Active Large Cap Managers Face Small Cap Levels of Volatility

– David Wanis, August 2025

More than any single company result or trend in revisions, the outcome of the full year 2025 reporting season that will reverberate across portfolios is the volatility and trauma inflicted upon large cap active managers. Small cap managers are used to volatile reporting seasons and this one was above average. In the past few years, small cap managers have also been used to being the out-of-favour asset class.

These phenomena have made their way to active large caps now in a big way. Suddenly what were the safe blue chips, which provided investors with psychological safety, liquidity and strong returns were put under intense scrutiny. Active portfolios who choose to pursue alpha not by searching in the hundreds of mid and small cap opportunities but rather via concentrating even further into Top 50 non-bank names had landmines going off almost every other day. And despite glimmers of hope, banks ended up outperforming in August anyway!

The Small Ords (ex100) returned +8.4% in August. The Mid 50 index +5.5%. The Top 50 Leaders +2.1% and given the S&P 200 Bank Index was +4.6%, it was tough going elsewhere in large cap land. It isn’t like EPS revisions through reporting season for small caps were so outstanding as to be the driver of this result, but share prices embed expectations other than near term earnings – and going into reporting season, the P/E multiple for small caps was the lowest it had been relative to the ASX100 since the GFC as we flagged in our last monthly report.

Over the last 12 months we have been talking about what a positive environment for small caps may look like. It seemed so alien from the investor experience since 2021 that many investors we talk to have all but given up hope. Small and mid-caps are benefiting from a few of the recent headwinds now turning into tailwinds. Interest rate increases (headwind) are now interest rate cuts (tailwind). Small cap P/E multiple premiums to large caps (headwind) are now large discounts (tailwind). And of course, unique to small caps relative to large caps are the hundreds of potential investment opportunities in a diverse range of industries and in all stages of the company lifecycle – from start-ups and early stages all the way through to mature and declining business.

Consumer Discretionary

There are always winners and losers from an EPS revision perspective in consumer discretionary. Average like-for-like (or same-store) sales for the brands we follow, having troughed at -4.5% in 1H FY24 have improved every half since, with 2H FY25 clocking in at +3.4% with post June 30 trading updates showing early signs of further improvement. New Zealand remains subdued but the outlook seems to be improving.

Investors rewarded turnaround stories, with Adairs (ADH) and Baby Bunting (BBN) gaining traction, while Super Retail (SUL) continued to defy competitive concerns with strong comps and healthy margins. Guzman Y Gomez (GYG) reminded the market that despite the narrative-inflated P/E multiple it remains a fast-food operator with long-term economics not vastly different from peers. Domino’s Pizza (DMP) showed what that can look like at maturity – and possibly into decline. ARB’s slight earnings miss was overshadowed by growing optimism around its Americas expansion, with tariff impacts offset by pricing power.

Health Care

There were three areas of interest in healthcare during results:

1. Health insurers vs Hospitals: there is a consensus view in the market that owners of legacy hospital assets are not getting their fair share of returns in the Australian market. The alternative argument is that not only are the Australian returns fair – Ramsay Healthcare (RHC) Australia division reported a ROCE of 16.5% – but a significant portion of the assets themselves are not “fit for purpose” under an evolving healthcare system. Just because owners of legacy assets have a sunk capital cost does not mean the world owes them a return. Our research suggests this alternative argument looks more likely to play out.
2. Pathology vs GPs: The pathology sector is facing a much more difficult financial environment than the COVID boom years. The government is in no mood to provide more funding for this sector. Results from Australian Clinical Labs (ACL) and Healius (HLS) show how much value is leaking to GP clinics in the form of rents and pathology industry profitability is clearly depressed (with Healius losing money and their medium margin targets looking optimistic). Arguably this sector can solve its own problems with consolidation of labs, private payments and increased discipline in rent agreements. Unlike hospitals, pathology is a centralised scale-based business.
3. Nanosonics (NAN): A long-term holding in the fund, which is demonstrating improved revenue from their blades (consumables) even if their razors (Trophon devices) are not growing as fast as the market would like. CORIS continues to progress towards commercialisation and we think the market will start to include this in the valuation over the next 1-2 years.

Industrials

Although the sector saw EPS downgrades, results were bifurcated between strong performance in mining-services and service-related businesses and weak results from stocks like Fletcher Building (FBU), Auckland Airports (AIA) and Johns Lyng (JLG).

Two areas of particular interest to the portfolio:

1. Mining services: Since late 2021 we have been increasing positions across the mining services sector including MMA Offshore (MMA), McMahons (MAH), Perenti (PRN), NRW Holdings (NWH), SRG Global (SRG), Monadelphous (MND) and Mader (MAD). Our thesis was that consolidation in the sector since 2014 had resulted in increased discipline and the ability for the industry (and players within it) to move returns on capital from a volatile single digit level to a more stable double-digit level. This reporting season confirmed this continues.
2. Salary Packaging and Novated leasing: SmartGroup (SIQ) and McMillan Shakespeare (MMS) have likewise been core holdings for a number of years on the thesis that post COVID car availability would allow delivery into their backlog of orders and an improvement in margins. The FBT exemption on PHEV’s and EV’s have also helped the businesses but arguably not the stocks as discounts start to get built into earnings for policy risk.

