“It is a like a finger pointing away to the Moon,” Lee declares sagely. His disciple duly focuses on said digit, earning a brisk slap to the head for his lack of understanding. “Don’t concentrate on the finger,” Lee warns, “or you will miss all that heavenly glory.”

Wise words. However, while it might be handy in the context of laying waste to a disgraced former Shaolin monk and his army of henchmen, this axiom may be less than ideal for investors – especially those seeking to grasp the long-term appeal of the UK’s smaller companies.

It is widely recognised that UK equities in general have endured a challenging few years. Whether they have deserved to fall out of favour is a matter of opinion, but the fact is that much of the investment community has consistently preferred to look elsewhere – most obviously towards the US.

The malaise arguably set in after the 2016 vote for Brexit. which cast Britain in a negative light in the eyes of many investors. The COVID-19 pandemic piled on the pressure. Continued economic and political instability, ranging from the nation’s infamous multi-billion-pound “black hole” to all-too-familiar policy U-turns in Parliament, has not helped the cause since.

Yet all this is the stuff of “heavenly glory”. This is the Moon. While the bigger picture undoubtedly has its place, the attractions of UK businesses – particularly in the small-cap space – are likely to become apparent only if investors adopt a more much granular approach to stock selection.

Getting beneath the surface

The sheer unpredictability of the Trump 2.0 era has served as a potent reminder of why it can pay to diversify. In turn, this has persuaded many investors that they are pursuing a granular approach.

Often, though, they are hardly scratching the surface. Taking a step back from the US and re-embracing the UK, for example, is rather different from diversifying across the market-capitalisation spectrum within the UK.

The default choice is usually to home in on the household-name stocks that populate the FTSE 100 index. Similarly, there has been a tendency in recent years not to search far beyond the Magnificent Seven tech titans in the US.

Yet in the UK, as in other markets, smaller companies can offer superior long-term growth. Despite the risk of heightened volatility, they have a record of outperforming their larger counterparts over time.

Why, then, are they consistently overlooked? Maybe the simplest explanation is that they are routinely under-researched, which means many investors never even get to hear about them.

This is where diligent stock-picking and direct engagement enter the reckoning. As active managers who specialise in this arena, we meet with hundreds of UK smaller companies every year in a bid to identify those best positioned to reward investors over the long run.

Bigger picture versus unique attributes

These meetings underline that many UK smaller companies have shown considerable resilience in the face of difficult circumstances. In spite of everything – Brexit, COVID, the revolving door at 11 Downing Street – they have survived and even thrived.

Some are acknowledged leaders in fields such as aerospace and defence, chemicals, construction, engineering, healthcare, life sciences and medicine. Others are conspicuously agile, highly innovative and keenly placed to respond to and benefit from emerging opportunities.

So what are we actually interested in when we engage with a business’s management team? Ideally, we want a frank discussion of a company’s specific policies, practices, prospects, strengths and weaknesses – in effect, an articulation of the likely way ahead.

In other words, we want to know what makes a business unique. We want to know precisely where it sits within the broader landscape. We want to be in a position to appreciate how macro events apply at the micro level. Ultimately, we want to make informed decisions rather than sweeping generalisations.

And this is the vital point: in the UK, as in other markets, it makes no sense to tar all companies with the same brush. The chances of every last one of them simultaneously doing well or doing badly are zero. Each must instead be judged on its own merits.

Like Lee’s hapless pupil, investors are free to admire the splendour of the bigger picture. It can be useful and even beguiling. But in the end, at least in our game, it is the details that matter.

Eustace Santa Barbara is co-manager of the IFSL Marlborough Special Situations, UK Micro-Cap Growth and Nano-Cap Growth Funds.

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This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.

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