Harley Grosser: Why I’m bullish as investors leave ASX small caps

Harley Grosser has a fairly unflattering assessment of Australia’s small-cap market. There are fewer buyers, listed companies face growing costs, and private equity is picking off some of the better businesses.

He also thinks it is a promising place to look for investments.

The Co-Founder and Co-Chief Investment Officer at HD Capital Partners says the withdrawal of capital is creating opportunities to buy profitable businesses at prices he finds difficult to ignore.

“You want to go where capital is scarce because there’s just a higher chance of mispricing of good businesses.”

That optimism comes with a distinction between time horizons. Grosser is bullish about the opportunities available over the short and medium term, while concerned about the longer-term health of the listed small-cap market.

Large fund managers have increasingly moved away from smaller, less liquid companies. Some specialist managers have closed, while retail investors are directing more money towards passive ETFs. For companies too small to contemplate index inclusion, attracting sustained investor interest has become harder.

Since our last conversation in 2021, Grosser has responded by shifting more of the portfolio towards substantial, profitable businesses, while remaining selective about microcaps. He is interested in the scale and economics of the business, rather than simply its market-cap classification.

His first test, however, remains the possibility of losing money.

Grosser distinguishes between a falling share price and permanent damage to an investment. A stock dropping 20% on immaterial news does not necessarily mean the original assessment was wrong. Paying too much for a business, misunderstanding its value or suffering a permanent impairment is a different matter.

That distinction also shapes position sizing. An attractive base case and substantial upside will not earn a large allocation if the range of outcomes includes a serious loss.

“The less downside we see, the larger the position size is.”

He acknowledges that those assessments can be wrong. The aim is to build a collection of investments where he believes the risk of permanent loss is limited, rather than rely on one favourable outcome.

Finding a cheap business is only part of the task. With fewer buyers chasing smaller companies, Grosser wants returns that depend less on the market eventually awarding a higher multiple.

Dividends and buybacks can return cash while investors wait. Takeovers offer another route to realising value. HD approaches investments with the mindset of a potential owner of the whole business, and Grosser describes one instance where its own bid prompted a higher offer from another buyer.

LaserBond (ASX: LBL) illustrates how he separates an investment’s underlying value from its growth possibilities. The surface engineering company uses technology that extends the working life of components in heavy industry. Grosser believes its services and products businesses could justify the price HD paid, with technology sales providing additional upside.

Sales of laser-cladding plants to Komatsu have strengthened his confidence in the technology. But tungsten costs, exposure to mining customers and reliance on large equipment manufacturers remain risks.

Praemium (ASX: PPS) is another substantial holding. Grosser argues that board-level uncertainty has weighed on its shares, while simple comparisons with HUB24 and Netwealth can obscure differences in the businesses.

Praemium’s established position in administration and reporting for assets held outside platform custody is central to his investment case. Nearer term, he expects announced cash cost savings to drive earnings growth, with the February half-year result offering an opportunity for investors to assess their impact. Beyond that, he sees growth tied to Australians’ increasing wealth.

In the interview below, Grosser explains how he balances these opportunities with capital preservation. We also revisit his Disney nomination from five years ago and the unusually hands-off approach he takes to that part of his personal portfolio. Stay to the end for the investment he would choose if markets closed for the next five years.

Chapters:

• 00:00 – Introduction
• 01:05 – How Harley’s small-cap approach has changed
• 05:48 – Why capital is leaving ASX small caps
• 12:33 – Capital preservation versus share-price volatility
• 15:41 – How downside risk shapes position sizing
• 19:50 – Catalysts, cash returns and takeovers
• 24:09 – Where Harley is finding value
• 26:06 – Staying disciplined in a tough market
• 29:02 – LaserBond: technology, growth and risks
• 38:22 – Praemium: why Harley sees a valuation gap
• 43:52 – Custodial versus non-custodial platforms
• 47:14 – Praemium’s cost savings and organic growth
• 50:36 – Disney: revisiting the five-year investment pick
• 54:03 – The experiences that shaped Harley’s investing
• 55:41 – What investors are getting wrong
• 57:18 – Harley’s investment pick for the next five years