The other notable Industrial component includes defense stocks like Austal (ASB) which was a stock no-one wanted at 0.5x book value and is now a market darling at 4x book. Electro Optic Systems (EOS) and Droneshield (DRO) are in the same thematic group.

Information Technology

The sector saw meaningful EPS downgrades – although for some businesses this was due to the reinvestment into higher revenue growth which may be more value accretive than current earnings downgrades suggest should management execute.

Audinate (AD8): Having long held a strong position in audio, Audinate are investing heavily to capture the video market. The recent Iris acquisition will require another $25m to take to market in FY26, surprising consensus expectations of around $13m. The disappointment and subsequent earnings downgrades weighed heavily on the stock price.

Megaport (MP1): A new holding in the portfolio around this time last year, when the new chair, new CEO, new U.S go-to-market strategy and expanded product portfolio were put in place. In our view, all very welcome changes to the business. The result itself confirmed strong delivery and execution although how the market interprets the doubling down for growth at the expense of margin will probably see some volatility.

RPMGlobal (RUL): The newly separated clean SaaS business reporting a clean set of accounts with strong growth, an ongoing share buy-back, and new strategic partnerships with Tier 1 miners led to strong earning upgrades for RPMGlobal. The share price has appreciated from $2.45 lows this year to $3.88 post result, and they have since received a takeover bid at $5 per share.

Codan (CDA): Codan has been the sector standout for several consecutive reporting periods. The FY25 result was a 5% beat to consensus, again showing the benefits of the global and channel diversification they have been building. Slowdown in the US has been offset by global contract wins with communications achieving 19% organic growth against a target of 10-15%. Conflicts are a tailwind for this business, whereas humanitarian aid is the driver for the countermine division. Detector sales were also modest in the US but doing very well globally, presumably helped by high gold prices. They continue to execute well, lifting margins from 35% to 39%.

IRESS (IRE): The result itself was overshadowed by the emergence of a potential takeover offer from Blackstone and Thoma Bravo announced in early August and the subsequent stepping down of CEO Marcus Price. We suspect it likely whoever the owner is of IRESS over the next few years, the stickiness of customers and price elasticity of their products – particularly XPlan – will be thoroughly tested through aggressive price increases.

Communication Services

Other than Aussie Broadband (ABB), most stocks in the sector saw EPS downgrades as competition in the Telco space showed no signs of easing. Incumbents continue to battle for mobile subscribers while challenger brands steadily carve out share in the NBN market. The result has been disappointing growth trajectories for names such as TPG (TPG) and Chorus (CNU), both facing earnings pressure as subscriber additions underwhelmed. Superloop (SLC), by contrast, put up strong operational performance but could not escape modest downgrades. Among media names, Nine Entertainment’s (NEC) stock swung wildly on results but has since settled back to pre-announcement levels, underscoring the market’s skepticism around its structural revenue headwinds. EVT also disappointed, as cinemas were hit by both weak film supply and the QLD cyclone.

Energy

The two stocks of interest in the energy sector were Beach Energy (BPT) and Karoon Energy (KAR). Beach remains strategically well positioned with growing production (once Waitsia is finally commissioned and producing at nameplate) in a market likely to be short gas over the medium term. As seems to be a creeping influence across many sectors, energy politics (including the proposed takeover of Santos) seems to overshadow economics and is creating more regulatory uncertainty – never great for valuations. More significant issues appeared in the Uranium sector, as production (lower) and costs (higher) show what happens when hype meets reality. In a similar vein, the Yancoal (YAL) result showed that dividend yields need cash flow backing and the 10%+ fully franked yield of recent years evaporated along with earnings as dividend per share was cut by around 80%. Cyclical stocks and income needs are often not the greatest bedfellows.

Financials

Despite large market swings, financials was a sector that saw limited changes to earnings expectations post results. This is a very interesting and diverse sector, and we see several opportunities across payment businesses, wealth platforms, debt collections, financial infrastructure, asset management and insurance.

Insignia (IFL) and Platinum (PTM) stood out for the wrong reasons. Both companies continue to grapple with revenue headwinds and cost-saving initiatives which have disappointed. Cost control remains an ongoing challenge across the sector – seen also at Perpetual (PPT). PTM and IFL have agreed to takeover bids and are in the process of implementing schemes which makes the operating results no longer a problem for current shareholders.

ZIP Co (ZIP) continues to be a portfolio performance detractor, as the company demonstrated accelerating growth in their US business and a return to TTV growth in ANZ. We do not own the company due to the significant leverage in the business, but we acknowledge that the new management team appear to be doing a good job. Helia (HLI) delivered another strong on the back of subdued claims.