I thought the below as interesting take on the changed structure of the market.
Small and micro-cap stocks are meant to be the mid to large caps of the future. But a combination of structural and cyclical trends have some in the market questioning their long-term viability.
The unstoppable wave of money flowing into exchange-traded funds is causing a crisis in capital formation for the hundreds of small and micro-cap stocks that comprise the bulk of the 2000 companies listed on the ASX.
The 1700 listed companies outside the S&P/ASX 300 are in the midst of a slow and painful decline that is undermining the two core reasons for listing: access to capital and liquidity.
Perennial’s head of smaller companies and micro caps, Andrew Smith, says the sector is turning the corner. Louie Douvis
Big super started to put small and micro-caps stocks in the dumpster in 2022 when the federal government’s Your Future, Your Super legislation made the S&P/ASX 300 the benchmark for MySuper’s Australian equity market returns.
The government was warned at the time that the MySuper benchmarks could encourage short-term decision-making, discourage investments that were not well represented by the benchmarks and reduce choice, diversification, active management and innovation.
That’s precisely what has happened.
Big super embraced index hugging to avoid being pinged by the regulator for the poor performance of their MySuper products. This profound structural change contributed to the closure of many small and micro-cap funds as well as the exit from the industry of half a dozen small-cap fundies.
“The challenge for most smaller growth companies is that they need access to capital and right now they’re being absolutely starved of capital,” says Mike Henshaw from Pure Asset Management, which runs the $112 million Pure Income and Growth Fund.
“We have this huge superannuation industry investing in venture capital in the US, which has abundant access to capital, but they won’t make an allocation to their home market for small caps outside the ASX 300.
“There are 1700 other listed companies which are deemed too illiquid or risky for the super industry, but AustralianSuper recently lost $1.1 billion on a private US tech stock.”
Small technology stocks trade at about one times revenue whereas big super, through private equity and venture capital mandates, pays three to four times revenue.
Another obvious anomaly is that the average price/earnings multiples for smaller companies (ex-S&P/ASX 300) are 40 per cent below the average P/E ratios for much larger companies.
Exchange-traded funds have become the preferred equity market exposure for retail investors, particularly young people. As a consequence, actively managed small and micro-cap funds have witnessed $2.4 billion in negative flows from the top 40 small-cap funds in the three years to December.
Australian exchange-traded funds now have a market cap of $255 billion, up 34.8 per cent or $66 billion over the past year, according to the February 2025 update from Betashares.
The retail exodus from small caps can be seen starkly in the consistent wave of redemptions from one of the most successful long-term small-cap funds, the Perennial Value Smaller Companies Trust run by Andrew Smith.
The trust’s equity peaked at $234 million in December 2021 and then got hit by a wave of redemptions over the next three years, slashing net assets to $59 million at December 2024.
However, Smith, who was profiled by The Australian Financial Review as a Monday Fundie last year, says Perennial’s total FUM including small-caps, micro-caps, private companies and cash is about $1.2 billion, down from $1.3 billion three years ago.
Smith believes recent inflows into Perennial’s small-cap strategy, which is based on analysis of fundamental value, show that not only is the flight of institutional capital over, it is being replaced by renewed interest from industry funds.
“We all know some of that money went to passive and that creates a bit of volatility and less inefficient markets, which are good for stock pickers in the long run,” he says.
He says the recent similar movements in the share prices of large-cap stocks and small-cap stocks mean there is a huge catch-up to happen, because history says smaller companies outperform larger companies over the long run.
The inherent value among small- and micro-cap stocks is evident from the fact that since the beginning of 2023 40 small-cap industrials have been acquired at an average premium of 96 per cent.
The avalanche of passive money into the S&P/ASX 300 has seen many small-cap managers focus on picking the stocks about to go in the index because it usually means a 25 to 30 per cent re-rating.
Henshaw says successful privately owned small companies can initially raise money through friends and family, and then second or third degree connections, but at some point the network “just isn’t there to support the capital you need for growth”.
“So, Australian companies tend to list really early compared to elsewhere because there’s so little private capital out there, or at least the capital that is there is very hard to find,” he says.
“If you’re a small company making $20 million revenue and $1 million to $2 million profit, you need to spend nearly half of that being listed. You pay a heavy price for accessing the ASX, but you’re doing it so that you can raise capital and get liquidity, but right now, largely, you get neither.”
The predominance of the S&P/ASX 300 index as a benchmark and the breadth of stocks covered by the S&P/ASX Small Ordinaries Index has seen many small-cap funds reweighted toward stocks that are, in effect, large caps.
Australia’s equity capital markets are heavily reliant on smaller companies for capital expansion, as detailed by Melbourne University academic Carole Comerton-Forde, who found nearly 80 per cent of capital raised by IPOs over the last 20 years was for companies with market caps of less than $75 million.
But in her report for the Australian Securities and Investments Commission published in February, she said the amount of capital raised in 2022 and 2023 was at the lowest level since 2012. The number of listed companies fell by 145 between January 2023 and December 2024, the largest two-year decline since the 1990s recession.
A spokesperson for the ASX says its twice-yearly small and mid-caps conference (SMIDCapa Conference) hosted by the ASX provides a platform for smaller listed companies to pitch their strategies directly to retail investors.
Also, since 2021, ASX has been supporting research by brokers on more than 100 smaller companies.
Max Cunningham, chief executive of the NSX, says his exchange offers smaller companies an alternative listing platform to the ASX with 50 to 60 per cent lower admission and annual fees.
Henshaw says it is positive that the Future Fund gave a small-cap mandate to Maple-Brown Abbott, but the market is in such dire trouble it needs federal government intervention such as an obligation on super funds to put 0.25 per cent of assets in small listed Australian companies that meet a minimum performance criteria.