Investors in UK small and micro-cap companies have had a torrid time since September 2021. The FTSE Aim All-Share index had fallen 49 per cent in value by late October 2023 and is still 46 per cent off its 2021 high. The larger market-capitalisation-weighted FTSE SmallCap index is down 21 per cent in the same 27-month period.
This represents a deep underperformance of the wider market and one that has been accentuated by fund outflows and market-wide risk aversion. Analysis by River and Mercantile UK Micro-Cap Investment Company (RMMC) reveals that UK SmallCap funds have seen outflows every month since September 2021 and UK Smaller Companies (as measured by the closed fund’s comparative index) have underperformed the wider market by 37 percentage points, a level of relative underperformance that has not been seen since 1989 to 1991. The fund manager cannot find a previous longer period of fund outflows.
UK small-cap minnows are not only unloved, but they are massively undervalued, too. Such is the mispricing that their 10 per cent earnings yield – the reciprocal of the price/earnings ratio – is six percentage points higher than the 10-year UK government bond yield even though earnings are likely to grow over time. The pricing anomaly has not been lost on cashed-up predators, and corporate activity is likely to be a major theme in 2024. Five small-caps on my radar offer obvious bid potential.