By David Rogers
After the best year for WAM Active since inception 18 years ago, the fund manager cautions that the easy money in small caps may be over, largely because stubbornly high inflation caused such a dramatic shift in interest rate expectations in late 2025.
“A lot of the calls for a recovery in the small caps sector – particularly in the domestic-facing companies – haven’t really materialised,” WAM Active deputy portfolio manager Shaun Weick said.
WAM Active has about $80m as part of Wilson Asset Management’s $6bn of funds under management.
The fund has returned 41 per cent for the 2025 calendar year and 33 per cent in 2024.
Since inception in January 2008, the fund has delivered 13 per cent annually.
“The market has very quickly retested this narrative over the last few weeks,” he told The Australian.
“You can really put that down to the stubbornness of inflation, which has seen the market effectively reprice the outlook for rates in what looks like it’s going to be the shortest and shallowest ever interest rate cutting cycle by the Reserve Bank.”
In the second and third quarters of 2025, investors waded into small industrials as rate cuts appeared imminent. But in the final two months, they switched back to resources.
“We’ve seen those guys actually start to suck money out of the small industrials,” Weick said.
Although 2025 was a great year for small companies, it wasn’t in the way most expected.
The ASX Small Ordinaries index rose 21.8 per cent, its best year since 2009, and three times more than the ASX 200.
But most of the performance came from resources.
The ASX Small Resources index soared 70 per cent while the Small Industrials rose just 5.6 per cent.
Investors who focussed on small resources companies and high-flying defence stocks like Electro Optic Systems and DroneShield potentially did much better than passive funds.
With the Reserve Bank expected to start lifting interest rates as soon as February, how investors position them themselves within the sector could be even more important in 2026.
IPO carnage
The shift in sentiment has savaged the initial public offering market.
Medical device company Saluda Medical raised $US230m at a valuation of $US780m pre-IPO and promptly crashed 50 per cent on day one – the worst IPO performance in a decade.
Meanwhile, BMC Minerals, a gold and copper play, raised $US200m at valuation of $US550m.
But BMC closed up 25 per cent on day one of its IPO.
“We’re seeing a clear shift in sentiment between industrials and resources, and particular from high valuation companies,” Weick said.
High-flying tech stocks trading on revenue multiples rather than profits have been “pole-axed”.
Sports analytics firm Catapult has fallen despite upgrading earnings.
Location-sharing app Life360, widely held by Australian investors, has tumbled even though Weick says fears of slowing user growth are overblown. Life360 is held by WAM Active.
The exodus of US hedge funds hasn’t helped.
International money had flooded into Australia during the “end of US exceptionalism” narrative, when China looked uninvestable.
“CBA was just seen as a sort of safe bet. And I think indirectly helped a lot of small cap tech companies too,” Weick said. That trade has reversed.
The Trump effect
Donald Trump’s policies have created both winners and losers.
Defence stocks DroneShield and Electro Optic Systems soared 20 to 40 times as Trump’s America First rhetoric added to the strong tailwinds provided by wars in Ukraine and the Middle East.
The AI boom, turbocharged by instant tax write-offs on capital spending, lifted infrastructure plays.
Mayfield Group, an electrical infrastructure company, is seeing explosive demand with an order book that “stands out massively compared to history”.
Mining and industrial services groups like Tasmea, Vysarn and GenusPlus are benefiting from both AI infrastructure and broader electrification themes. WAM Active has Mayfield, Tasmea and GenusPlus.
Downer is another beneficiary, whilst NRW’s recent acquisition of Fredon targets the same opportunity. The outlier is Worley, struggling with depressed oil prices.
“With Trump’s midterms coming up this year, the one thing he doesn’t want is oil prices to rise,” Weick said.
Reporting season risks
February’s reporting season looms as a potential minefield for small cap investors.
“It feels like one of those months that’s going to have an increased level of volatility,” Weick warned.
Analyst estimates are now looking quite stale – most haven’t been updated for three or four months and don’t reflect the dramatic shift in the domestic interest rate outlook.
“It just feels like there’s stale numbers out there, and the risks to the downside for some of the more cyclically exposed domestic stocks have probably risen,” Weick said.
Some stocks that reported good results with upgraded earnings have still sold off as investors use the liquidity to exit positions.
“I feel like it’s going to be one of those sort of reporting seasons where you could potentially say good news gets sold, I suppose, in the industrials complex.”
Where to find value
Despite the challenges, Weick does not foresee selective opportunities in small-mid caps for 2026.
Shares of Singapore telco Tuas Limited – owned by WAM Active – haven’t kept pace with the benchmark in 2025. But Tuas is in the final stages of a transformational acquisition of M1 Limited.
Recent IPO Gemlife Communities Group, in the land lease community space, has excellent management and a pipeline more than double the size of the business over the next five years.
Being vertically integrated provides protection against cost inflation, particularly in Queensland with Olympics spending set to kick off in 2026. WAM Active has Gemlife shares.
Wholesale distributor Stealth Group – another WAM Active shareholding – has made a transformational acquisition in building products, with scope to take market share from Metcash.
Flight Centre looks interesting, given relatively low earnings expectations, with potential to pick up contracts from troubled rival Corporate Travel – also owned by WAM Active.
Corporate Travel shares have been in a trading halt for months due to its accounting scandal.
“The importance of bottom up stock picking only increases in this type of environment,” Weick said. “It does really favour an active, catalyst-driven approach where you can remain nimble.”
The bigger picture
Weick believes government spending in Australia is driving inflation whilst necessary reforms on taxes, deregulation and supply constraints remain unaddressed.
“We’re a developed economy with among the best and cheapest energy in the world, but our energy costs are now among the highest in the world. Something’s wrong there,” he said.
For the overall small cap sector, he expects a tale of two halves.
“The market’s effectively trying to price in a lower growth, sticky inflation, higher interest rates type environment, and not necessarily reflecting what I think could be the resilience of the economy.”
Once the high inflation numbers are behind us the outlook may improve, but until then the resources part of the small caps sector maybe the safer bet.
Small industrial stocks will need to prove themselves when results arrive in February, particularly if the Reserve Bank announces an interest rate hike on February 3.
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