Hargreaves Lansdown predicts FTSE small cap surge amid low valuations
Hargreaves Lansdown have backed the investment case for the smallest companies in the UK, predicting that the FTSE small cap sector will rally thanks to its low valuations.
Describing the smaller companies investment space as “compelling,” the investment platform noted that over the last five years, the FTSE small cap index (excluding investment trusts) has delivered a return of 78.3 per cent.
This is ahead of the 72.9 per cent growth of the FTSE 100, and the 41.7 per cent return from the FTSE 250 index (excluding investment trusts).
“At current undemanding valuations, there’s an opportunity for investors to add excellent long-term growth potential to their portfolios,” said Hargreaves Lansdown.
Joseph Hill, senior investment analyst at Hargreaves Lansdown, said that despite the strong returns for the FTSE small cap index, domestic equities have failed to attract the attention of investors.
British investors have pulled cash from UK equity funds for 46 of the last 47 months, with £521m pulled from the funds in April alone, according to data from Calastone.
Hardest hit
The small companies sector has been hit the hardest as cash slowly dwindles for fund managers to invest with. Last year, Columbia Threadneedle and Aviva both shuttered their UK smaller companies funds, having each run since 1998.
“This downward pressure on stock prices has seen UK equity valuations trading at well below their long run averages, and particularly in small cap,” said Hill.
UK small caps have traded at a 37 per cent average premium to the rest of the British market using a 12-month forward price to earnings ratio, but the ratio is currently much lower.
In addition, British small caps have also historically outperformed the FTSE 100 following an interest rate cutting cycle, with the Bank of England expected to continue slashing rates throughout the rest of 2025.
Research from Berenberg showed that in the year following an interest rate cut, the valuations of UK smaller companies has traditionally grown by 9.3 per cent, compared with just 6.5 per cent for the FTSE 100.
Hill noted that last year, the average takeover on the UK equity market came at a 44 per cent premium, indicating that stocks were trading significantly lower than what they’re truly worth.
“From a business owner’s perspective, the motivation to IPO when valuations are low, is understandably limited,” said Hill.
“It’s been a tough time, and with the headwinds faced, investors would be forgiven for thinking the sector had been best avoided. But that would’ve meant missing out on some pretty good returns.”