After years of underperformance, UK smaller companies are starting to attract renewed investor interest. Juliet Schooling Latter, Research Director at FundCalibre and Chelsea Financial Services, explores what’s driving the revival and whether it can continue.
For some time, smaller companies have been poised for a turnaround. Fund managers have pointed out that they look cheap on almost any metric, that earnings were improved and then…tumbleweed. Investors have continued to sell, and performance has continued to lag.
That is, until the last few months when small and mid-cap companies have staged a significant revival. This is all the more surprising because it has come against a backdrop of rising bond yields – usually a red flag for smaller companies.
Over the past quarter, the FTSE 100 is up 1.82%. That’s a respectable performance among its peers: the MSCI World, for example, is up 1.79% over the same period*.
Yet the FTSE 250 (ex investment companies) is up 9.61%, while the FTSE Small Cap (ex investment companies) index is up 7.28%. That’s around double the return from the Nasdaq*. Over the past two quarters, the mid-caps are up 18.8% and the small-caps up 17.6%*. What might explain this turnaround? And can it last?
A better backdrop for UK companies
There are a number of factors that may be influential. The UK economy, for example, has taken an unexpected lurch higher in recent months.
GDP growth has been outpacing expectations. In its latest World Economic Outlook, the IMF said UK GDP was set to grow by 1.3% in 2026 — an upgrade of 0.5 percentage points. That puts it as the second fastest growth in the G7, alongside Germany**.
At the same time, the UK is forecast to see the biggest fall in its deficit among G7 nations**. Attention has turned to France as the problem child of debt markets, while the UK looks relatively stable in comparison.
UK bond yields may have risen, but they have risen less than many of their peers. These are all better signs for the UK economy, which may be helping more domestically-focused mid and small-caps.
Georgina Brittain, manager of the JPMorgan UK Small Cap Growth and Income Trust, says that consumers are finally spending. Consumption remains around two-thirds of the UK economy, and an important swing factor for growth.
For some time, consumers have prioritised saving over spending, with the savings ratio peaking at over 10% in early 2025. They needed some confidence to start spending again and that now appears to be happening, with the savings ratio falling to around 9% by June of this year***.
The small and mid-cap company indices hold many consumer-facing companies, and this has been another factor in improving performance.
Simon Murphy, manager of the VT Tyndall Unconstrained UK Income fund, has seen similar signs of improvement. He believes the environment for the UK consumer is starting to improve, albeit from a very low base, and points to a particularly strong summer for some consumer-facing stocks. That improvement has started to show up in performance, he says.
Overseas buyers spot the opportunity
Takeover activity has also been a significant factor, particularly for the mid-caps. Recent activity includes a £2.7 billion bid for Tate & Lyle, a £ 4.3 billion takeover approach for Easyjet, a £1.3 billion bid for Senior, £1 billion bid for Gamma Communications and a £1 billion bid for Spire Healthcare, plus various bids for property and clean energy assets****.
UK retirement specialist Just Group was bought by Brookfield Wealth Solutions at a 75% premium. Spectris, the precision instrumentation business, attracted a bidding war and was ultimately bought by private equity group KKR at close to a 100% premium. Bodycote – a specialist in heat treatment and thermal processing – also received a conditional approach^.
Paul Jourdan, manager of the WS Amati UK Listed Smaller Companies fund, says: “Takeover activity continues to stalk London-listed businesses, offering an average premium of around 40% to the share price. Moreover, the growth of international investors entering the UK stock market is a notable development and a reminder of the value on offer.”
For Georgina, the takeover activity proves the valuation discount. This started with small-cap takeovers and has progressed to larger companies. “Finally, people are starting to notice,” she says. She has been urging the companies she holds that are subject to bid activity to hold out for higher prices believing the under-valuation of the UK market is still material.
The missing piece of the puzzle
Outflows from the UK market have long been a drag on smaller companies, but Georgina believes this might be changing: “For so long, we’ve been asked “but what is the catalyst?”
Money is the catalyst. While we wouldn’t call the bottom of the market, there are signs that selling pressure can’t last. The amount of smaller-company exposure in pension funds, for example, has gone from 50% to 2-3%.”
Georgina says that in general, many funds have managed well in spite of the selling pressure on smaller companies funds. “All it would take would be some inflows and investors won’t be able to buy at these prices any more.” In other words, when the market turns, the lower liquidity in smaller company shares means that it is likely to turn quickly.
Simon agrees that flows remain the missing part of the puzzle. Despite the improvement in performance, they say flows into UK equities are still negative or, at best, too low to provide meaningful support.
That arguably makes the recent rally more interesting: mid-caps have started to outperform before there has been a significant return of investor money to the asset class. If those flows eventually improve, it could provide another source of support. Equally, their continued weakness is a reminder that the revival is not yet complete.
Valuations still have room to recover
This part of the market remains cheap. Fraser Mackersie, manager of the Unicorn UK Smaller Companies fund, says the prolonged period of mid-cap underperformance in particular is ‘highly unusual in both its length and depth.
This dynamic has created significant valuation opportunities in a number of high-quality FTSE 250 companies, where share price performance has become detached from operational performance, leading to a widespread de-rating.’
Encouragingly, the current rally has not been driven by any particular sector, though some areas remain significantly out of favour. Real estate and other interest-rate sensitive sectors, for example, are still difficult. However, the change in sentiment appears to have run across multiple sectors.
Can the revival survive the Budget?
The big risk for the small and mid-caps is the upcoming budget. Any significant tax rises or other disincentives for business could swing sentiment away from this part of the market.
Chancellor John Healey seems to understand the problem. He has ruled out a proposal from some senior Labour figures to equalise the rates of capital gains tax and income tax, which has helped set entrepreneurs’ minds at rest.
He has also said he will help ease the costs of doing business, recognising that businesses have been hit hard by rising taxes, increasing wage costs and inflationary pressures.
The small and mid-cap revival is well-founded, led by international buyers who recognise the value in the UK market. Valuations are still low and the next few months will be crucial in seeing whether the rally can build momentum. The budget will be an important focal point. If it goes through with minimal impact for business, it could be the turbo-charge needed for the rally in smaller companies.
*Source: FE Analytics, total returns in pounds sterling, quarter end 30 September 2026
**Source: Financial Times, 13 October 2026
***Source: Trading economics, UK household saving ratio, ONS, June 2026
****Source: Morningstar, 29 June 2026
^Source: Schroders, 16 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.
Main image: UK, investment, sean-p-WuCX5qOLu3Q-unsplash
