Active Isn’t Dead, Its Just Smaller
While passive investing has swept global markets with its promise of low fees and easy diversification, one corner of the ASX is proving that active management still has an edge. According to Morningstar’s latest Active vs Passive Barometer, Australian small and mid-cap managers have consistently outperformed their passive counterparts, by 1.8 percentage points over three years, 2.2 over five and 3.3 over a decade.
That is not just a statistical win, its one of the clearest signs yet that stock-picking can still pay off, provided you’re fishing in the right pond. Roughly 95% of active small-cap funds beat their index-hugging peers over the long term, defying the narrative that “you can’t beat the market.”
So what makes the smaller end of the market such fertile ground for active investors?
The Edge: Inefficiency and Opportunity
Unlike the large-cap universe, dominated by the big four banks and iron ore giants, small-caps remain under-researched and often overlooked. Fewer analysts cover them, liquidity is thinner, and information tends to travel slower.
If you’re doing a good job as an analyst, it’s easier to find mispriced companies and easier to work out if a company’s doing better than the market.
Luke McMillan, Ophir Asset Management
That asymmetry of information gives skilled managers room to identify early-stage growth stories before they hit institutional radars. Over time, that research advantage compounds, especially when benchmark indices like the S&P/ASX Small Ordinaries are poorly constructed for performance.
Passive small-cap ETFs must hold about 180 companies from the bottom of the ASX 300, a grab bag that often includes cyclical miners, speculative industrials, and microcaps with weak fundamentals. Active managers, by contrast, typically hold 30 to 40 carefully chosen stocks, pruning exposure to low-quality names and tilting toward growth and profitability.
The small-cap index is suboptimal… It’s not an ideal representation of small-caps, and that’s why many quality small-cap managers are beating the index compared to large-cap managers.
George Boubouras, K2 Asset Management
Why Passive Struggles in Small Caps
Morningstar’s analysis highlights how the structure of passive indices limits their performance potential. Because small-cap benchmarks rebalance infrequently and use rigid inclusion criteria, they tend to over-weight yesterdays winners and underweight emerging players.
Meanwhile, active managers can pivot dynamically, reducing exposure to overheated sectors or rotating into early-cycle beneficiaries. That flexibility has mattered in 2025, a year when ASX small-caps have rallied 21%, easily outpacing the ASX 200’s 8% gain.
Even after fees, active managers are maintaining their edge, a rare feat in an era when cost pressure and ETF competition have driven consolidation across the funds management industry.
Survival & Scale
Risks still present themselves. Morningstar also noted a 71% survivorship rate among small and mid-cap funds over the past decade, meaning nearly one in three have folded, merged, or been wound down. Managing scale is a real issue.
As funds balloon, liquidity dries up, forcing managers to spread across more holdings or avoid smaller names altogether. That’s why successful small-cap funds like Ausbil’s Small Cap Fund recently shut their doors to new investors after surpassing $650 million in assets. Too much money, and the very advantage that drives outperformance begins to fade.
What It Means For Investors
For investors, the takeaway is clear:
- Active can still work, but only where inefficiency exists. Small-cap and micro-cap strategies remain fertile ground for alpha generation.
- Manager selection is everything. The dispersion between top and bottom performers is huge; sticking with proven, disciplined teams matters more than ever.
- Be mindful of capacity. Funds that cap inflows or manage liquidity actively are signalling prudence, not exclusivity.
In contrast, large-cap and index-heavy exposures may still make sense through passive ETFs, where efficiency, scale and cost control dominate. A balanced portfolio might pair passive exposure to large-caps with active exposure to smaller companies, blending consistency with opportunity.
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Outlook: Alpha Still Lives at the Edges
The lesson from Morningstar’s findings, and the surge in small-cap fund performance this year, is that alpha isn’t extinct; it’s just concentrated. In market where algorithms and index flows move billions a day, human insight still has value where the data is thin and inefficiency thrives.
As AI and passive flows dominate headlines, the quiet success of small-cap stock-pickers reminds us that markets still reward those who do the work. For investors, that may be the most active decision worth making.