Small caps are back. Here is what active managers are buying

Small caps have been having a rough time. Macro uncertainty, tariff noise and volatile sentiment have knocked the sector around. But April delivered a meaningful bounce, and the active managers inside the Third Link Growth Fund are finding opportunity in the rubble.

The Third Link Growth Fund is a fund-of-funds managed by Chris Cuffe AO. It invests across a line-up of high-quality Australian equity managers, with a distinctive twist: all net proceeds go to charity. Since February 2012, the fund has returned 8.9 per cent per annum net, with more than $24 million donated to charitable causes over its 17-year life.

Cuffe points to a clear theme coming through from his underlying managers right now.

“Performance dispersion within small caps remains elevated, reinforcing the importance of bottom-up research, active management in small caps, selective capital deployment and balance sheet discipline.”

In plain terms: the rising tide is not lifting all boats. This is a stock picker’s market. And the managers with the right process are making the most of it.

The AI and data centre trade is still very much alive

If there is one theme that cuts across every manager in the fund, it is AI infrastructure. The build-out of data centres and the electrification required to power them continues to drive real earnings outcomes for smaller companies.

1851 Capital’s Emerging Companies Fund returned +6.1 per cent in April, outperforming the Small Ordinaries benchmark by 2.8 per cent. The standout was SKS Technologies, which surged 69 per cent after upgrading contract sizes at a hyperscale data centre development in Melbourne. 1851 Capital originally purchased the stock at $0.37 in March 2024. It is now one of the fund’s strongest performers since inception.

Other contributors included Southern Cross Electrical (ASX: SXE), IPD Group (ASX: IPD), Zip Co (ASX: ZIP) and Cuscal (ASX: CCL). The manager believes elevated volatility continues to create attractive entry points, particularly where markets have overreacted to macro uncertainty.

Firetrail Australian Small Companies Fund tells a similar story. The fund returned +5.17 per cent, outperforming the benchmark by 1.84 per cent. Its strongest contributor was NextDC (ASX: NXT), which announced a major lift in contracted capacity. Contracted utilisation rose 60 per cent to 667 megawatts, pointing to a potential five-to-six-times increase in future revenue as new data centre capacity comes online.

Lennox Capital also holds NextDC, citing the company’s equity raising to accelerate expansion of its Sydney data centre footprint. Lennox stays structurally underweight speculative mining, preferring businesses with clear long-term earnings visibility and strong free cash flow.

Firetrail puts it plainly: AI adoption is now starting to materially impact real-world earnings, creating winners and losers across the small-cap universe. The time to be watching this space is now.

Defence and lithium add to the mix

Beyond the data centre trade, a few other themes are generating serious returns.

Eiger Capital’s Australian Small Companies Fund sees the current environment as “volatility is the new normal,” with sharp market swings continuing to create openings for long-term investors. One of its strongest performers was Codan, which surged after issuing a major earnings upgrade. The company guides FY26 EBIT and NPAT growth of more than 60 per cent, driven by structural demand for defence-linked communication systems. Codan’s communications division also reached its target margins a full year ahead of schedule.

Eiger also highlights a strong rebound in lithium. Liontown Resources rallied 43 per cent after delivering its first positive net cash flow since commencing production. Supply disruptions and recovering EV and battery storage demand are tightening lithium markets globally. Eiger believes periods of market dislocation provide opportunities to accumulate businesses capable of doubling earnings over a five-year horizon.

Firetrail shares the lithium conviction, flagging Elevra Lithium (ASX: ELV) as a key opportunity on the back of renewed optimism around EV and battery demand. It also highlights Greatland Resources (ASX: GGP), driven by strong gold production and cash flow generation.

The case for active management in small caps

It is worth stepping back and asking why this matters for advisers and their clients.

Small caps are not a passive game. Stock dispersion is high, meaning the gap between the best and worst performers is wide. Passive exposure captures both. Active managers with genuine research capability and balance sheet discipline are capturing the upside while avoiding the landmines.

The themes driving returns right now, AI infrastructure, electrification, defence, lithium, are structural. They are not going away next quarter. But accessing them well requires knowing which companies actually benefit from the tailwind versus which ones are just talking about it.

Lennox Capital also flagged oOh!media (ASX: OML), which rallied following a takeover proposal from private equity firm Pacific Equity Partners, reinforcing the strategic value of premium outdoor media assets. It is another reminder that not every small-cap opportunity comes from tech.

Cuffe sums it up well. In an environment where macro uncertainty and AI disruption continues to impact markets, the focus remains on active managers who can identify durable businesses. That is where the Third Link fund puts its conviction.

What advisers should do with this

If your clients have small-cap exposure sitting in a passive vehicle, now is a good time to review whether it is doing the job. The dispersion in this part of the market is high, which means passive is carrying more risk than it may appear on the surface.

The value of active management in small caps is clearest when markets are like this: volatile, dispersed and driven by company-specific outcomes rather than broad beta. The Third Link Growth Fund offers that exposure across multiple managers, with no management fees charged by the underlying managers and 100 per cent of net proceeds donated to charity. That is a compelling structure for advisers looking to add value and differentiate their offer.