UK small-cap equities are “undervalued and overlooked”, according to a new Morningstar report that calls on investors to give attention to an asset class long neglected by the market.
The report highlighted that UK small caps are trading at a discount to their fair value below historic averages, offering a “potentially attractive entry point for long-term investors”.
“UK small caps have been out of favour in recent years, impacted by domestic and global issues like Brexit, Covid-19, and political instability. Assets are at a 10-year low after surging post-Covid, with more fund closures than launches so far in 2025,” said Henry Ince, analyst, equity strategies at Morningstar. “UK small caps have been an attractive asset class over the long term, and despite these headwinds, should not be overlooked by investors. They remain attractively valued on both an absolute and relative basis which has resulted in elevated share buyback and M&A activity.”
Morningstar’s analysis comes as UK equities continue to lag behind global markets, with investor focus on US stocks. UK small caps, in particular, have suffered from this trend, witnessing 14 consecutive quarters of outflows. This prolonged lack of interest has pushed valuations to levels that Morningstar analysts consider compelling, shared Morningstar.
“The inclusion of FTSE AIM shares in the UK’s Mansion House Accord is also a much-needed sentiment boost for a market that remains a fertile hunting ground for patient small-cap investors,” added Ince. The Accord, which aims to funnel £25 billion into UK assets by 2030, is seen as a crucial step toward revitalising the domestic equity market and supporting growth-focused companies.
Morningstar also pointed to the challenge of fund closures in the UK small-cap space. Since 2023, sustained outflows have pressured the viability of these funds, prompting several high-profile asset managers—including Baillie Gifford, Aviva and Ninety-One—to exit the category. The result is the lowest number of open-end funds in the sector since 1997.
Despite these setbacks, private equity and corporate buyers are becoming active in the small-cap space, drawn by attractive valuations. Acquisition deals have been on the rise since 2020, while private equity firms are ready to deploy substantial capital in the hunt for undervalued opportunities. UK companies themselves have also been taking action, with aggressive share buyback programmes signalling boardroom confidence. Morningstar noted that buyback activity reached record levels in 2024 and shows no sign of slowing in 2025.
The report argued that the case for UK small caps is not solely about valuation. Easing monetary conditions could act as a catalyst, as small caps have historically outperformed larger caps in the periods following interest rate cuts. The inclusion of AIM-listed shares in the Mansion House Accord is also expected to provide policy-driven support for the sector in the years ahead.
With only one passive fund currently available to UK small-cap investors—the iShares MSCI UK Small Cap ETF—Morningstar highlighted the case for active management in this market. Active managers in the UK small-cap equity category achieved a five year success rate of 59%, outperforming their counterparts in the UK large-cap and mid-cap equity categories, where success rates were just 24% and 25%, respectively. “The vast number of smaller companies creates a broad and often overlooked universe, resulting in an opportunity for active managers to add significant alpha over the long term,” said Ince.
