Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 510

Thinking small to win big

Conventional wisdom suggests that ‘time in the market’ is a less risky strategy than ‘timing the market’. Boom and gloom provide attractive entry and exit points but only if the timing is right. Accurately identifying market peaks and troughs is notoriously difficult. In our experience, gradually allocating more to markets during times of market distress and less when ‘everything is awesome’ is a preferable approach.

Small caps, and in particular, industrials, present an opportunity for investors at current levels. The Small Ordinaries benchmark has underperformed the ASX100 since November 2021. Notably, industrials have underperformed resources, which have been supported by thematics such as energy security, battery materials, and gold. In addition, adjusting to tighter monetary policy has weighed on small industrials. The recent underperformance presents a chance for investors to incrementally allocate to the sector.

Small Ordinaries relative to ASX 100

Source: Novaport Capital, IRESS

Falling liquidity signals capitulation

Investors’ willingness to trade reveals their confidence, or lack thereof, in the market. Rising liquidity can create a virtuous circle during a bull market, when abundant liquidity entices more capital into markets (attracted by lower trading costs). Yet when liquidity falls and markets are falling, the cycle works in reverse. Capital ceases to flow to (or exits) the market due to illiquidity concerns.

Small Industrials Quarterly Share Turnover (million shares)

Source: Iress

Since November 2021, liquidity in the small industrials sector has dropped meaningfully. In 2023, the daily average value of turnover for small industrials has been $704 million, down a third (from $1.07 billion) during the same period in 2021. The decline in liquidity indicates that a lower amount of new money is being put to work in Small Caps. Contrarian investors have a better chance of picking up a bargain now, relative to last year.

Microcaps have been hit hardest

Not surprisingly, the decline in liquidity has been most pronounced for the smallest of small caps. 74% of the smaller small industrials (with a market capitalisation of less than $1 billion) had lower turnover in the last 12 months relative to the previous year. Adjusting for stocks which benefited from index inclusion, 85% of companies saw turnover decline. The impact on liquidity has been lower for the larger small companies, 63% had lower turnover (or 69% adjusting for index changes). Unsurprisingly, 37% of ‘larger’ small caps (market cap >$1 billion) outperformed the benchmark relative to a mere 14% of the ‘smallest’ companies.

One of NovaPort’s holdings, Quantum Intellectual Property Ltd [ASX:QIP], provides a case study of the current dynamic in microcaps. Quantum has a meaningful and growing share of the Australian Patent, Trademark and IP Legal Services market. Over the last year, its share price has fallen by 19%, materially under-performing the small cap benchmark. On our estimates, the company trades on an attractive discount to earnings and yield metrics relative to the broader market, however its share turnover is 23% lower than the previous year. In a recent market update, the company reaffirmed expectations for organic growth, improving margins and further consolidation opportunities. The decline in liquidity merely reflects that the stock has fallen off the market’s radar in our view, creating an investment opportunity. Quantum is just one example of similar opportunities arising in the current market environment.

Different exposures than large caps

The Australian stock market is heavily weighted towards highly profitable bank and resources stocks. The smaller end of the market has a wider range of exposures, from resource exploration stocks and retailers to fast growing technology businesses. The composition of the small caps benchmark evolves over time. Furthermore, industrial companies are less risky than three years ago. We estimate that loss making companies are now only 5% of the small industrials’ universe, down from over 30% before the pandemic. The current small cap market has a lower exposure to risky, early stage, or loss-making companies.

Following the recent underperformance of small caps, we see attractively priced opportunities relative to the large cap universe. For example, Domain Holdings [ASX:DHG] offers faster growth than REA Group [ASX:REA] (as it increases market penetration), yet it trades at a discount. At the same time, small cap building materials companies in markets with high barriers to entry, trade at through cycle earnings multiples in the mid-teens, despite having more favourable industry structures relative to historical averages.

Smaller companies have traditionally been more volatile and sensitive to the economic environment, which is expected to be challenging. There are valid reasons to be cautious. However, the small industrials benchmark is comprised of more robust businesses post the 2022 market correction. Its underperformance relative to large caps and the withdrawal of liquidity suggests the market is already fearful. This presents us with an opportunity to increase our exposure to quality, but overlooked, businesses.

 

Sinclair Currie is a Principal and Co-Portfolio Manager at NovaPort Capital, a boutique Australian equities investment manager specialising in small and microcap ASX-listed companies. This article is for general information only and does not consider the circumstances of any individual.

 

RELATED ARTICLES

Social media’s impact is changing markets

Why Europe is back on the global investor map

Why caution is needed in Aussie small companies

banner

Most viewed in recent weeks

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 606 with weekend update

The boss of Australia’s fourth largest super fund by assets, UniSuper’s John Pearce, says Trump has declared an economic war and he’ll be reducing his US stock exposure over time. Should you follow suit?

  • 10 April 2025

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

An enlightened dividend path

While many chase high yields, true investment power lies in companies that steadily grow dividends. This strategy, rooted in patience and discipline, quietly compounds wealth and anchors investors through market turbulence.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

Latest Updates

Investment strategies

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Investment strategies

Does dividend investing make sense?

Dividend investing offers steady income and behavioral benefits, but its effectiveness depends on goals, market conditions, and fundamentals - especially in retirement, where it may limit full use of savings.

Economics

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

Strategy

Ageing in spurts

Fascinating initial studies suggest that while we age continuously in years, our bodies age, not at a uniform rate, but in spurts at around ages 44 and 60.

Interviews

Platinum's new international funds boss shifts gears

Portfolio Manager Ted Alexander outlines the changes that he's made to Platinum's International Fund portfolio since taking charge in March, while staying true to its contrarian, value-focused roots.

Investment strategies

Four ways to capitalise on a forgotten investing megatrend

The Trump administration has not killed the multi-decade investment opportunity in decarbonisation. These four industries in particular face a step-change in demand and could reward long-term investors.

Strategy

How the election polls got it so wrong

The recent federal election outcome has puzzled many, with Labor's significant win despite a modest primary vote share. Preference flows played a crucial role, highlighting the complexity of forecasting electoral results.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.