A “valuation disconnect” between groups of larger stocks on the ASX versus their smaller counterparts will throw up plenty of value opportunities in 2025, helped by an overdue pullback in global sharemarkets.

That’s the view of the small and mid-capitalisation team at funds manager Investors Mutual. Senior portfolio manager Simon Conn expects smaller stocks will be in focus next year and that the local market will see one or two rate cuts by the Reserve Bank, rather than a significant easing cycle.

“The data is showing you that inflation is still relatively high and particularly the services components,” he said in an interview, noting wage growth, electricity prices and government spending as areas of concern.

“It’s pretty unlikely the government suddenly will stop spending in the lead-up to an election.

“The (macro-economic) backdrop is not showing a consumer-based recovery, it’s not a cyclical recovery, it’s just sort of a slow grind.”

The S&P/ASX200 followed the US market lower, bearing the brunt of selling again on Friday and shedding a further 1.2 per cent after a 1.7 per cent slide the prior day.

The S&P/ASX Small Ordinaries Index fared better on Friday, declining 0.9 per cent.

Investor jitters have returned and prompted selling, given expectations of fewer rate cuts in the US next year.

On a total return basis, in the year to date the ASX200 has outperformed the Small Ordinaries Index with the former at almost 10.1 per cent and the latter at 7.2 per cent.

“The whole (small to mid-cap) sector has been … a bit unloved and less researched,” Mr Conn said, as he lamented a
hollowing out of equities research of smaller ASX stocks.

“There’s still this divergence between small and large cap industrials. But for a stock picker like us there are still plenty of opportunities. Typically, you’d start to see people gravitating to smaller companies because there’s better value on offer in the smalls (small capitalisation stocks) …

“We own some stocks that trade at big discounts to their large cap peers and it’s just a valuation disconnect.”

Mr Conn cited companies including financial services group ClearView and transport firm Lindsay Australia as examples.

Wilson Asset Management’s lead portfolio manager Oscar Oberg told investors this week the firm remained upbeat on small cap stocks going into 2025.

“Since the market began pricing in an imminent interest rate cut in the US six months ago, US small caps (S&P 600) generated a total return of 17 per cent, outperforming large caps by almost 6 per cent,” he said.

“We forecast a Reserve Bank of Australia rate cut around March/April 2025, with additional rate cuts throughout the year. The strong performance of small cap companies in the US following a rate cut illustrates how it can be a tailwind for small caps in Australia.”

Mr Conn noted Investors Mutual’s relevant funds were seeking quality companies that were mis-priced within a lower economic growth environment.

“We’re looking for businesses that have recurring and predictable income,” he said.

Investors Mutual’s small cap fund – whose biggest holdings include Kelsian, Hansen Technologies and Cuscal – has delivered a one-year total return of 30.4 per cent, net of fees. That outperformed its benchmark, the Small Ordinaries Index (excluding Property Trusts), which returned 19.9 per cent.

Over three years, the fund has delivered 5.7 per cent in total returns per annum, beating a flat return for its benchmark.

The firm’s future leaders fund – whose 10 biggest holdings include Aurizon, Integral Diagnostics and Ampol – has a one-year total return of almost 26 per cent versus 22.3 per cent for the S&P/ASX 300 Accumulation Index, excluding property trusts and the S&P/ASX50.

Over three years, the differential narrows to the fund returning 4.8 per cent per annum compared to 3.9 per cent per annum for the S&P/ASX 300 Accumulation Index, excluding property trusts and the S&P/ASX50.

Investors Mutual portfolio manager Marc Whittaker said he backed stocks including pathology group Australian Clinical Labs and medical imaging group Integral, which would be buoyed by factors including demographics and government healthcare spending.

“They’re (Integral) starting to recover and now they’re starting to see more referrals,” he added.

Investors Mutual has $4bn in funds under management across nine funds, less than half the $9bn when France’s Natixis acquired a majority stake in then Anton Tagliaferro-led firm in 2017. Mr Tagliaferro retired last year, coinciding with Investors Mutual’s 25th anniversary.

Mr Conn said like other local fund managers the firm had not been immune to trends that had seen industry funds merging as well as shifting large proportions of the management of their equities portfolios in-house.

He noted a shift to more passive investment styles by many investors.

“It’s been a tough couple of years for active managers, there’s no shying away from that.”

Mr Conn noted the firm missed out on the boom in lithium stocks about four years ago, which had since sharply reversed.

The firm has, however, benefited from owning shares in Sigma Healthcare, which is merging with Chemist Warehouse, and from being an early backer of David Di Pilla’s HMC Capital.

“We were the first institutional investor in HMC when it was called Home Consortium … we backed it from day one. It’s been a great performer for us,” said Lucas Goode, an Investors Mutual portfolio manager and analyst.

Mr Conn views the Chemist Warehouse model as a “category killer”.

“There’s a huge opportunity to add more stores because they’re significantly underweight NSW and Queensland.”

But Investors Mutual participated in the ASX listing of payments group Cuscal, which on Friday remained below its November issue price.

Mr Conn said he still believed the company had a compelling business model. Mr Goode said: “The business has a really strong competitive position in a moat, great recurring earnings, strong cash generation and industry tailwinds.”

 

This article first appeared in The Australian.

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