Investment Trusts

Less is more? The case for UK small caps

UK market performance has struggled this year – but the plight hasn’t been distributed evenly.
November 2020

Peter Hewitt

Director, Portfolio Manager, Multi Asset Solutions

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Risk Disclaimer 

Capital is at risk. The value of an investment is dependent on the supply and demand for the trust’s shares rather than its underlying assets. The value of the investment will not be the same as the value of the trust’s underlying assets.

Past performance should not be seen as an indication of future performance. Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned

Financial markets have exhibited stellar performance over recent weeks amid positive headlines around coronavirus vaccines. Among them was the FTSE 100, which soared to a five-month high.

But to blindly celebrate this good news would be to ignore the starker facts that remain very much relevant. The pandemic has wreaked major economic damage, with major indices still down significantly from the levels seen at start of the year. Harsher lockdowns have been reinforced across Europe to control rising case numbers, while an accelerating surge of cases in the US threatens the economic outlook there.

From an investor perspective, I’ve seen many sectors struggle this year. But importantly, this hasn’t been evenly distributed. Travel & leisure companies, as well as those in the oil & gas space, have been among the hardest hit as demand for the products and services shrivelled up as lockdowns created a new normal that confined us to our homes. Turning to alternatives for a moment, the UK commercial property market has had a particularly tough time this year too, with big issues around the struggling retail sector, as well as issues collecting rent. Meanwhile, pharmaceutical and biotechnology companies have been a notable exception to the doom and gloom, benefitting from increased investor interest in search of solutions to the pandemic. Technology has also performed relatively better than other sectors, as many companies have continued to operate almost seamlessly despite the lockdowns. In fact, many tech companies have seen a surge in demand for their products and services as people around the world have been forced to stay home for work and play.

In the UK, this divergence has been evident on a market cap basis too. You might assume that in troubling times it’s safer to stick by the big names – those of the FTSE 100 – to ride out the volatility. During the first lockdown back in March, small and medium-sized businesses certainly were especially vulnerable to the pause in economic activity, with their prospects of survival severely threatened. The funds investing in these companies were hit hard too, with spooked investors causing significant sell-offs as they tried to get out quick.

But fast forward a few months to October and – even before the positive vaccine news began circulating – signs of life were beginning to reappear within the small cap space; that month, the FTSE 100, 250 and All Share all lost ground, while the FTSE Small Cap, by contrast, was up.

Why so? Well, the pandemic is accelerating changing societal trends – such as the way we work, what we do for fun and an increased importance on our health. Many smaller companies are in these ‘new economy’ sectors that are surging during lockdown life – gaming, e-commerce and cybersecurity to name a few. Furthermore, small and mid-sized companies operating in more traditional sectors that are agile enough to take advantage of shifting social trends are likely more able to adapt their business models and start generating profits quicker than their larger counterparts.

 

What’s next for markets?

I expect more domestic UK companies (in other words, small and mid caps) to perform relatively well from here. They would be further supported by a Brexit deal, if that’s still on the cards. Conversely, a no deal Brexit, delayed vaccines or more lockdowns, would all be bad for the UK domestic economy – so I’ll certainly be keeping a close eye on the headlines.

Risk Disclaimer 

Capital is at risk. The value of an investment is dependent on the supply and demand for the trust’s shares rather than its underlying assets. The value of the investment will not be the same as the value of the trust’s underlying assets.

Past performance should not be seen as an indication of future performance. Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned

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