The Great Disconnect in UK Smaller Companies

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Why periods of maximum pessimism can create the most compelling opportunities

For the past three years, investing in UK smaller companies has felt uncomfortable. Political uncertainty, weak domestic sentiment, persistent fund outflows and a lack of IPO activity have all combined to create an extremely challenging environment – and investor confidence has suffered.

Yet periods like this often create an important question for long-term investors: when sentiment becomes overwhelmingly negative, are markets still pricing businesses correctly?

When reviewing the performance of the BlackRock Smaller Companies Trust over recent year compared the performance of the underlying holdings, a striking disconnect is clear across parts of the UK market. Many smaller companies have continued to deliver resilient operational performance, maintain healthy balance sheets and grow earnings, yet their share prices have fallen regardless. The chart below shows how far FTSE 250 valuations have fallen relative to their history. Share price weakness has often reflected a collapse in appetite for the asset class rather than a collapse in company fundamentals.

That distinction matters.

Today, many quality UK smaller companies trade on valuations that appear depressed relative to their growth prospects, profitability and financial strength, in our view. At the same time, takeover activity across the sector continues to accelerate, with overseas buyers and private capital increasingly willing to acquire UK-listed businesses at sizeable premiums.¹ While these bids can appear attractive relative to current share prices, they also reinforce the view that UK public markets may be undervaluing many assets.

Importantly, the Trust itself has also evolved. Following the merger with BlackRock Throgmorton Trust, the combined vehicle now benefits from greater scale, improved liquidity, lower fees and a simplified long-only structure. The introduction of quarterly dividends and a performance-linked tender mechanism also reflect a stronger alignment with shareholders at a time when investors are increasingly focused on structure and governance as well as performance.

None of this removes the risks. The UK still faces an uncertain political and economic backdrop, investor flows into domestic equities remain weak, and smaller companies are likely to remain volatile while sentiment stays fragile. 

However, our historical analysis suggests that some of the best long-term opportunities emerge precisely when pessimism is at its highest. Valuations rarely become compelling when confidence is abundant. Instead, we believe attractive entry points appear when investors are focused almost exclusively on short-term risks and unwilling to look through potentially temporary uncertainty.

For patient investors willing to tolerate volatility, today’s environment may therefore represent a rare opportunity to access high-quality, entrepreneurial UK businesses at valuations that already reflect a challenging future. 

As ever, selectivity remains critical. We don’t think all smaller companies will navigate this environment successfully. But for active managers focused on financially strong, differentiated businesses with durable growth prospects, periods of market dislocation can create fertile hunting grounds for long-term returns.

Source:
¹BlackRock Fundamental Equity analysis, May 2026

Risk Warnings

Fund-specific risks

Counterparty Risk

The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.

Gearing Risk

Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.

Liquidity Risk

The Fund's investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair.

Smaller Companies

Shares in smaller companies typically trade in less volume and experience greater price variations than larger companies.