This week's chart comes from Morningstar's manager research team. Eva Cook, Director of Manager Research looks at 5 reasons why small caps may shine bright in 2025. She believes that as 2025 unfolds, small cap stocks are positioned to potentially add significant value to investors' portfolios.

The first reason focuses on the likely trajectory of interest rates in 2025 and the impact on small cap companies. Small cap companies often have a capital structure that is more sensitive to short-term interest-rate movements. After central banks cut rates, the debt servicing costs for these companies become less burdensome, potentially leading to better performance within the small cap segment.

Domestic interest rates vs Australian small caps performance

The report leans on insights from co-portfolio managers of the Maple-Brown Abbott Australian Small Fund. Ohillip Hudak and Matt Griffin say, 'Historically, interest-rate cuts have resulted in subsequent positive performance at the smaller end of the domestic equity market. Last year, the RBA was uncoordinated with other central banks, remaining more hawkish, given stickier domestic inflation, although have recently recast a more dovish tone with interest-rate cuts expected to commence in the first half of the 2025 calendar year with the market factoring in close to 0.75% reduction by year-end. This setup is expected to be supportive and renew investor interest for Australian small caps.'

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