It is possible to sidestep sectors that are struggling and target sectors with stronger growth prospects. However, at the moment, it is possible to be optimistic in most areas within smaller companies.
UK small companies divide into three broad categories – consumer, industrial and financial. All three sectors are providing good stockpicking opportunities today.
There is much discussion over what may be the catalyst for a small cap revival – and there are a number of possibilities, from stabilising interest rates, to M&A activity, to buybacks. However, in the longer term, it is the outlook for these three areas that will determine the outcome for small cap stocks in the longer term.
Consumer sector
Taking these sectors one by one, the first main area is the consumer sector. This is a broad category, and includes travel and leisure companies, many of the housebuilders, plus construction and traditional retail groups.
Many companies in this part of the market have struggled as inflation has squeezed household spending, but a revival could be imminent.

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Consumer strength is supported by a shift in the interest rate cycle and weakening inflationary pressures, which has helped stabilise household finances. Areas such as travel and leisure have seen a significant bounce-back, as demand has returned in the wake of the pandemic (source: The ONS – Travel Trends 2023 – May 2024). We have also been adding to housebuilders and construction companies as the housing market strengthens.
Industrial sector
The industrial sector is also an important part of the UK small cap equity universe. It covers capital goods, aerospace and defence, alongside ‘traditional’ industrials, such as precision engineering companies. These groups often have significant market share in niche areas, and larger companies depend on the products and services they provide.
We see potential strength among these companies as well. With wage inflation likely to be structurally higher, companies will need to invest to boost productivity. This should be reflected in industrial capital expenditure. As a result, we’re positive on this area, believing industrial demand is likely to translate into stronger earnings for many companies in this part of the market.
Financial sector
The final area that is well-represented among small cap stocks in the UK is financials. This includes some niche financials, including specialist lenders, smaller banking groups, plus a number of asset management groups.
While there are some pitfalls in this part of the market, there are also a number of high-growth companies trading at compelling valuations. We find interesting opportunities among discretionary fund managers, for example, which should be beneficiaries of a market in flux.
There are also more difficult areas. We don’t like the energy sector, for example, which is reliant on volatile commodity prices, and this is not represented in the portfolio.
In the long run, it is the fortunes of individual companies that will determine the outcome for smaller companies.
While lower interest rates, or greater confidence in the UK economy will be important for short-term sentiment, growth in earnings is likely to determine the long-term growth of the sector. We see operational strength and a brighter outlook for the three major sectors in smaller companies.
For more information on this trust, visit: www.blackrock.com/uk/brsc.
Roland Arnold is manager of BlackRock Smaller Companies Trust plc