One of the emerging stories in 2025 was the success of ASX small-cap shares.
In fact, ASX small-cap shares outperformed the larger companies by almost 2.5 times in 2025.
The S&P/ASX All Ords Index (ASX: XAO) delivered total returns (capital growth plus dividends) of 10.56% last year.
This index contains the 500 largest ASX listed companies, and accounts for roughly 84% of Australia's equity market.
Meanwhile, the S&P/ASX Small Ords Index (ASX: XSO), which tracks companies ranked 101 to 300 by market cap, delivered a total return of 24.96%.
However, it appears the pendulum has now swung the other way in 2026.
Since the start of the year, the Small Ords Index has dropped approximately 12%.
This fall is significantly further than the All Ords Index which is down roughly 3% in the same period.
Image source: Getty Images
Why are they struggling in 2026?
A small-cap stock typically has a market capitalisation ranging from a few hundred million to $2 billion.
Subsequently, these companies are much more sensitive to interest rates than bigger companies.
One reason for this is that these stocks rely more on debt and external funding.
Additionally, many are not yet profitable, which means valuations depend heavily on future growth.
In 2026, Australia has seen elevated inflation, causing the RBA to deliver two interest rate hikes.
It seems markets are now repricing for tighter financial conditions, causing smaller companies to be hit disproportionately.
In essence, the Small Ords Index isn't falling because "small caps are broken" – it's falling because:
- Macro conditions are flipping against them
- Liquidity is tightening
- Risk appetite dropped suddenly.
Is there any upside?
With many small-caps falling throughout the start of 2026, investors might be considering swooping in on what could appear to be a relative value.
Some notable ASX small-caps that have fallen include:
These companies have drawn some positive outlooks from brokers, however it's important to consider that in the short term, returns could be minimal, if these economic conditions persist.
Alternatively, if investors are aiming for a more broad, diversified entry into the small-cap market, there are several ASX ETFs to consider:
- iShares S&P/ASX Small Ordinaries ETF (ASX: ISO) – designed to track the performance of small-capitalisation Australian equities included in the S&P/ASX 300 index, but not in the S&P/ASX 100 index.
- Vanguard MSCI Australian Small Companies Index ETF (ASX: VSO) – Tracks the MSCI Australian Shares Small Cap Index.
- VanEck Vectors Small Companies Masters ETF (ASX: MVS) – offers exposure to a diversified portfolio of roughly 61 ASX-listed small companies.
