Years of outflows and negative sentiment have left UK smaller companies trading at some of their lowest valuations in decades. Yet resilient company fundamentals and rising takeover activity suggest investors may be overlooking a compelling recovery opportunity. Juliet Schooling Latter, Research Director of FundCalibre discusses through her latest fund review.
There has been a crescendo of negative noise around UK smaller companies for more than a decade now. Brexit, Covid and the fall in markets in 2022 have all contributed to this uncertainty.
The UK stock market has seen outflows of $160 billion since 2016*, with a disproportionate share coming from UK small and mid-cap funds.
Every time there has appeared to be light at the end of the tunnel it has turned out to be an oncoming train. Things appeared more positive at the back end of 2025 and the start of this year with interest rates and inflation falling – only for war between the US and Iran and political instability in the UK to temper any optimism.
The challenge is not the operational success of UK small-caps, they are known for both their innovation and resilience. In a stock market where most things are expensive versus their own history – we must remember UK small-caps are trading at 30-50% discount below their long-term PE averages** – these are ludicrous, multi-decade low valuations.
Others have noticed the trend, with M&A on the rise – the FTSE SmallCap index is the most affected, seeing a steady decline in the number of constituents and market capitalisation, while IPO activity has been limited.
But there is help on the way. Despite the geopolitical issues in the Middle East slowing things down, we have seen six rate cuts in the past two years; inflation has cooled from its 2022 peak; while ongoing discussions around pension reforms to boost UK companies continue at government level.
Unicorn UK Smaller Companies has been one of the leading funds in the IA UK Smaller Companies sector for the past decade. Managed by Simon Moon since 2013, it targets quality companies that are profitable, cash generative but which are trading at an attractive value to their long-term average, or against their peers.
Simon, who manages the fund alongside Fraser Mackersie, says the fund is neither an out-and-out growth or value portfolio – preferring to place it as a pure small-cap (unlike a number which can drift into mid-cap holdings) with quality and liquidity at the heart of the process.
Quality and communication
That quality focus is highlighted by the fact that all companies must be profitable at the point of investment and the team looks for those with lasting competitive advantages, experienced management teams and strong balance sheets. Regular company meetings are key.
Investment ideas are rigorously researched and analysed in-house by a team with dedicated small-cap experience, enabling them to more accurately assess the true value of a company.
“It takes a while to get into the fund. We have many meetings with management to get to know them and their strategy. The quality focus has also helped us in a challenging period for the sector,” Simon says.
Simon cites largest holding Goodwin as a classic example of this approach. He says that, despite its size it was a relatively unknown business when it was added to the portfolio.
“The Stoke-based engineering firm was founded in the 1870s and is now run by the sixth generation of Goodwin’s – but they do not engage with the City, it’s a company you’ve got to put the leg work into and unearth. It was a hidden gem that has grown into a FTSE 250 business.”
He says M&A activity has been a consistent theme in recent times – but not always a welcome one. Recent examples include Alpha Group International, which they have held since 2016 and was subsequently acquired by US corporate payments company Corpay last year.
“Despite making a good profit, we were sorry to see it go given the stunning organic growth,” Simon says. Another example is Ocean Wilson, which was acquired by Hansa Investment Company**.
M&A and widespread valuation opportunities
Turnover has tended to sit around the 20% mark in the portfolio. The M&A activity has seen them delve into a market they believe still has plenty of valuation opportunities. Recent additions include Concurrent Technologies**, the designer and manufacturer of high-performance embedded computing products, which works with a number of defence companies.
“M&A shows you do not have all the time in the world when it comes to getting access to these companies at such attractive valuations. Plenty of them are being picked off at cheap levels,” Simon says.
Perhaps the most interesting take away from the team is the eye-watering trading discounts of their underlying companies relative to their long-term average valuations.
Despite a focus on quality the average discount to long-term average forward P/E sits at 25%**.
Examples of the discount include document management and IT lifecycle services company Restore. The team says it has highly recurring revenues – trades on around 10x forward adjusted earnings, with a forward dividend yield approaching 3% and a £20 million buyback underway.
Another is RWS, which is trading on 5-6x forward adjusted earnings with a yield near 9%, even after the board rebased the dividend to a level comfortably covered by cash flow**.
Simon says: “RWS profits halved in FY25, but that reset increasingly looks like the trough: the company returned to organic growth in the first half, with adjusted profits up a third.
Cash generation, meanwhile, never broke – £80 million of operational free cash flow against a market capitalisation of roughly £270 million, with conversion above 100%.
The market is pricing terminal decline; the operating numbers are pointing the other way.”
Simon says a turnaround in fortunes can come quickly and organically for the sector. While hopes of pension reforms are on the agenda, an improvement in the interest rate and inflation cycle are probably the most tangible opportunity, given many UK small-caps are already trading on such low valuations.
This is a true small-cap fund in every sense of the word – investing in genuinely smaller companies rather than mid-cap stocks. Another positive is that the fund avoids low quality, cash-burning businesses.
It is backed by a solid investment process and a highly competent team. We like the focus on company fundamentals, as well as the need to understand businesses in detail. It is a strong contender in a very competitive sector.
*Source: Morningstar, A decade after Brexit, May 2026
**Source: Unicorn Asset Management, June 2026
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Juliet’s views are her own and do not constitute financial advice.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
Main image: review, laptop, analyse, john-schnobrich-FlPc9_VocJ4-unsplash-2
