Fund managers have highlighted potential for small caps to benefit from a more favourable macroeconomic environment and the alignment of various positive factors, with Australian small caps expected to outshine their international counterparts this year.
Datt Capital’s Emanuel Datt explained that while US small caps offer possibly greater depth and diversity, Australian small caps present distinct advantages for investors seeking value and growth.
“The inefficiencies and relative under-coverage of the Australian market create fertile ground for identifying overlooked gems and undervalued assets,” the chief investment officer of Datt Capital said.
The Australian small cap market remains under-researched, which in turn can present unique opportunities for astute investors to uncover undervalued assets and generate outsized returns.
“The Australian market is considerably cheaper than the US market on a relative basis,” Datt said. “Valuation differentials between the two markets are quite apparent, with Australian equities trading at more attractive multiples compared to their US counterparts.
“This affordability could appeal to investors seeking exposure to high-growth companies at more accessible entry points.”
Looking to the future, Datt said Australian small caps present opportunities for growth, particularly in emerging industries like technology, healthcare, and renewable energy.
“These sectors may offer significant growth potential for investors seeking exposure to innovative companies.
“Whilst the US small cap sector is expected to the benefits from an ongoing economic recovery, improving economic fundamentals across our local economy could support the performance of Australian small cap companies.
“Continued innovation and investment in these sectors from both private and public investors could drive growth opportunities for small cap companies with unique business models and products.”
Speaking on an episode of the Relative Return podcast earlier this year, Ausbil’s Andrew Peros predicted a “renaissance” for Aussie small caps this year.
Noting that the aggressive rate hike cycle employed by central banks, aimed at taming inflation, had disproportionately affected small caps, Peros declared that the tide was turning.
“History suggests that when rates peak and an easing cycle commences, small caps tend to outperform large caps,” Peros stated, citing the mid-90s as a precedent.
“The scenario that we’re seeing here at Ausbil in the small cap team is very similar to what we saw in the mid-90s, when the RBA raised rates three successive times in 1994. Inflation was an issue there, and as always, there was this fear of an economic slowdown and risk of a hard landing that didn’t eventuate. And then small cap started to take off.
“So as the market got confidence that that worst case scenario was unlikely to play out, small cap started to rally and then the RBA cut rates, and that really fuelled the next leg of outperformance for small caps. So, we think the environment that we’re in at the moment is very similar to that in the mid-90s, hence why we’re pretty excited about small caps this year.”
Similarly, on a more recent episode of Relative Return, American Century Investments’ Christopher Chen highlighted the potential for small caps to benefit from a more favourable macroeconomic environment.
For Chen, the world of small caps is currently brimming with potential.
“The key thing, I think, for small caps is that the headwinds against small caps over the last couple of years, that has gone away and it can become a tailwind,” Chen said.
“That’s on the macro side, that we think that there’s going to be some tailwinds for the asset class. And I think we can talk also more about fundamentals on valuation, even timing. I think many of these sorts of stars are aligning for small caps, which is why we think it’s pretty exciting”.
Chen is one of the speakers at Momentum Media’s upcoming Australian Wealth Management Summit, which will be held in Sydney on Wednesday, 8 May.
