Chris Stott: Three proven small caps and one poised for a rebound

As reporting season draws to a close, small caps have been in the spotlight for all the wrong reasons – volatility, sharp sell-offs, and earnings misses. But for seasoned investors like Chris Stott, Chief Investment Officer of 1851 Capital, these turbulent periods often create opportunity.

I sat down with Chris to get his take on the small cap market, the broader outlook for equities, and some of the stocks that have defined his fund’s performance. He also addressed a big decision looming on the horizon – whether to cap the fund at $600 million to protect liquidity and ensure continued outperformance.

A wild ride: The most volatile reporting season in 20 years

According to Stott, the most recent reporting season has been one of the most extreme he has witnessed in two decades.

"Probably the most volatile reporting season I can remember in 20 years… Intraday swings in share prices such as Integral Diagnostics, which fell 35% at one stage, only to finish down 12% – extraordinary volatility", noted Stott. 

Sharp moves in response to earnings results were commonplace, with investors reacting swiftly to any sign of weakness. A key theme that emerged was the impact of cost pressures – particularly in labour and rents – which led many companies to miss expectations, despite relatively solid revenue growth.

A small cap revival on the horizon?

Despite recent struggles, Stott remains optimistic about the outlook for equities, particularly small caps. Historically, this segment of the market has tended to outperform when interest rates are falling and economic growth is above trend – conditions that may soon return.

"The small cap market tends to outperform when rates are coming down and the economy is growing above trend. That’s the period we believe we’re entering now", said Stott. 

However, structural changes in the market present challenges. The rise of passive investing – now accounting for 23% of the Australian market, up from 11% a decade ago – has reduced liquidity and increased volatility. Large super funds managing money internally have also impacted small cap flows.

"The micro-cap space looks the most hated it’s been in the last 10 years. That’s where we’re seeing the best opportunities", said Stott. 

Stocks that have delivered (and one that hasn’t)

Over the past five years, some standout stocks have driven 1851 Capital’s returns. Among them are:

• Uniti Group (ASX:UWL) – a telecommunications firm that was taken over in a successful exit.
• Pinnacle Investment Management (ASX:PNI) – an asset manager benefiting from strong inflows and diversification.
• Tuas (ASX:TUA) – a Singapore-based telecom company, led by TPG founder David Teoh, which continues to gain market share.

However, not all bets have paid off. Stott pointed to Frontier Digital Ventures (ASX:FDV), an investment in emerging market real estate portals, as a tough lesson in selling discipline.

‘We sold Frontier Digital Ventures at a 40–50% loss. Tough decision, but since then, the stock has halved again. Sometimes you have to cut your losses.’

The Next big opportunity? A forgotten name in fast food

Looking ahead, Stott highlighted Collins Foods (ASX:CKF), the operator of KFC franchises in Australia, as an overlooked opportunity. The stock has been under pressure following leadership changes and a period of sluggish growth, but signs of a turnaround are emerging.

"Collins Foods hasn’t run at all. It’s probably halved from its highs, but we think there’s real upside with the new management team", said Stott of CKF. 

With its valuation at 16 times earnings – the cheapest it has been in years – and positive indicators from US fast food peers, Stott believes there is room for strong share price gains.

Managing growth: Why Stott might cap the fund at $600m

1851 Capital has grown to $530 million in assets under management over the five years since Stott founded the firm. But he’s flagged that if it exceeds $600 million, he may close the fund to new money. Liquidity challenges in small caps mean that larger AUM can impair a fund’s ability to generate outsized returns.

"As the fund grows in small caps, the harder it is to outperform. If we get over $600m, we may introduce restrictions to ensure we can still deliver strong returns", said Stott. 

Measures being considered include restricting reinvestment of distributions or returning capital to investors, ensuring the fund remains nimble.

A turning point for small caps?

With expected rate cuts and a recovering market, small caps could be on the verge of a strong period of performance. While structural headwinds remain, Stott remains disciplined in his process, balancing opportunity with risk. Investors looking for value should watch for liquidity, stock-specific catalysts, and shifts in market conditions – as the small cap sector gears up for what could be a long-overdue rebound.