market. She says the CEO had done a great job of rescuing the business, but ultimately the share price had not moved, and that management persuaded them this was the best move for the business to grow.

Share buybacks have continued aplenty as boards take a more positive view on their company’s own outlook, believe they have surplus capital and, perhaps most importantly of all, see their shares as materially undervalued.

There are other factors that could prompt a change in sentiment among investors when it comes to UK smaller companies – particularly political moves. Measures such as adjustments to stamp duty, changes in ISA allocations towards stocks and shares, and pension reforms could all stimulate market activity.

Ultimately there are two key factors that can lift share price returns over the long term – earnings growth and share price re-rating. We have seen signs of the former in 2024 and 2025, with UK small-caps delivering high, single-digit returns with no re-rating. A re-rating is tied to sentiment, which – although in the doldrums – can change fast.

History shows us UK small-caps outperform their larger peers consistently – having delivered a compound annual growth rate of 14% since 1955**. They are also good at delivering strong recoveries post financial crisis. Could now be the nadir for these fledgling businesses, having returned 64.6%, compared to the FTSE 100 returning 131.2% in the past decade^?

Funds to consider

A good all-rounder worth considering is the IFSL Marlborough Special Situations fund. The fund’s sub-investment manager is Canaccord Asset Management, which in our view has one of the best small-cap teams in the country. The fund invests in around 200 small and mid-cap companies and has an excellent long-term track record.

Those looking for income might consider JPMorgan UK Small Cap Growth and Income, which invests in 60-120 companies. The trust also pays four equal quarterly dividends, with a total that is equivalent to 4% of NAV. Another income offering with a focus on UK small and mid-caps is the WS Montanaro UK Income fund, where each holding will offer an attractive dividend yield or the potential for dividend growth.

A final consideration for investors is whether a new flavour of smaller companies fund might come to the fore if a recovery emerges. Quality managers are due a resurgence. An example here would be the Liontrust UK Smaller Companies fund or the Premier Miton Tellworth UK Smaller Companies fund.

*Source: Scottish Financial Review, 19 June 2026
**Source: Unicorn Asset Management
***Source: FTSE Russell, 24 August 2026
^Source: FE Analytics, total returns in pounds sterling, 24 August 2016 to 24 August 2026