Sheldon MacDonald's view on: How small caps have outperformed after interest rate cuts

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With the Bank of England poised to begin cutting interest rates, potentially as early as June 20th, we believe the UK’s smaller companies are strongly positioned to outperform in a similar fashion.

In our view, the UK’s smaller companies look undervalued in absolute terms, in comparison to other developed markets and relative to their historic averages.

The exceptional value offered by these companies at current valuations has not gone unnoticed by private equity houses and trade buyers. In 2023, 59 companies were acquired in the UK and of these 50 had a market capitalisation (total stock market value) of less than £500m.

Smaller companies have fallen out of favour for a number of reasons. Higher interest rates made it more expensive for them to borrow to finance their growth, while market volatility increased liquidity concerns, driving investors to seek shelter in larger companies.

The economic slowdown also deterred investors from holding smaller companies, which tend to be more sensitive to negative macroeconomic conditions.

This has created a double discount because the broader UK stock market was already unloved by global investors, with broker Panmure Gordon estimating the overall UK market is at a discount of 19% to comparable stock markets in other developed economies.

This double discount has enabled our smaller companies team to invest in quality businesses, which they believe have exceptional long-term growth prospects, at highly attractive valuations.

Now, with economic concerns easing, we believe the tide may be turning and that rate cuts could act as a catalyst for a sustained period of outperformance by UK smaller companies.

In our view, this is a rare opportunity. We do not believe investors will ignore indefinitely the disconnect between current valuations and the outstanding long-term growth potential of these businesses. And when the smaller companies market begins to turn, past experience teaches us that it can move quickly. Investors sitting on the sidelines risk missing out on significant potential gains.

Marlborough has earned a reputation as the home of UK smaller companies investing, with one of the largest and most experienced investment teams specialising in this area of the market. We have three funds focusing on the growth potential of the UK’s smaller companies: Marlborough Special Situations, Marlborough UK Micro-Cap Growth and Marlborough Nano-Cap Growth.

Sheldon MacDonald, Chief Investment Officer

*Small caps are the smallest companies by total stock market value (market capitalisation).

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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.