Is it time to start buying up ASX small-cap shares?

Can small-caps deliver big returns? One fund manager has the answer.

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ASX small-cap shares have a history of being volatile, but it's also the place where we can find the major winners of tomorrow. After everything that's happened recently, is this the right time to hunt for hidden gems?

Names like Altium Limited (ASX: ALU), Pro Medicus Ltd (ASX: PME) and REA Group Ltd (ASX: REA) were all very small businesses over a decade ago. Now they're all multi-billion dollar companies. Not every company will turn out as successful as that, but the small end of the market can be an exciting hunting ground.

Difficult environment for ASX small-cap shares

The market has faced a lot of disruption and volatility over the last two or so years because of elevated inflation and higher interest rates.

Fund manager Monash Investors has suggested over the last two years it has taken the market longer than usual to reward stocks that experience a (positive) step change in their outlook. This is because of a lower risk tolerance due to the "upward momentum in inflation and interest rates".

In this situation, Monash Investors said, the ASX large-cap stocks have tended to do well because of their "strong balance sheets, more stable businesses and better share market liquidity".

Inflation has supposedly largely benefited the revenue growth and profits of large companies, which are "more likely than small companies to have the pricing power to pass on inflationary pressures to preserve, or even grow, their margins".

Is this the time to invest?

Monash Investors certainly thinks so, commenting:

However, now that inflation is moderating and the market is anticipating interest rate cuts, we are moving into a much more favourable environment for small caps. Looking forward the large cap stocks generally have modest growth outlooks, while the headwinds to small cap growth are abating. If history is any guide to the future, investors will increasingly look to invest in the smaller end of the market.

Some of the positions that appeared to be in the Monash Investors Sml Companies Trust (Hedge Fund) (ASX: MAAT) portfolio within the last couple of months included Johns Lyng Group Ltd (ASX: JLG), Credit Corp Group Limited (ASX: CCP), Austin Engineering Ltd (ASX: ANG), NRW Holdings Limited (ASX: NWH) and Monadelphous Group Ltd (ASX: MND).

I recently wrote two articles, here and here, about ASX small-cap shares that I thought (and still think) look like excellent longer-term opportunities for investors. I've already bought two of them for my portfolio.

Motley Fool contributor Tristan Harrison has positions in Altium and Johns Lyng Group. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Altium, Johns Lyng Group, Pro Medicus, and REA Group. The Motley Fool Australia has recommended Johns Lyng Group, Pro Medicus, and REA Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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