Callum Burns

The significant market volatility in 2025 creates a buying opportunity for investors keen to diversify their portfolios to take advantage of the attractive entry points for small companies, according to Callum Burns, portfolio manager at ICE Investors.

“We are seeing a significant opportunity in Australian small caps due to the underperformance of small companies in recent years when compared to large caps. This presents an enhanced opportunity for investors keen to broaden their diversity out of the large cap banks and miners, which still take up a large portion of many investors’ portfolios,” he said.

“In this environment, small caps offer greater diversification opportunities for investors, extending beyond broad market trends and traditional blue-chip shares, such as the big banks and big miners.  In addition, in many instances small caps are less impacted by potential tariffs than large caps.

“Moreover, we see good value in small caps. The extreme underperformance of small caps versus large caps, coupled with historical trends, indicates good timing to buy into small companies. By focusing on companies with robust business franchises with durable economic moats, investors can leverage the potential for persistent earnings growth and superior long-term returns,” he said.

Robust business franchises are characterised by several key features, including companies with difficult to replicate assets, such as licenses and brands, a good quality management team, an entrenched customer base, a sustainable competitive advantage and barriers to entry for new competitors, which helps to establish an economic moat and pricing power. 

In essence, companies exhibiting these characteristics are more likely to achieve strong share price growth and outperformance over the long term, outpacing lesser-quality small caps and even large caps. These are quality businesses poised for durable growth, Mr Burns says.

For example, EBOS and Paragon Care are key players in pharmaceutical distribution, a sector defined by scale, compliance, and reliability. The infrastructure and logistics expertise required to operate effectively as the premium operator in the case of EBOS and as the low cost operator in the case of Paragon in this space create barriers to entry. As a result, each benefits from a defensible market position and recurring revenue streams, reinforcing their investment attractiveness.

Mr Burns also believes in the potential of artificial intelligence (AI) to create new business opportunities for companies. 

“We believe that AI can help to promote structural changes that lead to new business franchises and enhance the operations of existing companies’ operations. Within our portfolio companies, AI can help to automate and cut costs for insurance brokers, such as Ausbrokers. It can also help lead to differentiation of existing products and offer improved efficiencies, for example for retailer Temple & Webster,” he said.

“Our focus is on companies with an economic moat. We look for businesses with assets that are difficult to replicate, where the company enjoys sticky customers and produces a product or service with a repeating business with the client, and where we can identify the potential for an attractive internal rate of return over the medium to long horizon at the right price. 

“To identify these companies takes the expertise of a fund manager experienced in the small cap space, who can conduct in-depth research to reveal these hidden gems,” Mr Burns said.

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Callum Burns

The significant market volatility in 2025 creates a buying opportunity for investors keen to diversify their portfolios to take advantage of the attractive entry points for small companies, according to Callum Burns, portfolio manager at ICE Investors.

“We are seeing a significant opportunity in Australian small caps due to the underperformance of small companies in recent years when compared to large caps. This presents an enhanced opportunity for investors keen to broaden their diversity out of the large cap banks and miners, which still take up a large portion of many investors’ portfolios,” he said.

“In this environment, small caps offer greater diversification opportunities for investors, extending beyond broad market trends and traditional blue-chip shares, such as the big banks and big miners.  In addition, in many instances small caps are less impacted by potential tariffs than large caps.

“Moreover, we see good value in small caps. The extreme underperformance of small caps versus large caps, coupled with historical trends, indicates good timing to buy into small companies. By focusing on companies with robust business franchises with durable economic moats, investors can leverage the potential for persistent earnings growth and superior long-term returns,” he said.

Robust business franchises are characterised by several key features, including companies with difficult to replicate assets, such as licenses and brands, a good quality management team, an entrenched customer base, a sustainable competitive advantage and barriers to entry for new competitors, which helps to establish an economic moat and pricing power. 

In essence, companies exhibiting these characteristics are more likely to achieve strong share price growth and outperformance over the long term, outpacing lesser-quality small caps and even large caps. These are quality businesses poised for durable growth, Mr Burns says.

