A once-in-a-generation valuation opportunity?

UK equities may offer a once-in-a-generation valuation opportunity, according to the portfolio managers of the JPMorgan UK Small Cap Growth & Income Investment Trust (JUGI). The FTSE All-Share Index is trading at almost a 50% discount to the S&P 500 Index based on 12-month forward price to earnings (P/E). Strong M&A activity also suggests that private equity firms and company managements are finding value in the UK market. Looking at deal value as a percentage of market capitalisation, the UK is leading Europe, the US and the global average.

Deal activity is particularly robust in the small-cap segment of the market, with JUGI’s portfolio managers seeing deal announcements almost every week. While the pickup in M&A is evidence of the attractiveness of small-cap valuations, fundamentals are also strong, with many smaller companies benefiting from strong free cash flow generation, which is a key sign of corporate health. JUGI’s focus on quality companies has resulted in a portfolio with a historical free cash flow yield of 8.5%, which the portfolio managers consider to be extraordinarily high and another potential signal that UK smaller companies are undervalued.

Improving backdrop for UK equities

The low valuation story is not new news. A number of structural factors have contributed to investors moving out of UK equities for over a decade, including the closure and subsequent de-risking of defined benefit pension schemes, changes to the equity benchmark and Brexit. However, JUGI’s portfolio managers believe that much of the selling related to these changes may now be near the end, and that the current low valuations could start to attract more flows into UK smaller companies.

The macroeconomic environment also has potential to provide support for UK small caps. With more than half of UK GDP driven by the consumer, JUGI’s portfolio managers keep a close eye on consumer confidence and household balance sheets. UK consumers have relatively high savings, especially compared to global consumers, and recent data showed a small pickup in consumer confidence. The portfolio managers expect that a trend of improving confidence would encourage consumers to start spending more, which would in turn boost the UK economy and UK stocks.

Diverse drivers of recent portfolio returns

Over the 12 months to 28 February 2025, a wide variety of companies positively and negatively impacted JUGI’s performance. The top contributors to the portfolio’s returns included XPS Pensions, a pensions advisory company benefiting from regulation in the industry, and Alpha Group, a foreign exchange and risk management consultancy. However, the next biggest contributors operate very different businesses: Premier foods, a large food producer and distributor, and Morgan Sindall, a construction company benefiting from increased spending on infrastructure. M&A activity also helped JUGI’s performance, with its holding in Ascential taken out at a large premium.

The portfolio’s position in Ashtead Technology Holdings, which operates asset rental for energy companies, underperformed the broader market as the pace of its growth slowed. However, JUGI maintains a large holding, given the portfolio managers’ high confidence in the company’s management team, and the company’s strong order book. JUGI’s position in Next 15 Group, a digital marketing business, has also struggled due to disappointment surrounding a large contract that was not renewed. However, the portfolio retains a reduced position, given the company’s attractive free cash flow and low valuation.

Finding new opportunities across sectors

JUGI’s portfolio managers look to invest in companies that offer the portfolio a combination of value, quality and momentum. At the moment, they are finding opportunities in businesses across many sectors. MJ Gleeson, a new addition to the portfolio, is a housebuilder focused on lower-priced housing in the northern part of the UK, making it a favourite of local councils. Another new holding is Volution, which provides ventilation systems and is benefiting from regulation and concerns over air quality. The portfolio participated in the initial public offering (IPO) of Applied Nutrition and also added a position in Hostelworld, a booking app for travellers seeking hostels around the world. With these new additions and the current portfolio of high-quality holdings, JUGI’s portfolio managers seek to extend the investment trust’s strong track record of long-term outperformance.