Why Major Asset Managers Are Turning to ASX Small Caps

Why Major Asset Managers Are Turning to ASX Small Caps

Australia’s equity landscape is shifting. BlackRock, the world’s largest asset manager, has increased its exposure to ASX small caps while trimming positions in large-cap names. This rotation reflects changes in valuation, market sentiment and earnings expectations across the domestic market. For investors, this shift is a signal that conditions in the small-cap segment warrant closer attention.

This analysis outlines why the rotation is occurring, how market structure is evolving, and what selective exposure to Australian small companies can achieve in the current environment..

Why ASX Small Caps Are Attracting Institutional Capital

BlackRock’s decision to add exposure to the S&P/ASX Small Ordinaries Index highlights a broader institution-led trend. Several factors underpin the shift:

Valuation support

Small caps continue to trade at a discount relative to large caps. Price-to-earnings ratios near 11 compare with closer to 20 for the major index names.

Earnings resilience

Earnings expectations are stabilising. A growing number of smaller companies are reporting stronger margins and tighter cost management.

Liquidity improvement

Liquidity conditions have improved through recent quarters, broadening institutional participation.

Relative performance

The ASX Small Ordinaries Index has outperformed the broader market, driven by better pricing dynamics and improved sentiment.

Investors are reassessing companies with strong balance sheets, disciplined capital management and operating leverage that can translate into earnings growth once conditions strengthen.

How Valuations Compare Across the Australian Market

The valuation gap between large and small companies remains wide. This is unusual at this point in the cycle and reflects multi-year underperformance in the small-cap universe. Companies with strong unit economics have been overlooked in favour of larger, fully-valued blue-chip stocks.

“The valuation gap between small caps and large caps has persisted for years. That gap still exists today, creating attractive opportunities for long-term investors.” – Emanuel

As macro settings normalise, this gap is beginning to compress. Investors are allocating capital towards businesses with disciplined balance sheets and improving earnings visibility. The dispersion in fundamentals is significant, which creates an opportunity for patient, research-driven investors.

“Companies with strong balance sheets, durable earnings and management teams with proven records of capital allocation are expected to outperform,” – says Emanuel.

Capital Flows, Earnings and Market Structure

The rotation into small caps is underpinned by three structural drivers:

1. Improving earnings quality: A growing cohort of small-cap companies is reporting stronger margins, tighter cost management and sound revenue visibility.
2. Attractive entry points: After extended periods of underperformance, valuations provide a margin of safety that is difficult to replicate in the large-cap index.
3. Institutional signalling: When a major global manager increases exposure, it reflects a view that risk-adjusted returns are improving across the segment.

Investors are beginning to differentiate between companies with real operating leverage and companies with weaker business models.

Small Caps, Risk Control and Capital Preservation

Volatility is a normal feature of the small-cap segment, but it does not diminish its long-term role in a diversified portfolio. With thoughtful position sizing, rigorous due diligence and active monitoring, small-cap exposure can enhance risk-adjusted outcomes. This is especially relevant for investors seeking differentiated return streams in an environment where large-cap valuations remain elevated.

Market Outlook and the Path Ahead

The rotation into small caps is consistent with improving macro conditions. Interest rates are stabilising. Inflation pressures are easing. Domestic demand is normalising. Together, these conditions support companies with scalable earnings models and disciplined cost structures.

The renewed focus on ASX small caps reflects structural changes in valuation, earnings and investor behaviour. The segment still carries volatility, but it also presents an opportunity for investors who apply discipline and focus on business quality. Selective exposure to Australian small companies can contribute to long-term capital growth while supporting diversification and risk control.

Institutional flows are shifting. Valuations remain supportive. Earnings quality is improving. For investors with a clear framework and long-term mindset, the current environment presents a constructive entry point into a part of the market that has been overlooked for years.

About the Datt Small Companies Fund

The Datt Small Companies Fund focuses on high-quality Australian small and mid-sized businesses with strong balance sheets, resilient cash flows and disciplined management teams. The strategy uses our research-led Mosaic framework to identify companies with durable earnings, sound unit economics and the capacity to compound value over time. The portfolio is concentrated, selective and designed to provide exposure to differentiated opportunities within the small-cap segment while maintaining a clear focus on capital preservation and risk control.

If you would like to learn more about the Datt Small Companies Fund or discuss how the strategy may fit within your portfolio, please contact Daniel Liptak, Head of Distribution, at daniel@datt.com.au.