Time to take advantage of “hidden gems” in Australian small-caps

New commentary from Australian industrial small companies specialist, ICE Investors, has suggested Australian small caps are set to redeem themselves as an “attractive entry point” for investors looking to diversify amid ongoing market volatility.

Portfolio manager, Callum Burns, said the recent underperformance of small companies compared to large caps presents a significant opportunity for investors seeking diversification options away from the mainstream large cap banks and mining companies.

“In this environment, small caps offer greater diversification opportunities for investors, extending beyond broad market trends and traditional blue-chip shares, such as the big banks and big miners.  In addition, in many instances small caps are less impacted by potential tariffs than large caps,” he said.

“Moreover, we see good value in small caps. The extreme underperformance of small caps versus large caps, coupled with historical trends, indicates good timing to buy into small companies. By focusing on companies with robust business franchises with durable economic moats, investors can leverage the potential for persistent earnings growth and superior long-term returns.”

Burns said companies with a strong show of particular features, including “difficult-to-replicate assets, such as licenses and brands; a good quality management team; an entrenched customer base; a sustainable competitive advantage’ and barriers to entry for new competitors, which helps to establish an economic moat and pricing power”, are well placed for strong performance over the long-term and may even outgrow certain large caps.

“For example, EBOS and Paragon Care are key players in pharmaceutical distribution, a sector defined by scale, compliance, and reliability. The infrastructure and logistics expertise required to operate effectively as the premium operator in the case of EBOS and as the low cost operator in the case of Paragon in this space create barriers to entry. As a result, each benefits from a defensible market position and recurring revenue streams, reinforcing their investment attractiveness,” he said.

Burns also identified artificial intelligence (AI) as a crucial driver of new and innovative opportunities for small companies.

“We believe that AI can help to promote structural changes that lead to new business franchises and enhance the operations of existing companies’ operations,” he said.

“Within our portfolio companies, AI can help to automate and cut costs for insurance brokers, such as Ausbrokers. It can also help lead to differentiation of existing products and offer improved efficiencies, for example for retailer Temple & Webster.

“Our focus is on companies with an economic moat. We look for businesses with assets that are difficult to replicate, where the company enjoys sticky customers and produces a product or service with a repeating business with the client, and where we can identify the potential for an attractive internal rate of return over the medium to long horizon at the right price. 

“To identify these companies takes the expertise of a fund manager experienced in the small cap space, who can conduct in-depth research to reveal these hidden gems.”