UK sector review – are smaller companies starting to build momentum?

But the UK is a unique market. The FTSE 100 is made up of what some investors believe to be boring, more mature companies, but in recent years these companies have been the best performing part of the UK market.

Due to several factors, returns in the UK have been concentrated to a few sectors. Winners include banks, who are benefiting from higher interest rates, oil and gas due to higher oil prices, and mining companies from higher commodity prices.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, ask for financial advice. Investments and any income they produce can fall as well as rise in value, so you could get back less than you invest.

How are markets affected?

During the 12 months to the end of September 2026, the UK market, measured by the FTSE All-Share index, has delivered 16.8%*. This is ahead of European markets and only marginally behind the US.

Despite the strongest performance being concentrated to just a few sectors dominated by large companies, performance between larger and smaller companies has been much closer than expected.

Having lagged behind their larger peers for some time, small and medium-sized companies over the last six months have bounced back strongly.

Why have the valuations closed?

UK smaller companies entered 2026 after several years of trading below their historical valuations. This left greater scope for them to re-rate as investor sentiment improved. By contrast, the FTSE 100 had already performed strongly in 2025 and into early 2026, increasing the valuation gap to smaller companies.

Takeover activity has also helped highlight the value available further down the UK market. Corporate buyers and private equity investors have continued to find attractive opportunities among UK small and medium-sized companies. Several deals have already been announced in 2026, with buyers prepared to pay significant premiums to market prices in order to secure control of UK-listed businesses.

What has this meant for UK funds?

UK funds have generally delivered mixed performance depending on where they have been invested.

Despite smaller companies resurging more recently, funds focused on income typically performed better than those that don’t, as well as funds invested in smaller companies. When it comes to investment styles, value has typically outperformed growth.

On the Wealth Shortlist, the Jupiter UK income fund returned 21.0% and Fidelity Special Situations returned 20.5%. Both outperformed their benchmark, the FTSE All-Share, which returned 16.8%. Both funds benefited from their value style of investing being in favour.

Jupiter also benefited from the managers’ stock selection, particularly in the industrial and consumer cyclical sectors. This suggests the managers’ company analysis has added value, rather than performance being dominated by investing in the right sectors. Fidelity also performed well for similar reasons.

The CG Aegon Ethical Equity fund was the weakest of our UK Wealth Shortlist selections, returning 1.3%. The fund uses an 'exclusions-based' approach, so it doesn’t invest in companies involved in activities deemed unethical.

This is important because it means the fund excludes large parts of the market and that performance at times can look very different to the benchmark and peers. This has been the case more recently, as some areas of the market that have performed extremely well, this fund will not invest in. This includes defence companies like Rolls Royce, oil and gas companies BP and Shell, as well as some banks such as HSBC.

Although performance hasn’t been strong lately, the fund has gone through periods where performance has been much better. We take comfort that the fund’s manager, Audrey Ryan, has managed the fund since 1999 and she has maintained her philosophy and process through periods of stronger and weaker performance.

The Artemis UK Smaller Companies fund returned 8.5%, underperforming the broader smaller companies sector. The fund has a higher quality approach with a focus on not overpaying. This means we typically expect it to not fall as much during down markets but is unlikely to keep pace in rising markets.

All funds mentioned in this section invest in smaller companies which can add risk.

What we’ve been focussing on

During the last quarter, a key focus for us was the addition of Jupiter UK Income to the Wealth Shortlist. The fund was added following a detailed review of the manager, investment process, team and long-term performance potential.

We believe the fund gives investors access to an experienced UK equity income team with a disciplined focus on dividends, cash flows and long-term income and capital growth. The fund’s managers focus on companies whose share prices are currently below their true value.

The fund provides diversification alongside the existing UK income funds on the Wealth Shortlist, as it uses a more value-focused approach and invests more in smaller companies, while still keeping income at the heart of the process.

Overall, we’re impressed by Gosden and Morrison’s experience, track record, straightforward investment process and disciplined approach to income investing. We believe the fund offers a differentiated, value-oriented approach that has the potential to deliver attractive returns for patient investors over the long term.

Will a change of interest rates change UK Market leadership?

Interest rates have important implications for different parts of the UK stock market, and changes in expectations could influence which areas perform best.

From a style perspective, higher interest rates have tended to favour value-focused investors. This is largely due to banks, which had been cheap compared to the wider market for a number of years. Higher interest rates support bank profitability by increasing the difference between the interest they earn on lending and what they pay on deposits. This has provided a favourable backdrop for banks, which have performed strongly in recent years.

At the same time, growth investors are often focused on businesses who have potential to increase future revenues and profits a long way into the future. Higher interest rates reduce the present value of those future earnings, which can put pressure on their share prices.

Larger companies are typically better placed to withstand higher interest rates, while smaller companies can be more sensitive to changes in borrowing costs. Smaller businesses often have less access to alternative sources of finance and can be more reliant on borrowing to fund their operations and growth. Higher interest costs can therefore consume a greater proportion of their earnings and leave less money available for investment.

Could falling rates change leadership?

Although falling interest rates could help change market leadership it’s expected that interest rates will remain elevated and are likely to rise in the near term.

As it currently stands, with inflation running at 3.5%, above the Bank of England (BoE) 2% target and with higher oil prices keeping inflation elevated, the expectation is that the BoE will have to take action in order to tame inflation.

Despite the near term looking like a continuation of the current theme this will likely change at some point. When this will be is unknown, but market dynamics change over time and can change quickly, this is why we recommend investors diversify their portfolios.

When interest rates do begin to fall, this wouldn’t necessarily be good news for every company. Banks, for example, could see some of the benefit they've enjoyed from higher rates begin to fade.

However, lower borrowing costs could provide some relief to businesses and consumers and potentially create a more favourable environment for parts of the market that have been lagging behind.

The performance of small and medium-sized companies has already begun to pick up. And those companies more sensitive to changing interest rates could continue to benefit if rates fall in future as well.