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Three tactics to tap robust UK small caps

Three tactics to tap robust UK small caps

While 2022 has posed considerable challenges for British investors, with surging inflation, rising interest rates and an escalating cost of living crisis weighing heavily on sentiment, there is cause for optimism.

There remain scores of high-quality resilient companies on offer listed in the UK – at the often overlooked smaller end of the spectrum.

The agility and niche positioning of many smaller companies can allow them to navigate more smoothly through economic headwinds.

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Moreover, the heightened uncertainty witnessed this year has meant many British small caps are trading at considerable discounts compared to their large-cap peers.

Investors able to buy now can set themselves on a solid footing to generate strong returns moving forward.

Lower valuations and a weaker sterling have also made UK small caps more compelling for foreign investors. As such, British equity investors could see their holdings acquired at attractive multiples over the coming months – another avenue for generating meaningful upside.

To take advantage of the opportunity within UK small caps, here are three tactics and stocks investors could consider.

Target tech-led

One strategy that can yield outsized returns over the long term is to target technology-led companies, including software providers and platforms.

These companies are inherently asset-light, as they do not need to expend capital on shipping products or repairing and upgrading physical assets.

Their more modest capex requirements mean tech-led businesses are typically more cash generative – a particularly attractive trait amid cloudier markets.

Moreover, these qualities permit tech-led businesses to scale more rapidly and in a sustainable way. 

For example, one tech-led business we recently invested in is a provider of teleradiology services in the UK.

The company’s technology platform enables its roster of more than 500 consultant radiologists to provide their services remotely, thereby facilitating the rapid availability of trained specialists.

Given the demand for radiology services in the UK is growing rapidly, driven by the developing sophistication of medical imaging and the country’s ageing population, the company's tech-enabled offering has scaled quickly, with its platform now used by more than 100 NHS hospitals.

Select sector specialists

Investors can also secure resilient returns by seeking out businesses that target a niche area of the market.

Sector specialists that are leaders in their field can build strong brand recognition and boost customer retention over the long term, better insulating them against macroeconomic headwinds.

For example a leading online travel agent globally, focused exclusively on the hostel segment.

Having specialised in hostelling for more than two decades, the company has collected an immense amount of long-term data around the unique preferences of its user base.

This has enabled the company to refine its customer experience and value proposition far more effectively than generalist competitors – such as online travel giant – cementing its position as market leader in this space.