The range of returns for Australian listed companies last year was among the widest seen in 20 years, according to Sean Freer, director of global equity indices at S&P Dow Jones Indices in Singapore.

Brett Grant, head of product, customer experience and marketing at AUSIEX said small caps are considered by many analysts and investors to be one of the first asset classes to recover after a downturn.

“They are considered to be more nimble and easier to turn around than their large cap counterparts as economic conditions improve,” Mr Grant said.

“This is obviously reliant on economic conditions turning and especially interest rate rises halting. Some investors are less certain that rate rises are nearing their peak and that a recession can be avoided.”

Mr Freer said the S&P/ASX 50 outperformed the S&P/ASX Small Ordinaries by 20.28 per cent in 2022 as rising interest rates and energy costs impacted profit expectations. Large caps also outperformed the S&P/ASX MidCap 50 by 8.14 per cent.

“Small caps are often the first to be removed from asset allocations in favour of large cap equities or more defensive assets,” he said.

“The underperformance accelerated as the Reserve Bank of Australia began increasing interest rates in May 2022 – and was then further compounded as notable larger small caps stocks were removed from the small-cap index.

“Now, following that underperformance, specialist small-cap investors suggest the outlook for the sector is brighter and that last year’s sell-off provides a number of investment opportunities.”

Mr Grant said small caps will close their relative underperformance around the peaking of interest rates – both official rates and long-term bond yields.

“The small-cap index typically has more growth-oriented companies versus the large-cap index, so lower discount rates will help,” he said.

“It also has a greater percentage of domestic demand stories, so falling interest rates will likely help both the earnings and the earnings multiple.

“Advisers should consider the objectives of their clients and how small caps could contribute to their portfolio, while meeting their risk tolerances – as with any investment, there can be risks.

“Exchange-traded funds or ETFs can remove some of the downsides by leaving the stock selection to professionals.”