What have the UK’s smaller companies ever done for us?

Rather than dealing in speculation, perhaps we should focus on what we actually know. To that end, with due respect to Monty Python’s Life of Brian, maybe the question we ought to pose is simply this: “What have the UK’s smaller companies ever done for us?”

Below are just a few responses that existing and prospective investors alike might bear in mind. We believe they are worth reflecting on both during the run-up to October 30 and in the aftermath, whatever the Chancellor’s long-awaited decisions might turn out to be.

They have delivered growth

UK smaller companies’ recent travails are well known. The pandemic, inflation and rising costs have sustained a perfect storm during the past few years. Yet it is also well known that small-caps consistently outperform their large-cap counterparts over time¹.

Their advantage in this regard lies in a notable capacity for long-term growth. In the UK, historically, the London Stock Exchange’s AIM sub-market has frequently showcased this tendency in selected names.

Since 1995, when it was launched, AIM has supported more than 4,000 businesses in raising almost £135 billion². Around two thirds of this total has come from further issues, underlining AIM’s claim to be “the world’s most successful market for dynamic high-growth companies”³.

They have driven innovation

Many of these growth stories have been underpinned by a commitment to innovation. This is an attribute that frequently sets smaller companies apart.

While large businesses can have little or no incentive to disrupt the status quo, small-caps are more likely to position themselves at the cutting edge. Provided with the financial backing needed to fulfil their potential, they can use their superior agility to respond to and even drive progress.

The lower end of the UK market-cap spectrum is home to important innovators in fields including aerospace and defence, chemicals, construction, engineering, healthcare, life sciences and medicine. Although they might not be household names, they have helped shape significant advances in multiple arenas.

They have strengthened the economy

Under current rules, as long as they are still held on death and remain qualifying, AIM shares that have been held for more than two years should become free from inheritance tax (IHT). The Chancellor has been widely tipped to end this exemption as part of efforts to plug the “black hole” in the UK’s finances.

The Institute for Fiscal Studies has calculated such a move could generate more than £1 billion a year⁴. Yet in 2023 alone AIM companies contributed almost £70 billion in gross added value to the UK economy through a combination of direct, supply-chain and induced impact⁵.

This illustrates our belief that most investors do not back UK smaller companies to enjoy a tax break. They do so because they expect these businesses to perform well and reward them – and the wider economy – over the long run.

They have provided remarkable investment opportunities

Valuations of UK equities have been unusually low relative to peer markets – most obviously the US – for several years. The aforementioned perfect storm has not been the sole reason for this.

UK smaller companies in particular are often under-researched. Each constituent of the FTSE 100 Index might be “eyeballed” by around 20 investment analysts, whereas the figure for micro-cap companies – that is, those typically valued at between £40 million and £235 million – is normally two or fewer.

This lack of coverage may sound like bad news for investors, but it can strengthen the hand of investment teams that conduct their own research and have a reliable and proven process. Those that know where to look can unearth highly attractive opportunities, irrespective of the index involved or the ambiguity that might surround it.

Beyond the gloom

The Life of Brian character who asks “What have the Romans ever done for us?” intends the question to be purely rhetorical. Famously, the slew of answers to which it gives rise leaves him increasingly exasperated.

By contrast, the responses to “What have the UK’s smaller companies ever done for us?” can be seen as encouraging – not just for investors but for policymakers. They underscore the inherent appeal of the small-cap space, highlight its broader economic importance and cast additional doubt on the wisdom of further deterring investment in a market that already receives less attention than it deserves.

It may be easy right now to think of UK smaller companies as hopelessly shrouded in doom and gloom. Think again. Quite regardless of the Budget, investors might develop a more realistic view if they try to look on the bright side of life.

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A version of this article was first published on Professional Adviser on 21/10/24.

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¹See, for example, Deutsche Numis: “Smaller Companies Index”

²See, for example, London Stock Exchange Group: “Charting AIM’s positive economic impact”

³See, for example, London Stock Exchange Group: “AIM: London Stock Exchange’s market for small and medium-size growth companies”

⁴See, for example, Institute for Fiscal Studies: “Raising revenue from closing inheritance tax loopholes”, April 18 2024

⁵See, for example, London Stock Exchange Group: “Charting AIM’s positive economic impact”

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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.