That said, looking below the surface, we can get an understanding of the areas that provide the foundation for informed future investment decisions.
 

Relative Performance Comparison

Chart 1 compares the performance of what are typically considered large-cap ASX-listed companies (S&P/ASX200 Index) versus ASX emerging companies (S&P/ASX Small Ordinaries Index) or “small caps”. 

When viewing the 10-year relative performance (both indices are rebased to 100 in 2015), we can see that, for the most part, emerging companies have outperformed their larger counterparts. 

As chart 1 shows, this long-term relationship started to change in 2022, marking the start of the most rapid rate increases we have yet seen by the Reserve Bank of Australia. Recall that interest rates rose from 0.1% to 3.1% within a space of nine months. 

As chart 1 shows, since that period, emerging companies have effectively given back the previous outperformance against large-cap stocks. In NAOS's view, this appears to suggest significant relative underperformance of emerging companies vs large companies over the past few years. 
 

Chart 1

Source: S&P Global, NAOS

From NAOS’s perspective, what is particularly interesting is that, in recent months, the relative underperformance of emerging companies appears to have started to shift back towards outperformance over large-caps, as chart 2 shows.

Is it a coincidence that this shift aligns with what now seems to be the beginning of a likely (but gradual) interest rate easing cycle? 

As chart 2 shows, emerging companies tend to outperform in environments where interest rates are falling and underperform when rates are rising. In such conditions, equities generally become more attractive relative to fixed income, as the opportunity cost of capital declines.  

In NAOS's experience, emerging companies, some of which have higher growth potential, can benefit in a lower inflationary environment.

Chart 2

Source: S&P Global, NAOS

Key risk: higher volatility

From NAOS’s perspective, the trend described suggests a potentially improving outlook for emerging companies on ASX. 

The major caveat, however, is that with a heightened risk profile in the smaller end of the market, the variance in returns can be more pronounced on a company-by-company basis [higher volatility can be reflected by larger price falls or gains in small-cap stocks].

Furthermore, share price volatility is also typically higher for smaller companies compared to larger companies. [Risk, or standard deviation, is higher for small companies compared to large companies over 10 years based on a comparison of the S&P/ASX Small Ordinaries Index to the S&P/ASX 200 Index, at March 31, 2025. Source: S&P Global].

Thus, investors in emerging companies must be prepared to live with higher potential share-price volatility, even in an arguably more accommodative outlook (due to expected interest rates cuts this year).

As equity market investors, volatility is something that cannot be avoided. Any long-term equity investment will most likely require an ability to withstand large fluctuations in share prices. After all, that is the temperament of "The Market". 

The difference between volatility and risk essentially comes down to the likelihood of a permanent capital loss event occurring. Risk involves the probability of experiencing a loss, whereas volatility is a way of describing the degree to which share prices fluctuate.
 

Conclusion

At NAOS, we predominately focus on investing in ASX-listed emerging companies. We do this in a concentrated manner with a long-term investment horizon. 

This emerging companies segment of the market has undoubtedly faced a challenging environment over the past 24 months. In NAOS's opinion many small-cap companies are trading at valuations we view as being at or near historical lows. Higher share-price volatility among small-cap stocks is part of that picture. 

That said, NAOS believes that many of these businesses have used the past 24 months to do a lot of “hard yards” internally, improving their operations to become more efficient, resilient businesses. 

In NAOS’s view, despite geopolitical factors (such as Trump’s tariffs) affecting global equity markets, the shift in investor appetite following the end of the rate hike cycle and the start of an easing cycle, could create a potentially positive outlook for equity markets. 

If this renewed investor demand trickles down to the smaller end of the market (typically on a lagging timeline versus larger companies), NAOS believes this may have the potential to support emerging companies. 

While we, nor anyone else, can predict what will occur over the short term, history does show that emerging companies have experienced sustained periods of outperformance once investor risk appetite returns.

Are we witnessing the beginning of another period of outperformance of emerging companies? At NAOS, we believe that the period of relative underperformance for small-caps relative to large-cap companies could potentially be nearing its end. 

DISCLAIMER

Important Information: This material has been prepared by NAOS Asset Management Limited (ABN 23 107 624 126, AFSL 273529 and is provided for general information purposes only and must not be construed as investment advice. It does not take into account the investment objectives, financial situation or needs of any particular investor. Past performance is not necessarily indicative of future results. Before making an investment decision, investors should consider obtaining professional investment advice that is tailored to their specific circumstances.