Don’t lose the plot with UK smaller companies

As the frenzy of speculation surrounding the Autumn Budget continues to build, now seems an appropriate time to remember Alfred Hitchcock. The Master of Suspense would surely have revelled in the enervating uncertainty accompanying the run-up to October 30.

One of Hitchcock’s finest achievements in the eyes of cinema buffs was to popularise the idea of the “MacGuffin”. This can be loosely defined as a plot device that matters a great deal to a film’s characters but rather less to the audience.

The $40,000 that secretary Marion Crane steals in the opening reel of Psycho is a classic example. It serves as her motivation to flee, as a result of which she eventually ends up at the Bates Motel.

Yet the viewing public pretty much forgets all about the money when, around three quarters of an hour into the movie, Marion is suddenly stabbed to death in the shower. Our focus instead switches to what Psycho is really about – a homicidal maniac.

With apologies for the unflattering link, this brings us back to the thoughts of Chancellor Rachel Reeves. I would argue that in the story of UK equities – and UK smaller companies in particular – her first Budget could prove the latest in a long line of MacGuffins.

By way of illustration, let’s rewind to the immediate aftermath of Labour’s election victory. The prevailing narrative was that political stability would reignite interest in the UK’s capital markets.

It didn’t happen. It turned out that political stability isn’t the same as political credibility, which is what the new government is now required to demonstrate at the end of this month.

The narrative of choice today is that the Budget will bring pain. The Prime Minister has literally said as much¹. Precisely how it will be inflicted remains to be seen, but making AIM shares subject to inheritance tax (IHT) has emerged among the likelier options.

AIM shares that have been held for more than two years at the time of a person’s death currently qualify for IHT relief. The Institute for Fiscal Studies says the removal of this tax break could generate more than £1 billion a year by the end of the decade², which would go some way towards filling the infamous “black hole” in the nation’s finances.

Understandably, a good number of investors have been spooked by this prospect. Many have been taking profits from their UK investments, presumably in anticipation of what the chief executive of the London Stock Exchange has described as a threat to AIM’s “ongoing viability”³.

As with a Hitchcock masterpiece, though, it may be useful to pause, step back and think about what’s truly important here. In our opinion, the fundamental attractions of UK smaller companies are what counts.

First, for several years – most obviously since the worst ravages of the COVID-19 pandemic – many of these businesses have been significantly undervalued. This trend has persisted in spite of companies’ impressive resilience and solid fundamentals.

Second, this corner of the market has long been consistently under-researched. This is one of the main reasons why it has been underappreciated and out of favour for such a lengthy period.

Third, UK smaller companies have a record of delivering growth and outperforming their larger counterparts over time. This reflects a pattern that can be found in many other countries and regions⁴.

It’s hard to imagine the Budget could radically alter these facts. They would essentially hold true even in the event of AIM’s worst fears being realised. In many ways, in our view, they represent the real story here. Everything else is “meta” by comparison.

Of course, within this encouraging plotline, UK smaller companies would still benefit from a rousing second act. We feel the necessary catalyst is more likely to come from monetary policy than from its fiscal foil.

An environment of falling interest rates should be to the advantage of small-cap and medium-cap businesses. Lower rates make borrowing easier – helping drive investment, innovation and expansion. The Bank of England hinted earlier this month that “more aggressive” cuts could be in the offing⁵.

Needless to say, it would be wonderful if fiscal policy could supply a boost of its own. But we perhaps shouldn’t hold our breath on that score.

And if it doesn’t, all being well, this Budget might just fade from memory soon enough – at least from the perspective of investors in UK smaller companies. Its MacGuffin status would thus be confirmed.

Asked to explain the nature of suspense, Hitchcock once remarked: “There is no terror in the bang – only in the anticipation of it.” There’s still plenty of reason to believe that in this instance, if and when it finally comes, the bang will be a positive one.

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A version of this article was first published on the IFA Magazine and DFM Wealth websites.

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¹See, for example, BBC News: “Autumn Budget will be painful, warns Starmer”, August 26 2024

²See, for example, Institute for Fiscal Studies: “Raising revenue from closing inheritance tax loopholes”, April 18 2024

³See, for example, Guardian: “Don’t kill London’s junior stock market, Chancellor”, September 24 2024

⁴See, for example, Deutsche Numis: “Smaller Companies Index”

⁵See, for example, BBC News: “Interest rates could fall more quickly, hints Bank”, October 3 2024

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The value of equities (shares in companies) may fall as well as rise. As a result, investors can lose some or all of their investment. Investment in smaller companies can involve greater risk than is generally associated with investment in larger, more established companies.

This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.