Why Stock Selection Mattered in Australian Small Caps in 2025

The 2025 calendar year was a strong one for Australian equities. While the broad S&P/ASX 300 delivered a respectable total return of 10.7%, smaller-cap stocks were the clear leaders. The S&P/ASX Small Ordinaries Index gained 25.0% for the year. Against this backdrop, the MarketGrader Australia Small Cap 60 Index returned 25.5%, outperforming the Small Ordinaries benchmark by 49 basis points.

Figure 1. The MarketGrader Australia Small Cap 60 Index (MG Australia SC 60)

3-Year Performance Ending 2025 in AUD

The objective of the MarketGrader Australia Small Cap 60 Index is to provide exposure to the Australian small-cap equity market with the explicit goal of outperforming the S&P/ASX Small Ordinaries Index. The strategy employs a rules-based and fully transparent methodology to select 60 companies from the Small Ordinaries universe. Stock selection is driven by MarketGrader’s fundamentals-based research, with a focus on identifying companies exhibiting attractive growth characteristics at reasonable valuations under its GARP + Quality framework. A more detailed description of the index methodology is available on the MarketGrader Indexes website. The results over the past three years suggest that this approach has delivered on its stated objective.

Given that the MarketGrader Australia Small Cap 60 Index is constructed using a bottom-up, rules-based stock selection process, it is useful to examine the sources of its performance in 2025. One way to do this is through returns-based attribution, which decomposes performance into contributions from common market factors such as size and style, as well as from stock selection. Factor loadings represent a portfolio’s implied exposure to these underlying factors based on how it behaves relative to factor benchmarks. These exposures are not explicitly targeted by the index methodology. Instead, they emerge as a by-product of the underlying stock selection process.

Figure 2 presents the size and style factor loadings of the MarketGrader Australia Small Cap 60 Index for 2025 and compares them with those of the S&P/ASX Small Ordinaries benchmark.

Figure 2. The MarketGrader Australia Small Cap 60 Index (MG Australia SC 60)

Size & Style Factor Loadings for 2025

From a size perspective, the MarketGrader index exhibited a similar combined exposure to large- and mid-cap factors as the benchmark, at 29.0% versus 26.5%. The more meaningful distinction appeared on the style dimension. The MarketGrader Australia Small Cap 60 Index displayed a substantially higher exposure to growth factors, with a combined growth weighting of 84.9%, compared with 65.7% for the benchmark. Conversely, its implied exposure to value was lower. In practical terms, the index entered 2025 positioned long growth and short value relative to the benchmark. Importantly, this positioning was not the result of an explicit growth tilt, but rather an implicit outcome of MarketGrader’s bottom-up GARP-based stock selection process.

Figure 3 decomposes total returns into contributions from size and style factors and from stock selection, comparing the MarketGrader Australia Small Cap 60 Index with the S&P/ASX Small Ordinaries.

Figure 3. The MarketGrader Australia Small Cap 60 Index (MG Australia SC 60)

2025 Size & Style Factor Attribution

As expected, the contribution from large- and mid-cap factors was similar for both portfolios, reflecting their comparable exposures. Within small caps, the MarketGrader index’s overweight to the growth factor generated a return advantage of 3.58 percentage points relative to the benchmark. This benefit, however, was more than offset by the index’s underweight to the small-cap value factor, which detracted 6.35 percentage points from relative performance. This outcome reflects the fact that small-cap value, as measured by the S&P Australia Small Value Index, was the strongest-performing factor in 2025, delivering a return of 34.7%.

Based solely on size and style factor attribution, the MarketGrader Australia Small Cap 60 Index would therefore have been expected to underperform the benchmark. In aggregate, factor exposure accounted for 17.99% of the index’s return, compared with 21.12% for the benchmark, implying a relative shortfall of 3.13 percentage points. The difference came from stock selection. The MarketGrader Australia Small Cap 60 Index generated 7.46% of its return from stock selection, nearly double the 3.83% attributed to selection in the benchmark. This stock-specific contribution more than offset the headwind from factor positioning and ultimately drove the index’s 49 basis point outperformance in 2025.

Active Manager Outperformance through Systematic Stock Selection

An additional perspective comes from comparing the index’s results with those of actively managed peers, based on data from Morningstar Direct. Over the one-year period, the MarketGrader Australia Small Cap 60 Index ranked in the 37th percentile of its peer group, closely aligned with the benchmark’s 38th percentile ranking. While this may appear unremarkable at first glance, it is worth noting that 62% of active managers in the category failed to keep pace with the benchmark over the same period, even before fees (these comparisons are based on total returns for active managers reported gross of fees, ensuring comparability with index returns, which do not reflect implementation costs). The outcome is particularly notable given the index’s structure as a concentrated, equally weighted portfolio of 60 stocks, compared with the benchmark’s nearly 200 constituents. Over longer horizons, the distinction becomes clearer. The index ranked in the 24th percentile over three years and the 14th percentile over five years, while the benchmark ranked in the 59th and 63rd percentiles, respectively, based on total returns in AUD.

(For a complete summary of the performance of all MarketGrader Indexes relative to their actively managed peer groups, please visit our 2025 MarketGrader vs. Active Managers Report Card.)

Taken together, the results from 2025 highlight the importance of disciplined stock selection in small-cap investing. Despite an unfavorable factor backdrop, the MarketGrader Australia Small Cap 60 Index delivered excess returns through superior security selection and has demonstrated consistent strength relative not only to its benchmark, but also to actively managed peers over full market cycles.

Note: The MarketGrader Australia Small Cap 60 Index is tracked by VanEck’s Small Company Masters ETF (ASX: MVS).