4 ASX small caps to back in a market that's looking away

This interview was filmed Thursday 1st October 2026.

For what is in many investors’ minds the most exciting and innovative part of the market, it is striking to hear that small-cap investing is “a little bit on the nose, a little bit of a dying breed”.

Sebastian Evans has spent 20 years at NAOS Asset Management, a long innings on any measure, and more so when it's at the volatile end of the market.

In that time, Naos has stuck to one thing: emerging companies. These are smaller businesses, listed or private, that are usually founder-led, operate in niche industries, and have a competitive advantage that can compound capital over time.

If small caps are indeed a dying breed, though, that means less people looking there - and more chance of finding what the market has missed. “For me, that in itself creates the opportunity,” Evans said.

In this interview, Evans explains the NAOS process and the state of small-cap investing. He also shares four stock picks, including the one he thinks is most undervalued, and the lessons that have changed the way he invests.

Why emerging companies

Evans gives three reasons. The first is the law of small numbers - growing a small business from a low base is easier than growing a large one. The second is access to industries the big end of the market doesn't offer.

"Unfortunately, the Australian stock market is dominated by the Big Four banks, the miners, Wesfarmers. I think if you're looking for exposure in software, truck parts, building materials, it's almost impossible to get that in the ASX 100 these days."

The third is management. "We're looking for people who have an owner's mindset, making the right decisions for the long term, not the right decisions for the next half year result."

Three LICs, three different mandates

NAOS runs three listed investment companies (LICs), each holding about 12 core investments. Evans explained the differences between each:

• NAOS Emerging Opportunities Company (ASX: NCC) – the oldest of the three, investing at the smallest end of the market in businesses worth roughly $20 million to $200 million. It can also invest in profitable private businesses that may list within three to five years. 

• NAOS Small Cap Opportunities Company (ASX: NSC) – a more typical small-to-mid-cap fund, holding companies worth around half a billion to a billion dollars that are easier to trade.

• NAOS Ex-50 Opportunities Company (ASX: NAC) – historically the most flexible of the three. It now focuses on founder-led or owner-minded businesses, both in Australia and overseas.

Concentration and liquidity

LICs are closed pools of capital. An investor who wants out has to sell their shares to someone else, so the manager doesn't have to sell holdings to meet redemptions. Evans says this lets NAOS choose businesses on quality rather than on how easily the shares trade.

"The terminology is if everything stopped trading today, you're happy to own that business even if it was private, regardless if it was listed today entirely liquid."

He thinks many investors pick stocks mainly for liquidity, and sees passive investing as part of that shift.

Four stocks in focus

1. XRF Scientific (ASX: XRF) makes equipment that miners and mineral labs, including BHP and Rio Tinto, use to prepare and analyse rock samples. The Perth company has a market cap of about $200 million and no substantial fund manager on its register. "It is quite unique because they've never issued a share since listing," says Evans. It now sells into the US, India and Europe.

2. SomnoMed (ASX: SOM) makes oral devices that treat sleep apnoea by moving the jaw slightly forward. Evans compares this key difference with ResMed's CPAP machines: "Out of all the people who use a CPAP machine, one in two give up because it's too invasive."

Revenue has grown every year for a decade, but profitability has been an issue. Evans says new executives, including a former ResMed hire, are now focused on fixing that. He also disputes the idea that weight-loss drugs (GLP-1s) threaten the sector. His view is that weight loss can make some patients treatable who weren't before.

3. MaxiPARTS (ASX: MXI) distributes aftermarket truck parts. "People probably fail to realise that the amount of freight moved through this country by truck has never been higher," says Evans. The company posted a record net profit after tax last year, holds net cash and is expanding its network.

4. Move Logistics (ASX: MOV) is a New Zealand freight company. Evans ranks it third or second in a market led by Mainfreight. It is founder-built but has had trouble integrating acquisitions. "We think that's probably the most undervalued stock in the portfolio, but at the same time probably has the highest amount of risk, which is probably what you'd expect."

Lessons from 20 years

Evans' first lesson is that "even the most well-credentialed people who are aligned with shareholders get it wrong." 

Plans rarely survive contact with reality. "It's all great to have the flash PowerPoint, but at the end of the day, as most of us know, it never goes that way. By the time you get to slide three, something's happened." His answer is to back businesses that don't need fresh equity or debt to survive.

The second lesson is the one that has cost him most. "I think some of my worst mistakes have been selling things too early." NAOS bought 20% of Gentrack at $2 and held it while it fell to $1 and recovered to $3. It sold at around $3 to $3.50. The stock then went to $14.

The point for investors, he says, is that "you never underestimate what someone else is willing to pay for the same asset, especially as the business becomes larger, it becomes more liquid, goes into an index."

The third lesson is one most would agree applies not only to investing: "Don't be afraid to be different to your peer group."

Testing the thesis

To stop high conviction turning into tunnel vision, NAOS talks to suppliers, customers and especially former employees. Evans also says negative feedback needs context, because the source may have its own reasons for what they say.

"Just because you hear one or two negative points doesn't mean your investment thesis is broken. It just means you need to challenge it, and that's what we try to do."

What could bring investors back

Evans says the past five years, not just the past 12 months, have been hard for small caps, blaming higher interest rates and the move into private credit, private equity and "cash plus" products.

However, he thinks fewer people watching the sector is itself the opportunity. 

"There's less investors, especially institutional investors looking at small caps, emerging companies and micro caps...So that in itself, in my view, creates the opportunity because you’ve got fewer eyes looking at hopefully undervalued assets in theory.”

He points to MaxiParts' fully franked yield of six and a half per cent as the kind of steady return that could tempt them back. "It's a GDP type stock. It's not SpaceX, but it's not going to blow up either."

Compare that with a year ago, he says, when investors could tell themselves, “I can go into private credit and get 12% risk-free supposedly, but now I probably can’t.” 

The signal he's watching is interest rates levelling off. “If rates plateau or even fall, it’s very bullish for small caps because a lot of these businesses, they are affected by interest rates.”

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