While small-cap talk is increasing, the asset manager has argued the segment looks likely to recover much further, with positive earnings growth prospects over the next 12 months and beyond.
Smaller companies have been increasingly in the spotlight as of late, particularly in Australia, with some local names praised for their attractive valuations.
Global asset manager Janus Henderson is backing a strong recovery for the asset class in the coming period.
Having recently launched the firm’s Global Smaller Companies Fund in Australia, Richard Brown, Janus Henderson’s client portfolio manager for global small caps, is currently visiting the country to explore Australian opportunities.
Reflecting on the past year, Brown told InvestorDaily that despite a recent rebound, the firm was somewhat surprised that small caps hadn’t delivered stronger performance.
“Small caps have done okay, but they haven’t outpaced large caps to any meaningful degree, and that’s kind of the next leg of the sort of small cap recovery that we’re waiting for,” Brown said.
He noted that historically, small caps have commanded higher valuations but offered greater growth potential, as smaller companies naturally have more room to expand than their larger counterparts. However, that all changed in 2022, when an aggressive rate hike cycle aiming to combat inflation prompted many investors to flock to defensive assets.
What’s unusual now, explained Brown, is that despite a global rate cut cycle, inflation hasn’t fallen consistently and small-caps have yet to fully rebound.
“Small-caps got penalised when rates went up and they’re not being rewarded at all as rates come back down again, and I think that is what we still have to come and that’s what makes us quite excited about the next leg,” he told this publication.
He acknowledged that many investors wonder what could spark a full small-cap recovery, and suggested there are two key catalysts, the first being positive earnings growth forecasts.
“Earnings growth for small caps has been quite tough actually in recent years, as there have been all of these fears around the global economy and trade tariffs and everything with that,” he said.
Brown added that many small-caps accumulated excess inventory during Covid, which they have since been reducing – a process that has temporarily limited earnings growth for the sector.
“Now it feels as though we’re towards the end of that, and actually, if you look at forecast earnings growth for small caps, it’s over 20 per cent looking 12 months into the future, you compare that with large caps, large caps somewhere between 10 or 15 per cent depending on how you measure it.”
Meanwhile, he said that despite global economic uncertainty, the firm remains optimistic due to several factors supporting underlying growth.
He suggested that in the US, ahead of the mid-term elections, the Trump administration is likely to ease some of its more aggressive international trade policies, while the recently passed tax bill is expected to increasingly benefit households through 2026.
Janus Henderson is not the only firm with an eye on the small-cap space, with the Seattle-headquartered Russell Investments recently outlining a “slightly positive” preference to US small-cap equities in its 2026 Outlook.
“The cycle should be supportive for small-cap equities, with decent economic growth and further reductions in interest rates,” its outlook stated.
Meanwhile, it described its US large-cap outlook as “slightly negative”, citing expensive valuations tempered by solid underlying fundamentals.
“Looking ahead, we expect market leadership to broaden, creating opportunities outside the mega-cap names,” it stated.
Janus Henderson’s Brown concluded that the small-cap market offers “one of the richest areas for active management”, explaining that the firm focuses not just on regions or sectors but on individual companies with strong fundamentals. Such examples included smaller artificial intelligence (AI) capex beneficiaries, including heating and ventilation firms for data centres.
“The inefficiencies we find in this space are dramatic, and it allows us to build portfolios with characteristics that I think you would struggle to build in a large-cap world.”
