For the first time in two decades, UK small caps yielded more than large caps last month, as smaller companies start to show similar attributes to the ones outperforming large caps had in 2025, says Aberdeen Investments.
Looking at the bottom 10% of the UK Main Market by market cap, UK small caps were yielding 3.4% on average in January, compared to around 3% for UK large caps*, with investor sentiment towards the UK market beginning to improve following a year of strong returns.
Despite dampened sentiment last year, UK equities delivered a strong performance in 2025, with UK large caps one of the best‑performing major asset classes globally. The FTSE 100 returned almost 26% over the year, outperforming both US and global equity markets, while the FTSE 250 also delivered a strong return of around 13%.
Abby Glennie, manager of the Aberdeen UK Smaller Companies Growth Trust and Aberdeen UK Smaller Companies Fund, said: “UK small caps today share many of the same attributes that made large caps so compelling a year ago, but with potentially stronger growth characteristics.
Valuations appear attractive, income is improving and the quality of businesses within the asset class is sometimes overlooked.
“UK smaller companies generate around half of their revenues overseas, spanning a wide range of geographies and business models, providing meaningful diversification beyond the domestic economy.
“At the same time, areas of the UK economy are showing resilience and recovery potential. Infrastructure‑related businesses, financials and support services are demonstrating strength, while housing‑related and consumer‑exposed companies offer scope for cyclical recovery.
“With a more stable economic backdrop emerging, the environment looks increasingly supportive for UK smaller companies.”
Small cap characteristics resembling those of large caps
A number of UK small caps are beginning to show characteristics similar to those that large cap stocks had in 2025, despite a significant difference in valuation. Valuations for UK smaller companies currently stand at a roughly 25% discount to large caps**, a gap that is wide by historical standards.
Income dynamics have shifted meaningfully for small caps, potentially broadening their appeal to income‑focused investors, while capital discipline is also increasingly evident among smaller companies.
Around 100 companies in the FTSE 250 are now running active share buyback programmes, underscoring balance sheet strength and confidence in future prospects.
As with large caps previously, allocations to UK small caps remain low, leaving room for renewed interest as performance improves. International buyers are also becoming more visible, particularly through direct stock holdings, suggesting that global investors are beginning to recognise the opportunity.
Valuations and quality drive UK large cap outperformance
The success of UK large caps last year was driven by a combination of factors that quietly came together at the right time. Valuations were compelling at the outset, particularly when compared with other developed markets.
UK equities also diversification benefits within global portfolios for investors, while also having attractive income characteristics and a strong culture of capital discipline. Share buybacks were also widespread, with nearly 40 companies in the FTSE 100 actively returning capital to shareholders.
The market also benefited from a high concentration of quality businesses, low starting allocations in global portfolios and growing interest from international buyers.
While the UK did see some political volatility throughout the year, the macroeconomic environment remained relatively stable compared to some other developed markets, reinforcing the case for global investors seeking stability and value.
The strength of sterling also plays a role in returns for UK based investors. For example, while the S&P 500 delivered returns of around 17% last year, that translated to less than 10% in sterling terms, underlining how currency can materially affect realised returns for domestic investors.
Supportive backdrop for small caps in 2026
The backdrop for UK small caps could well be more constructive in 2026. Inflation is now under control and is expected to continue easing into 2026, and while GDP growth forecasts remain modest, they are broadly in line with those of other major economies. Unemployment also remains low, while household savings rates are elevated and sterling has retained its strength.
Against this backdrop, the growth characteristics of smaller companies become particularly important. Historically, stronger growth has supported valuation re‑ratings in the small‑cap segment, while also underpinning future dividend growth.
The composition of the UK small‑cap universe adds to its appeal. The asset class is both high quality and highly diversified, an important attribute at a time when market returns have been unusually concentrated.
It is also notable that UK large‑cap returns in 2025 were achieved despite continued net outflows in the UK All Companies sector. That performance reflects the strength of demand from other sources, including global fund allocations and international buyers.
It also highlights the opportunity ahead – should those domestic outflows begin to reverse, the impact on returns could be powerful.
As investors reassess portfolio concentration and look beyond a narrow group of global winners, the breadth of opportunity within UK small caps becomes increasingly relevant.
The same factors that drove strong returns from UK large caps in 2025, attractive valuations, income, quality, diversification and low starting allocations, now appear to be firmly in place for smaller companies.
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: johannes-plenio-wRsqkpNw-MI-unsplash