For example, EBOS and Paragon Care are key players in pharmaceutical distribution, a sector defined by scale, compliance, and reliability. The infrastructure and logistics expertise required to operate effectively as the premium operator in the case of EBOS and as the low cost operator in the case of Paragon in this space create barriers to entry. As a result, each benefits from a defensible market position and recurring revenue streams, reinforcing their investment attractiveness.

Mr Burns also believes in the potential of artificial intelligence (AI) to create new business opportunities for companies. 

“We believe that AI can help to promote structural changes that lead to new business franchises and enhance the operations of existing companies’ operations. Within our portfolio companies, AI can help to automate and cut costs for insurance brokers, such as Ausbrokers. It can also help lead to differentiation of existing products and offer improved efficiencies, for example for retailer Temple & Webster,” he said.

“Our focus is on companies with an economic moat. We look for businesses with assets that are difficult to replicate, where the company enjoys sticky customers and produces a product or service with a repeating business with the client, and where we can identify the potential for an attractive internal rate of return over the medium to long horizon at the right price. 

“To identify these companies takes the expertise of a fund manager experienced in the small cap space, who can conduct in-depth research to reveal these hidden gems,” Mr Burns said.

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Callum Burns

Investing in small-cap companies can be considered a risky proposition, but it can also be a very rewarding one; the key for investors is to identify quality small caps that have the potential to become tomorrow’s top performing companies, according to Callum Burns, managing director & portfolio manager at ICE Investors.

Mr Burns says not all small caps are created equal and there is a significant performance dispersion between small companies. Many either fail to thrive or underperform. However, focusing on high-quality small companies with strong competitive advantages can yield significant long-term value for shareholders.

“The small-cap universe can be a significant challenge. There are a lot of opportunities out there, but there are also many pitfalls. This is why a careful, methodical approach to stock selection is extremely important in small cap investing. There are around 200 companies in the ASX Small Cap Index, and many more not even in the index, yet many of these companies are not attractive from an investment point of view,” he said.

According to research conducted by the ICE Investors team, the “sweet spot” of small cap investing can be found within a high-performing subset – the potential future top 100 companies —those companies with robust business franchises.

“Companies with strong competitive advantages are more likely to succeed in the long run. They are also more likely to be quality companies that can weather future economic storms,” he said.

Mr Burns said that one of the most important things to look for in a small-cap company is a strong competitive advantage. This could be anything from a unique product or service to a brand or unique infrastructure.

“Robust business franchises are characterised by several key features including having an economic moat around the business that protects revenue from competitors; difficult to replicate assets, such as licenses and brands; barriers to entry for new competitors; an entrenched customer base that faces obstacles in switching to competitors; sustainable competitive advantage and pricing power.

“With a focus on firms with strong business franchises, investors can tap into the potential for substantial outperformance and avoid lower quality companies that may lead to underperformance and ultimately, poor returns over the longer term.

“By undertaking comprehensive research and proper due diligence, investors will be better equipped to identify tomorrow’s top 100 companies,” he said.

Despite the potential of small caps for long-term growth, the S&P/ASX Small Ordinaries Index has shown significant underperformance of the S&P/ASX 100 index since early 2022, as highlighted in the chart below. According to Mr Burns, this dislocation in performance remains in place today, however the ICE Investors team believes this is only a temporary dislocation and that investing in small companies with strong business franchises can yield dramatically different outcomes over time as illustrated by the team’s research into the sector.

“This is demonstrated by looking at data over the last 20 years which shows that small companies with strong business franchises consistently deliver superior returns compared to the broader small-cap universe and the overall share market,” he said.

As the above chart highlights, the small cap businesses with solid franchises represented by the blue line provide superior risk-adjusted returns due to their robust business models and consistent earnings growth. In contrast, lower-quality small caps, represented by the lavender line, generally exhibit weaker prospects and less durable growth.

“There are still many great small-cap companies out there waiting to be discovered. However, investors need to be equipped with the right research and due diligence to differentiate between low-quality small caps, with little potential to outperform, from the next top 100 companies.

