Eustace Santa Barbara's view on: What might an interest rate cut mean for UK smaller companies

Samuel Goldwyn was a movie mogul during Hollywood’s Golden Age. He was also a master of malapropisms and convoluted remarks.

“Give me a couple of years,” he once said, “and I’ll make that actress an overnight success.”

This “Goldwynism” seems to sum up the recent travails of UK smaller companies. They have been out of favour for a lengthy period, patiently awaiting an event that might suddenly catapult them into the limelight.

A key question now is whether the decision by the Bank of England (BoE) to cut interest rates will provide the longed-for springboard. I very much doubt it will bestow immediate superstardom, but I do think it will help finally bring this market more of the attention it deserves.

Before we consider why, it is first useful to quickly remind ourselves why UK smaller companies have struggled to win investors’ affection of late. In tandem, it is important to grasp why their plight has in many ways been unwarranted.

To cut a long story short: these businesses have endured something of a perfect storm. They have been pummelled by the pandemic, battered by inflation and pounded by rising costs. As a result, many continue to find themselves both unloved and, crucially, undervalued.

Yet we know small-cap and mid-cap stocks tend to outperform their larger-cap counterparts over the long term. The past is not an infallible guide, of course, but this is what history clearly shows*. Moreover, there is nothing to suggest this trend has been permanently derailed.

So why should an interest rate reduction at last earn these companies renewed consideration? Perhaps the fundamental point is that the BoE’s move puts a different complexion on the competition for capital.

Unusually high savings rates have amplified the appeal of High Street banks and government bonds during the past few years. That appeal could diminish as rates start to come down again.

Investors should therefore once more look to cast their nets more widely. In doing so, many may be drawn to an asset class that is still notably cheap, has demonstrated resilience in a challenging environment and whose attractions are underpinned by a wealth of historical data.

Outlining his ideal film plot, Goldwyn once declared:

“We want a story that starts out with an earthquake and works its way up to a climax.”

That is not what we have here, and it is certainly too early to claim this market is on the cusp of its own Golden Age.

Yet this cut should mark a significant milestone on the comeback trail. My feeling is that we will see ongoing, incremental improvement in sentiment over time. We may even witness a rally that fails to gain the broader audience it merits, at least temporarily, with the herd’s gaze remaining fixed elsewhere.

Such a scenario would obviously benefit what we might call the early adopters – those who are ahead of the curve in acknowledging UK smaller companies’ true, long-term potential. We believe we have been comfortably ahead of that curve for some time already.

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*See, for example Deutsche Numis: "Smaller Companies Index"

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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.