The smaller company landscape in the UK is truly diverse, with a breadth of sectors represented. This makes it a fertile hunting ground for active stockpickers investing for long-term growth: it is possible to sidestep sectors that are struggling, and target sectors with stronger growth prospects. However, at the moment, it is possible to be optimistic in most areas within smaller companies.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
UK small companies divide into three broad categories - consumer, industrial and financial. All three sectors are providing good stockpicking opportunities today. There is much discussion over what may be the catalyst for a small cap revival – and there are a number of possibilities, from stabilising interest rates, to M&A activity, to buybacks. However, in the longer-term, it is the outlook for these three areas that will determine the outcome for small cap stocks in the longer term.
Taking these sectors one by one, the first main area is the consumer sector. This is a broad category, and includes travel and leisure companies, many of the housebuilders, plus construction and traditional retail groups. Many companies in this part of the market have struggled as inflation has squeezed household spending, but a revival could be imminent.
Consumer strength is supported by a shift in the interest rate cycle and weakening inflationary pressures, which has helped stabilise household finances. Areas such as travel and leisure have seen a significant bounce-back, as demand has returned in the wake of the pandemic1. On the BlackRock Smaller Companies Trust, we have been adding to housebuilders and also to construction companies as the housing market strengthens.
The industrial sector is also an important part of the UK small cap equity universe. It covers capital goods, aerospace and defence, alongside ‘traditional’ industrials, such as precision engineering companies. These groups often have significant market share in niche areas, and larger companies depend on the products and services they provide.
We see potential strength among these companies as well. With wage inflation likely to be structurally higher, companies will need to invest to boost productivity. This should be reflected in industrial capital expenditure. As a result, we’re positive on this area, believing industrial demand is likely to translate into stronger earnings for many companies in this part of the market.
The final area that is well-represented among small cap stocks in the UK is financials. This includes some niche financials, including specialist lenders, smaller banking groups, plus a number of asset management groups. While there are some pitfalls in this part of the market, there are also a number of high growth companies trading at compelling valuations. We find interesting opportunities among discretionary fund managers, for example, which should be beneficiaries of a market in flux.
There are also more difficult areas. We don’t like the energy sector, for example, which is reliant on volatile commodity prices, and this is not represented in the portfolio. On BRSC, we are not compelled to own any individual company or sector and back our judgement wherever investment opportunities arise.
In the long-run, it is the fortunes of individual companies that will determine the outcome for smaller companies. While lower interest rates, or greater confidence in the UK economy will be important for short-term sentiment, growth in earnings is likely to determine the long-term growth of the sector. We see operational strength and a brighter outlook for the three major sectors in smaller companies.
Sources:
1 The ONS - Travel Trends 2023 - May 2024
Risk Warnings
Investors should refer to the prospectus or offering documentation for the funds full list of risks.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.
Trust-specific risks
BlackRock Smaller Companies Trust plc
Counterparty Risk, Gearing Risk, Liquidity Risk, Smaller Company Investments
Counterparty Risk
The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Gearing Risk
Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
Liquidity Risk
The Fund's investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair.
Smaller Company Investments
Shares in smaller companies typically trade in less volume and experience greater price variations than larger companies.