“Our investment approach at ICE Investors, helps us to differentiate and identify the next top 100 in the small caps space by finding strong business franchises with a solid competitive advantage and strong prospects to outperform in the long term,” said Mr Burns.

Quality small companies are well placed to outperform large companies going forward according to new research from ICE Investors, whose flagship ICE Fund is distributed by SG Hiscock & Company.

A research paper on small cap stocks from ICE Investors finds that the opportunity for quality small companies to outperform large cap stocks is largely intact, even after gaining in value in recent times. The chart below illustrates the recent rise of the S&P/ ASX Small Ordinaries Index following its underperformance since late 2021.^[1]

ICE Investors’ research adopted the ASX/ S&P Small Industrials Index as the control group. The companies were compared after they were split into five quality categories as shown in the chart below, using the ICE Investors Business Franchise Process: ‘strong franchises’, ‘solid franchises’, ‘typical company’, ‘below average company’ and ‘challenged and/ or loss-making’.

The analysis shows that about half of the Smaller Industrials index consists of higher quality companies. These higher quality companies have better earnings growth, slightly lower debt levels and similar profit margins as compared to the top 100 companies.

The consensus earnings growth forecast for the year to 30 June 2024 was calculated for each company and the median for each category, as shown in the chart below:

Companies that fall into the three lower quality categories have minimal, and inferior earnings growth which justifies these companies trading at a discount. In contrast, the selloff versus large cap stocks is highly likely to have created opportunities in the higher quality half.

To explore where the best opportunities may lie in the prospective higher quality half of the Small Industrials, the median Price Earnings ratio for the Strong Franchises and Solid Franchise categories  was calculated and compared to that of the Top 100.

The research showed that some of the best opportunities on offer in the small cap space are for ‘solid franchise’ businesses, whose valuations are attractive relative to large caps and their own history (as the chart below shows).

The strong franchise category trades at a premium in absolute terms and relative to its own history, indicating the more challenging investment environment has unsettled investors and they have responded by buying into this group. These are excellent companies, but the valuations are far more attractive in the solid franchise category.

Other categories should be avoided because of their weaker business models or prospects and earnings which are not growing as much as they are contracting.

Overall the research indicates the best opportunities are likely to reside in the solid franchise category – the only one which the constituent companies overall have a durable advantage, growing earnings and trade at a valuation discount relative to large caps and their own history.

———-

Notes:
[1] All data presented is on or around 29 February 2024.

Callum Burns

Lead indicators are pointing to a more uncertain and challenging period for broader Australian equities, and while some headwinds will persist, there are opportunities for investors in smaller companies, according to ICE Investors managing director and portfolio manager, Callum Burns.

“Investment markets are undoubtedly in a more uncertain and difficult point in the cycle however this can result in stock opportunities that would not otherwise arise.

“Investors can become too focused on the short-term picture however we focus our attention on the long-term compounders.

“If you can maintain a longer-term view and keep your eye on the price, you can use the conditions to your advantage,” he said.

Mr Burns believes that along with strong balance sheets, pricing power is a critical stock attribute in an uncertain environment, and is on offer in select parts of the small cap sector.

“Pricing power is essential for companies to be able to maintain margins and speaks to the strength of a company’s competitive advantage which is a key driver of their ability to capture market share from competitors. A good example of this is EBOS Pharmaceuticals, which gained market share from competitors during and post COVID.

“When prices are rising, you increase your own to mitigate those cost pressures but the companies that are genuinely differentiated and with loyal customers, they’re faring the best.

“Also, top quality franchises at good prices are more readily available when investors are anxious, so be mindful of the challenges, but equally, be open to an environment that typically creates opportunities,” he said.

The SGH ICE Fund has recently had its highly recommended rating by Lonsec reaffirmed and received a Morningstar Analyst RatingTM of ‘Gold’ (as at 8/10/2022), the latter of which described the fund as having a “superb strategy” and one that “rises as one of our top picks in the Morningstar Category.”

