Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 513

Why Aussie small caps are consistent underperformers

An anomaly an Australian investor must contend with is that the alpha evident elsewhere in the world is not evident in local small-cap indices. The S&P/ASX Small Ordinaries Index has delivered lower cumulative returns relative to the broader Australian equities benchmark since 1998.

Unlike Australian small companies, global smaller caps have historically demonstrated outperformance relative to large companies over the long term. Below is the cumulative performance of MSCI World ex Australia versus MSCI World ex Australia Small Cap indices.

Australian small-cap conundrum

The Australian small-cap universe is hamstrung by structural nuances, not present globally.

1. Market size

An observation that might surprise Australian investors is that the global small-caps, in the context of market size, would be characterised as mid-caps in Australia when measured by market capitalisation. Global small-caps are, on average, two times larger than Australian small-caps, as represented by MSCI World Small Cap and S&P/ ASX Small Ordinaries. Furthermore, the largest global small-cap, in the context of Australian listed companies by market capitalisation, would rank as approximately the 20th largest on ASX, 80 places ahead of the largest Australian small-cap determined by the S&P/ASX Small Ordinaries Index (stock 101).

Higher average market capitalisation of global small-caps relative to Australia small-caps implies that these companies are more established businesses in the ‘growth’ phrase of the business cycle. They have grown to a size to be included in the MSCI World ex Australia Small Cap market coverage range by demonstrating an increase in sales and earnings growth. Australian small-caps by comparison have a higher proportion of companies in the ‘introduction’ phase, meaning that sales and earnings growth are likely to be more mixed, with a shorter track record.

This observation is reflected when comparing earnings per share (EPS) growth of small-cap benchmarks over the past 10 and 20 years. Global EPS growth outpaced Australia by more than three times. Average time since listing of global small-caps is also four years longer than Australian small-caps.

2. Unprofitable company coverage

The largest Australian small-cap sector is materials. In the global index, it is one of the smallest sectors. Many small unprofitable mining companies list on the Australian stock exchange in the ‘infant’ stage of the business cycle to raise capital for exploration or mine development where debt and private equity financing is unavailable. This is less common globally as offshore exchanges have stricter rules around profitability and financial viability requirements for listing1. This means that exposure to an Australian small-cap strategy may not be a sound investment approach. Australian small-caps have almost double the exposure to non-profitable companies, compared to global.

3. Geographic revenue exposure

Australia accounts for 1.7% of global gross domestic product (GDP) and 0.3% of the world’s population. If you exclude mining companies, Australian small-caps tend to be Australian centric operations with low global revenue. Primarily servicing Australian customers limits scope for expansion, unless the company goes through a capital raising to expand operations globally, often resulting in the company dropping from S&P/ASX Small Ordinaries coverage. However, global small-caps are more likely to have global operations, or, if they are only locally based offer the potential for significant market expansion by servicing countries that are larger by GDP.

Australia accounts for 1% of global small-cap revenue compared to 70% locally. Williams-Sonoma, Inc is a good example of a US small-cap that operates globally. The company is an American publicly traded consumer retail company that sells kitchenware and home furnishings, operating approximately 600 brick and mortar stores and distributes to more than 60 countries. Listed in 1983 and has a market capitalisation of A$11.9 billion [As at 31 March 2023].

Drawdown

Adding small-cap exposure to large- and mid-cap exposures in portfolios is known to increase the risk of losses. This is true globally with small-caps historically having slightly larger drawdowns during the global financial crisis (GFC) and COVID-19 market shocks. However, it is also worth noting that global small-caps returned to pre-shock highs faster following the GFC and 2001 dot com bubble. Noting, this should not be relied upon as an indicator of future performance.

In Australia, small-caps drawdown was materially worse than large caps during the dot com, global financial crisis and COVID-19 market shocks. This is in line with expectations as investors typically seek large companies during market stress events as their business models are seen to be more viable during economic downturns. The higher dispersion in the scale of the drawdown between small- and large-caps is a function of the market size of Australian small-caps relative to global.

Access to global small cap equities

Global small-cap investing has been an effective way to achieve excess returns relative to large and mid-caps over the long term. It is supported by modern portfolio theory, academics and illustrated through empirical research. However, when small-cap investment strategies are applied in Australian equities, they fail to achieve excess returns for three reasons: size, exchange listing requirements and sector exposure.

1 ASX listing rules profit test – A$1 million aggregated profit from continuing operations over past 3 years + A$500,000 consolidated profit from continuing operations over the last 12 months. NYSE listing profit rules - US$10 million aggregated profit from continuing operations for last 3 years.

 

Cameron McCormack is a Portfolio Manager at VanEck Investments Limited, a sponsor of Firstlinks. This is general information only and does not take into account any person’s financial objectives, situation or needs. Any views expressed are opinions of the author at the time of writing and is not a recommendation to act.

The VanEck MSCI International Small Companies Quality ETF (ASX:QSML) launched in March 2021 and is a passive strategy that tracks the MSCI World ex Australia Small Cap Quality 150 Index. Since March 2021 many investors have benefited from using QSML as the core of their global small cap equities exposure.

For more articles and papers from VanEck, click here.

 

RELATED ARTICLES

The case for a global small-mid cap portfolio

The cheapest small cap valuations in decades

Amid a tornado of headlines, where can investors find opportunity?

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

Latest Updates

Investing

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

Investment strategies

A closer look at defensive assets for turbulent times

After the recent market slump, it's a good time to brush up on the defensive asset classes – what they are, why hold them, and how they can both deliver on your goals and increase the reliability of your desired outcomes.

Financial planning

Are lifetime income streams the answer or just the easy way out?

Lately, there's been a push by Government for lifetime income streams as a solution to retirement income challenges. We run the numbers on these products to see whether they deliver on what they promise.

Shares

Is it time to buy the Big Four banks?

The stellar run of the major ASX banks last year left many investors scratching their heads. After a recent share price pullback, has value emerged in these banks, or is it best to steer clear of them?

Investment strategies

The useful role that subordinated debt can play in your portfolio

If you’re struggling to replace the hybrid exposure in your portfolio, you’re not alone. Subordinated debt is an option, and here is a guide on what it is and how it can fit into your investment mix.

Shares

Europe is back and small caps there offer significant opportunities

Trump’s moves on tariffs, defence, and Ukraine, have awoken European Governments after a decade of lethargy. European small cap manager, Alantra Asset Management, says it could herald a new era for the continent.

Shares

Lessons from the rise and fall of founder-led companies

Founder-led companies often attract investors due to leaders' personal stakes and long-term vision. But founder presence alone does not guarantee success, and the challenge is to identify which ones will succeed in the long term.

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.