The FTSE Small Cap Index will cease to exist by 2028 if the current level of takeover activity continues and the UK initial public offering (IPO) market fails to rebound, according to a new report by stockbrokers Peel Hunt.

“There has been minimal (UK) IPO activity for the past two years,” said Peel Hunt.

“We believe this needs to be actively addressed as the FTSE Smallcap will cease to exist by 2028 at the current run-rate.”

The number of companies listed on the FTSE Small Cap Index, excluding investment trusts, fell to 114 at the end of 2023 from 160 at the end of 2018, Peel Hunt Head of Research Charles Hall told clients in a note.

Peel Hunt said: “The pace of de-equitisation is relentless and will inevitably continue given the low valuation accorded to UK companies …

“If we extrapolate the current trend line, then the last company will leave the FTSE Smallcap in 2028.

“This all sounds very negative – but the reverse scenario can happen and can happen quickly. It really needs a trigger to break the cycle.”

Peel Hunt said increased fund flow will be the key driver and this could come from:

• Increased appetite by retail investors (eg British ISA, changes to CGT, IHT or dividend tax on UK shares)
• Reduced cost of ownership and benefit of higher liquidity through addressing the UK’s penal level of stamp duty vs other markets.
• Allocation by pension funds and insurance companies, through government incentivisation and regulatory change to enable a greater focus on performance rather than risk.
• Increase in share buybacks, reflecting the low valuations and tax differential between capital gain and dividends.
• Appetite from overseas investors if they perceived a material change in UK fund flows.

Peel Hunt concluded: “An improvement in the economic outlook would also change the negative dynamic, with reducing inflation driving the prospect of lower rates and an improvement in economic activity and investor appetite.

“If we do see increased demand for UK equities, then valuations should improve materially, which would then make an IPO a more attractive option.

“However, there are some deep-rooted issues in the UK regarding IPOs and the health of equity capital markets, which have material issues for long-term economic growth.”