Don’t wait on a cut: Opportunities abound for small caps investors

As Australian small company investors await a hotly anticipated interest rate cut, seen as a welcome shot in the arm for expansion-primed businesses, a senior analyst observes an already buoyant small caps market – one that investors should not wait to capitalise on.

With a rate cut already priced in for 2025, local small caps are poised to capitalise on this lower debt environment, says Mike Younger, portfolio manager for Prime Value’s small cap-focused Emerging Opportunities Fund.

“With interest rate cuts widely forecast for 2025 you can see that catalyst coming. We’re not sure when it might happen, but we know smaller stocks tend to jump out of the blocks,” he said.

Small companies are particularly responsive to an easing in policy rates, with the lower cost of debt incentivising businesses to invest, expand and innovate.

“Data shows small cap stocks are the first movers in a rate-cutting environment, and can provide significant outperformance,” Younger said.

With the cash rate remaining unchanged over the last 12 months, smaller companies also have “some ground to make up” against their large cap counterparts. However, investors were warned “not to get too caught up in the short term”.

For Younger, longer-term success in small cap stocks demands the confidence to invest through the cycle.

As well, he observed that, despite interest rates being at a 14-year high, quality small caps businesses have proved particularly resilient.

“In small cap investing there is always the opportunity to find quality, resilient companies in any market.”

Younger added: “While small cap stocks as a group may fluctuate on economic shifts there are many resilient smaller companies with resilient earnings, which can deliver consistency over time.

“Investors can do well targeting these stocks rather than just waiting for an interest rate rally.”

Further spruiking the appeal of small caps, he said: “Smaller companies offer more diversification than larger cap stocks, offering a bigger investment universe.

“There is always something interesting to look at, and this was underlined during the last reporting season where several quality companies surprised on the upside, including Regis Healthcare, Breville Group, and Chorus.”

Despite the challenging interest rate environment, Australia’s small caps market has performed particularly well over the last year, with the S&P/ASX Small Ordinaries index reporting an 18.1% return in the 12 months to November 2024, slightly above the All Ordinaries index (at 17.4%) for the same period.