Global investors have long overlooked the UK small and mid-cap (SMID) sector and often focus on the well-known large-cap stocks of the FTSE 100. However, there’s a hidden opportunity in the UK SMID scene that many are missing: a rich pool of over 400 companies paying attractive income. For income-focused investors, this segment of the market offers a fertile hunting ground, with many companies not only delivering compelling yields but also offering diversified exposure beyond the UK.
Despite the challenging macroeconomic backdrop in recent years, the UK SMID sector continues to provide unique opportunities for dividend-seeking investors. With a large portion of these companies generating strong yields and deriving a substantial portion of their revenues from international markets, this sector offers both income and growth potential in a variety of industries. Here's why the UK SMID space is worth a closer look for those in search of consistent returns and global exposure.
A rich hunting ground for income seekers
The UK SMID sector is home to a vast array of businesses, many of which offer significant dividend yields. With over 400 companies paying attractive income, the diversity and depth of this market are often underestimated. These companies span a wide range of sectors, from industrials and consumer goods to technology and healthcare, providing investors with ample opportunities to find reliable income-generating stocks.
The appeal of these SMID companies lies not only in their dividend payouts but also in their potential for capital growth. Many of these businesses are still in the growth phase of their lifecycle, meaning they have the capacity to expand revenues, grow earnings, and, in turn, increase dividend payments over time. For long-term investors, this combination of income and growth can result in strong total returns.
Global exposure: More than just a UK story
One of the common misconceptions about the UK SMID sector is that these companies are solely tied to the UK economy. In fact, many UK SMID companies have significant exposure to international markets, making them less vulnerable to domestic economic fluctuations.
This global exposure makes the UK SMID sector an appealing option for investors who want diversified income streams. These companies are often leaders in their industries, with strong positions in both developed and emerging markets. Whether through exports, overseas subsidiaries, or international partnerships, these businesses are tapping into global growth trends, providing stability and resilience in uncertain times.
For example, companies in the industrials and technology sectors are benefiting from demand in global markets, particularly in regions such as Europe, North America, and Asia. By investing in UK SMID companies, investors can gain exposure to these international markets without the need to diversify into foreign equities directly.
Attractive dividend yields
Income investors are drawn to the UK SMID sector for its generous dividend yields, which are often higher than those found in large-cap companies. Many SMID companies are committed to returning capital to shareholders through consistent dividends, making them an appealing choice for those seeking steady income.
In particular, companies in the UK SMID space have strong cash flows and solid balance sheets, enabling them to maintain or even increase their dividend payouts. Despite the challenging economic environment, many of these businesses have proven their resilience by continuing to generate income for investors.
This dividend-focused approach is particularly valuable in today’s low-interest-rate environment, where traditional income sources such as bonds offer nominal returns. For investors looking to boost their portfolio’s income potential, UK SMID companies provide a compelling alternative, with the added benefit of potential capital appreciation.
Diverse range of sectors
The UK SMID sector is not only attractive for its income potential but also for the broad range of industries represented. This diversity allows investors to build well-rounded portfolios that are not overly concentrated in any single sector, reducing risk while enhancing the potential for returns.
The potential for growth and income
One of the unique advantages of the UK SMID sector is its ability to deliver both income and growth. While large-cap companies are often seen as stable, dividend-paying stocks, they typically offer limited growth potential. In contrast, SMID companies are still in the growth phase of their development, meaning they have the potential to significantly increase revenues, profits, and dividends over time.
For investors with a long-term investment horizon, this combination of income and growth is particularly appealing. As these businesses grow, they can generate higher earnings, which in turn allows them to increase dividend payouts. This compounding effect can result in substantial total returns for investors who are willing to hold these stocks over the long term.
Additionally, as the UK economy stabilises and investor sentiment improves, many of these underappreciated SMID companies are likely to be re-rated, providing further upside potential.
Conclusion: An underappreciated opportunity
The UK SMID sector is an underappreciated gem in today’s market. With over 400 companies paying attractive dividends and offering significant growth potential, it is a rich hunting ground for income-focused investors. The sector’s diversity, both in terms of industries and geographic exposure, provides investors with a unique opportunity to capture both yield and growth, all while benefiting from international market exposure.
For those seeking reliable income in a low-yield world, the UK SMID scene offers a compelling alternative to large caps and fixed-income investments. As these companies continue to grow and increase their dividends, they are well-positioned to deliver strong returns for years to come. Investors who take the time to explore this hidden corner of the market could unlock significant value and income opportunities.
Josh McCathie, Manager of the VT Downing Small & Mid-Cap Income Fund
Risk warnings: Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in our funds should be held for the long-term and are higher risk compared to investments solely in larger, more established companies. Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice.
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