While the FTSE 100 has been busy setting new records this year, one corner of the UK market has remained stubbornly unloved: smaller company investment trusts.
The average discount that shares of UK smaller company trusts shares trade at compared to the value of the net assets in their investment portfolios is 12 per cent, according to data from the Association of Investment Companies (AIC).
Despite a swarm of hungry private equity buyers and deep-pocketed multinationals gobbling up dozens of UK companies over the past couple of years, that gap hasn’t closed. In fact, over the last year, the average discount has widened by about one percentage point.
By contrast, similar sectors such as the wider UK all-companies, Europe and even European smaller companies have seen discounts narrow by between one and over three percentage points.
However, this discrepancy is variable, while many UK small trusts possessing highly attractive growth records over the medium- and long-term, and many offering tempting dividend yields on top.
Before highlighting 10 standout funds, it’s worth first considering how investment trusts work, what’s been driving the current dislocation in valuations, and what might prompt a shift in sentiment.
Little liked: While the FTSE 100 has been busy setting new records this year, one corner of the UK market has remained stubbornly unloved: smaller company investment trusts
What, who, why?
A quick brush up on investment trusts for the uninitiated or those whose knowledge might have got a bit rusty.
A key feature of what are now often called investment companies is that they are closed-ended funds that are listed on the London stock market.
This means they have a fixed number of shares in issue, and these can be bought and sold, like any other company or exchange-traded fund, so their share price can go up and down.
Investment trusts are actively managed funds, with each set of fund managers making their pick of which companies they think are most likely to grow fastest or looking most undervalued.
UK smaller company trusts invest pretty much only in equities listed in the UK valued at below £2billion. Companies with lower market capitalisations can offer good growth potential, though they tend to be more volatile and less liquid than larger counterparts.
This lack of liquidity is part of why trusts investing in small caps might trade at discounts, though each trust’s net asset value (NAV) is ‘marked to market’ daily. In other words, the share prices of all its investments are totted up at the end of each London trading session.
Those justifying the discounts might point to the impact of management fees and how trusts were managed, though most UK smaller companies trusts have performed well in the long-term on a NAV basis.
Scope for returns
‘While we’ve heard a lot about money flowing back into European and UK stock markets given investors’ concerns about the US, the UK smaller company sector is clearly not at the front of the queue for these flows,’ says Nick Britton, research director at the AIC.
He agrees that the sector discount remains ‘wide’ and that there are long-established, well-regarded trusts trading at double-digit discounts and only a handful bucking the trend.
‘This offers considerable scope for strong returns if discounts should narrow, following the trends we are seeing in other equity sectors,’ he says.
‘Of course, nothing is guaranteed and investors in this sector need to be in it for the long term.’
The value on offer from UK small cap investment trusts has been flagged by others too.
Research from fund manager Aberdeen showed that earlier this year the forward price-to-earnings ratio – a measure that investors use to value companies based on their expected performance in the coming year – for the MSCI UK Small Cap Index was 24.3 per cent below its 10-year average January.
That’s the steepest valuation discount among all major global regions.
According to Abby Glennie, co-manager of the Abrdn UK Smaller Companies Fund, this reflects negative sentiment in the sector.
However, she said this is starting to be dispelled, as many UK small caps are delivering strong earnings growth, outperforming larger global peers.
Other structural factors are also at play, it is fair to say, with the number of active UK small-cap funds is at its lowest since 1997, reducing investor coverage and contributing to inefficiencies in pricing.
Glennie and Britton are not the only ones seeing potential for recovery.
Falling inflation and anticipated interest rate cuts should benefit smaller, more leveraged firms.
Acquisition activity is also increasing, with expectations that a significant share of UK small and mid-caps could be acquired in the coming year, following 73 UK companies being taken over by foreign companies in 2024 and an increased value of £19.2billion of takeovers in the first quarter of 2025.
Looking ahead, initiatives such as the Mansion House Accord, which aims to channel £25billion into UK-listed firms including small and AIM-listed companies by 2030, could support sentiment and capital flows into the sector.
Nine of the best UK small cap funds
This list includes the top performing small cap trusts over one-year, five-year and 10-year share price total return categories.
Rockwood Strategic is top or near on many of the categories, with manager Richard Staveley taking a value-orientated investment focus.
Top investments at its last update were RM, the provider of IT to the education sector; tech component maker Filtronic; fastenings specialist Trifast; and sub-prime lender Vanquis.
Another with a strong record of late is Crystal Amber, an activist fund that targets undervalued companies, aiming to improve their value through engagement and strategic changes.
A boost to its NAV was driven largely by its activism at De La Rue, where the sale of a division led to a boost in returns.
Aberforth Smaller Companies’ top holdings show a mix of UK small and mid caps, including information and training publisher Wilmington, ready meal supplier Bakkavor, casino owner Rank and construction group Galliford Try.
Marwyn Value Investors is another with a slightly different approach. It takes an almost private equity style approach with a small and tighter portfolio of listed companies, backing management teams to generally go on acquisitive growth strategies. Its top four investments account for over 90 per cent of its portfolio.
For all the breaking news on small- and mid-cap companies go to www.proactiveinvestors.co.uk.
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