Fidelity: UK small caps look valuable again

UK small caps offer the most compelling valuations going forward as more stable economic conditions, cheap financing and increased availability create a positive outlook, according to Fidelity.

An improving economic climate combined with a pick-up in corporate expenditure and increasing M&A activity, will have a positive impact on the sector, said Fidelity UK Opportunities fund manager Alex Wright.

"As we move into an environment of greater certainty this should be good for small caps which have historically performed well in times of positive economic momentum," he said.

Whilst Wright predicts GDP growth is likely to remain relatively low for some time, he said smaller companies are set to benefit as the country moves into a more stable economic environment and corporate expenditure picks up in areas including technology and media.

He added that, despite well publicised concerns over levels of lending to SMEs, increased availability of finance at low rates will also result in smaller companies being better placed.

His remarks come as business secretary Vince Cable warns banks could be subject to a tax if they do not increase lending to SMEs.

Increasing M&A activity will also positively impact the sector and, with valuations looking attractive, it is likely a growing number of smaller companies will be bid for at a premium to current share prices, he added.

The positive outlook comes on the back of UK Smaller companies being the best performing IMA sector over the last year to the end of April, returning almost 28%.

"In today's market, it's the very smallest companies that are offering the best value," added Wright. "The FTSE Small Cap Index is trading on a price/earnings multiple of around 11 times, and within this companies with a market cap of less than £150m are trading on a multiple of just nine times.

"This is almost a 30% discount to the equivalent valuation of the mid cap FTSE 250 Index."

Fidelity's UK Opportunities fund invests primarily in the smallest 10% of UK companies, with Wright seeking out companies which have underperformed but where the value in their potential recovery is not recognised.