Small caps, big returns?

Small caps tend to do very well for your money over the long run. But they’ve not come out to play in recent years – going more down than up. Now, there are early signs that such investments could be turning a corner soon. And there’s also evidence of potential superior long-term returns, as we show in our piece below.

Small caps under the cosh

Smaller companies make a huge contribution to UK plc. They employ around 17m people – 61% of the workforce. The listed amongst them pay some £25bn in tax every year. They come up with brilliant innovations.

That’s all great. But the problem is that these listed smaller companies – the top slice of that sector, large enough to be quoted on the stock exchange – have performed woefully.

In fact, you’d have lost money in them over the last three years, as the chart below shows.

The FTSE 100 and FTSE All Share, which each has fewer, larger companies than the FTSE Small Cap index, both did much better in that time. They would have paid you handsomely.

What’s happened? And, more importantly, what would it take for small caps to turn the corner?

Small caps under the microscope

Large investors, like pension funds and insurance companies, with trillions to invest, have been stepping away from UK companies in general for years.

Moreover, retail fund investors have also been selling UK smaller companies for over a year. Figures from the funds trade body say they offloaded £41m in July, £94m in June, £100m back in March. It’s all been adding up.

Such solid backers are essential to a properly functioning market.

And then macro issues, like Brexit and the pandemic, have combined to make London a less attractive place for international companies to list. A few years ago, the London Stock Exchange attracted 126 companies. In the first half of 2024 it was just eight.

The big picture for small companies looks bad.

Small caps on the up?

But that was then.

Now, several indicators suggest smaller companies could be turning a corner. They themselves believe things will take a turn for the better. Sentiment is up … not quite to pre-pandemic levels, but it’s a start.

Raspberry Pi listed on the London market a few months ago. And many have talked about it as a big moment for the London market. In a world of £1,000 iPhones, Raspberry Pi makes computing more affordable. They could have followed many other British companies and listed abroad – but they didn’t. Perhaps others will follow?

Lower interest rates, a stabilising economy and political certainty all provide a macro backdrop in which small caps tend to flourish.

Small caps have proportionality higher levels of debt than their larger bedfellows. A lower interest rate means less of their hard-earned money goes in debt servicing – and more in dividends to shareholders. Perhaps the Bank of England might cut rates, believing they’ve got as high as they need to?

Economic and political constancy help because some argue that small caps emerge from recessions or downturns much quicker than larger firms.

We don’t have a crystal ball, but the backdrop looks and feels more conducive to small cap performance.

There’s something else: evidence.

We love evidence. And the data say that smaller companies tend to do well over the long term. As one of the UK’s foremost academics puts it, “Research spanning over six decades in the United Kingdom (and even longer in the United States) has found evidence that smaller quoted companies have provided the best long-term returns.”

In other words, three years of underperformance isn’t anything to compare with six decades of strong performance.

So, we like small companies – irrespective of whether they bounce back now or later. And we think you should too.

This is why we spread your money across globally diversified opportunities, biased towards smaller companies. Evidence says this could turbocharge your returns.

It is important to note, however, that equity stocks of small and mid-cap companies carry greater risk, and more volatility than equity stocks of larger, more established companies. Diversification does not ensure a profit or protect against a loss in a declining market.

Contact us

If you’d like to know more about how we invest your money, please get in touch. We’re available at hello@firstwealth.co.uk or 020 7467 2700.

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.