Small caps, not the banks, drove active managers' quarter gains

A handful of bank and resource stocks have carried the S&P/ASX 300 for months. Everything else in the index has mostly been along for the ride.

That concentration cuts both ways: for stock pickers willing to look past the top of the index, it has left plenty of room to find returns the benchmark is missing.

The quarter by the numbers

The June quarter put a number on that gap. Third Link Growth Fund, a multi-manager vehicle that allocates across a panel of active Australian equity managers, returned 6.44 per cent for the quarter, 2.30 percentage points ahead of the S&P/ASX 300 Accumulation Index.

On the fund’s own figures, that puts the index return for the quarter at a little over 4 per cent.

Where the outperformance came from

The managers behind the outperformance were not the ones buying banks. Three underlying strategies stood out: L1 Capital Catalyst Fund returned 15.20 per cent, Lennox Capital Australian Small Companies Fund returned 15.89 per cent, and 1851 Emerging Companies Fund returned 8.87 per cent.

Each built its return on companies well down the index, away from the handful of large caps setting the market’s overall direction.

The macro backdrop

The Reserve Bank of Australia (RBA) held the cash rate in June, its first pause after three consecutive rises this year, even with inflation still running above target.

Third Link founding director and portfolio manager Chris Cuffe says corporate earnings held up and geopolitical risk eased over the quarter, both of which supported risk appetite. But he points to the same split that shows up in the fund’s numbers.

“Large-cap index returns continued to be dominated by banks and major resource companies, while significant dispersion in company performance created fertile ground for active managers.”

The test for active managers

That dispersion matters more to advisers than any single fund’s result. When an index’s return is concentrated in a few large stocks, a passive allocation captures that concentration and nothing else. It cannot distinguish between the bank whose earnings are flat and the small industrial company quietly compounding.

Active managers can, but only if they are actually looking outside the index’s top end. A manager holding the same ten stocks as the benchmark will get the same result as the benchmark.

That is the test worth applying to any active Australian equity manager on an approved product list: where is the return coming from, and does it look anything like the index.

A quarter like this one separates managers with genuine stock-picking exposure to small and mid caps from managers who are index-hugging with higher fees.

For advisers running the active-versus-passive conversation with clients, it is a concrete example of what dispersion actually buys you, and a reminder that the answer looks different every quarter depending on where in the market the spread opens up.