Australian hedge funds likely welcomed Monday’s market movements as Westpac’s earnings report triggered a sector-wide sell-off among the big four lenders. The bank reported a slump in mortgage applications following Labor’s budget tax changes, wiping 62 points off the S&P/ASX 200 Index. This contrasted sharply with the S&P/ASX Small Ordinaries Index, which, fresh off its best week in six years, gained 0.6 per cent. This outperformance continued on Tuesday after the Reserve Bank unanimously decided to keep the cash rate at 4.35 per cent. Cyan Investment Management portfolio manager Dean Fergie noted that large-cap sell-offs often redirect money into smaller companies, prompting investors to reassess long-held strategies.
This shift highlights a significant valuation gap, described by MST Marquee analyst Hasan Tevfik as a major risk to the Australian sharemarket. Heading into reporting season, the bank sector traded at nearly 20 times earnings, a 50 per cent premium to its long-term average. Hedge fund Regal Partners, an investment fund employing sophisticated strategies to generate high returns for wealthy investors, has been flagging this disparity for months. Investment director Charlie Aitken considered betting against banks and backing small caps one of his career’s “great Australian long-short trades,” citing the high valuations of large caps versus the affordability of small caps.
Small-capitalisation companies, previously affected by surging oil prices and aggressive RBA rate hikes, are now seeing a resurgence. A softer inflation print for the June quarter has eased expectations for further tightening, directly benefiting smaller companies that often carry more debt. Furthermore, the sector is entering what Ellerston Capital portfolio manager James Barker calls “its most attractive set-up in years” due to the boom in artificial intelligence-related infrastructure spending. Many beneficiaries of this AI buildout are found in the smaller end of the market, echoing a trend observed on Wall Street where the Russell 2000 index is significantly outperforming the S&P 500.
