A reversal of historical small cap performance

As a manager of the JPM UK Dynamic Fund, I am part of a team that scours a universe of around 550 UK stocks in search of the best investment opportunities. The UK market has long been a great place for investors to find well-known brands across all sorts of sectors, from top financial and consumer companies to innovative healthcare and green energy businesses.

The small cap space is a particularly fertile ground for finding hidden investment opportunities. We invested in several names such as Games Workshop, Cranswick, Balfour Beatty and Babcock that have gone on to become prominent mid caps during the period we held them.

Historically, small cap stocks have outperformed their larger peers given their growth trajectory is often steeper. This has resulted in premium valuations, as investors looked to capitalise on this growth. However, in recent years – particularly since the Covid pandemic – small caps’ relative performance has dipped.

The small cap opportunity

The underperformance of small caps since Covid can broadly be attributed to two factors: cyclical challenges and structural changes. Cyclically, small caps are more exposed to economic downturns and rising interest rates because they carry higher, more rate-sensitive debt and are concentrated in sectors that suffer during uncertainty. This has led to weaker earnings and lower valuations compared to more resilient large caps.

Structurally, the growth of private equity and venture capital means many promising small companies stay private longer or are taken private before benefiting public indices. Combined with an influx of lower-quality, unprofitable firms into small cap indices, this has reduced their overall quality and growth potential, dampening performance.

The result of this underperformance has been a dramatic fall in valuations. However, with this fall comes opportunity. 

Investing in UK smaller companies offers a compelling opportunity that goes far beyond headline valuations. While these stocks are trading at a discount, their true appeal lies in the breadth of innovation, entrepreneurial spirit and growth potential.

The UK small cap universe is incredibly diverse, spanning a wide range of industries, many of which are market leaders in niche areas or are driving technological and business model advancements. This diversity means investors can access businesses with unique growth drivers, resilient earnings profiles and the ability to adapt quickly to changing market conditions.

Furthermore, smaller companies are often more agile, able to capitalise on emerging trends and respond to new opportunities faster than larger firms. Recent trends in M&A activity and share buybacks highlight how undervalued many of these companies are, with strategic buyers and management teams recognising their intrinsic worth and acting to unlock value.

Additionally, UK small caps have attracted increasing interest from international investors, who see the sector’s potential for long-term returns. Ultimately, investing in UK smaller companies is about tapping into a dynamic segment of the market where innovation, active management, and strategic change can drive performance well beyond what headline valuations suggest.

Where we’re looking in the small cap space

We’ve seized on the small cap valuation opportunity to add some high quality stocks to the portfolio over the last few months.

Consumer electronics and household appliances retailer Currys* is a familiar name to many people. The company serves customers in the UK, Ireland and the Nordics, operating both physical stores and an online platform, complemented by value-added services such as delivery, installation, credit solutions, repairs and recycling. It also owns iD Mobile, a UK-based mobile virtual network operator that uses the Three network.

The company has emerged from a period of transformation with a strengthened balance sheet and is now focused on delivering growth and accelerating shareholder returns, supported by robust free cash flow generation. It has been taking market share with strategic initiatives driving expansion in services, business-to-business (B2B), and new product categories, as well as self-help measures – particularly in the Nordics – driving a more streamlined cost base and margin expansion. Its integrated product and services offering is a key differentiator, underpinning recurring, higher-margin revenue streams and deepening customer loyalty.

Currys trades at a notable discount to peers, presenting compelling upside potential as cash returns to shareholders increase and margin recovery continues.

A less familiar name is boutique management consulting company Elixirr*, which we added to the portfolio on the basis of its high growth potential and attractive valuation. The firm advises businesses on strategy, digital transformation and operational efficiency, helping clients adopt new technologies and innovative business models. Since its IPO in 2020, the company has consistently delivered against targets and analyst expectations with the four-pillar strategy underpinning revenue growth through 1) stretching existing partners, 2) promoting partners from within, 3) hiring new partners with expertise, and 4) acquiring businesses.

We believe that the differentiated, entrepreneurial model which combines strategic advisory with deep expertise in AI, data analytics and digital transformation will allow the company to continue winning market share from both boutique firms and large incumbents, all the while building a diversified blue-chip client base. Additionally, the cash-generative nature of the business provides scope for further accretive M&A opportunities and consistent returns to shareholders, supported by the high margin profile and asset-light model.

Conclusion

In summary, the ability to invest across the market cap spectrum means we can take advantage of the compelling opportunities currently available in UK small caps, while also drawing on the strengths of larger companies. This flexibility allows us to add innovative, high-growth names like Currys and Elixirr to the portfolio when valuations are attractive, while maintaining balance and resilience.