The Morningstar Managed Investment Report read: “SGH ICE is an excellent strategy backed by a strong team and repeatable investment process.

“In the 10 years to August 2022, the strategy has handily beaten both the S&P/ ASX Small Ordinaries and S&P/ ASX 300 indexes on a total return and trailing returns basis.

“It has also outpaced the equity Australia mid/ small-growth category average over the past 10 years, and returns on a risk-adjusted basis are solid. Stock picking has been the main driver of performance.”

ICE Investors is a boutique fund manager based in Melbourne, specialising in franchise style investing in Australian equities.

Mr Aliev was previously employed with Franklin Templeton Investments – Global Equity Group as a research analyst for eight years. Prior to this he held research positions with Mercer Investments and AXA Australia.

He holds a Bachelor of Commerce (Hons) from the University of Melbourne and is also a CFA Charterholder.

Mr Burns said the appointment reflects both the capabilities of Mr Aliev and also the demands of the current market environment.

“Given the uncertainty in the market and the need to identify sound, long-term stock opportunities, Roman joins the business at an opportune time.

“He is a passionate investor and a high performing global equity research analyst, with strong experience covering a wide range of geographies and sectors.

“His analytical experience and focus on identifying companies that are well positioned to grow shareholder value over the long term make him a good fit for the investment team.  We’re looking forward to having Roman join the team,” he said.

ICE Investors’ SGH ICE fund is a benchmark unaware fund that has a strong long term track record since its inception in 2006. It is an actively managed predominately small cap equity fund, that aims to invest in ASX listed franchise companies with a sustainable competitive edge.

The Fund currently holds 39 stocks which are a mix of longer-standing companies growing at a steady rate, and those that have been advantaged by the pandemic and experienced more significant growth as a result.

The underlying philosophy of the investment team is to focus on franchise companies with a durable competitive advantage, organic growth opportunities, appropriate debt levels and strong cash flow generation.

“We look for franchise companies that have high barriers to entry and use assets that are difficult for competitors to replicate. This typically leads to strong pricing power and, most importantly, sticky customers,” Mr Burns said.

“Inflation will continue to have an impact on markets, and the key risk to margins is not being able to pass on material or labour costs. As pricing power is such a key element of our investment process, many franchise companies are well suited to this market environment. We’re continuing to identify opportunities for the fund,” he said.

Stocks currently favoured by ICE Investors include Ooh Media (ASX: OML), carsales.com (ASX: CAR), Steadfast Group (ASX: SDF), and medical supplier, EBOS Group (ASX: EBO).

According to Mr Burns, the appointment reflects the recent strong performance of the SGH ICE Fund and growth prospects within the small cap sector of the market.

“With substantial experience in asset management, Mason is an excellent fit both culturally and from an investment philosophy perspective. He has a proven track record in being able to achieve strong returns and understands the demands of a retail client base.

“His appointment places the ICE Investors team in a very strong position to continue to deliver superior investment performance for our clients,” he said.

Prior to joining ICE Investors, Mr Willoughby-Thomas was senior co-portfolio manager of the Ausbil Investment Management small and microcap funds. He was also previously employed as portfolio manager/ senior analyst at Australian Ethical Investment and held analyst positions at ING Investment Management and AMP Capital Investors.

He holds a Bachelor of Commerce with honours from the Australian National University and is a Chartered Financial Analyst.

Mr Burns said the appointment of Mr Willoughby-Thomas comes at an opportune time for the domestic small cap sector, with certain industries poised for particularly strong growth.

“Companies connected to pharmaceutical distribution, cloud software, online services and food are likely to do well as the economy reopens. We’ll be continuing to focus on franchise companies with a durable competitive advantage, organic growth opportunities, appropriate debt levels and strong cash flow generation he said.

SGH ICE is a benchmark unaware fund, but draws most of its investments from Small Industrial stocks which have outperformed during COVID-19 and over the long term.

It currently holds 43 stocks which are a mix of longer-standing companies growing at a steady rate, and those that have been advantaged by the pandemic and experienced even more significant growth as a result.