It looks like the smart money is going in to Australian small caps this year

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The value of ASX-listed investment company WAM Research Limited’s portfolio increased by a marketing-beating 25.5% in the 2016 financial year.

Compare that to a flat return from the ASX in general for the 12 months. The ASX 200 fell 4.1% in the 12 months to June 2016. Including dividends, the total return was up a mere 0.6%.

WAM Research achieved that one quarter increase in value with a portfolio containing an average 39% in cash and 61% in equities.

The best performing stocks for the year were small caps in the vehicle leasing, retail, health and professional services sectors.

They are: Smartgroup Corporation Limited, A2 Milk Company Limited, Mayne Pharma, IPH Limited and the Reject Shop.

WAM Research Limited today posted a 34.4% increase in operating profit after tax to $26.2 million. The company declared a fully franked final dividend of 4.25 cents, bringing the full year to 8.5 cents, an increase of 6.3% on the previous year.

The big companies haven’t been rating in terms of returns. The ASX 20 index posted a total return of -7% for the year to June.

Wilson Asset Management’s chief investment officer Chris Stott says these larger companies have struggled in an anaemic economic environment.

“The small-cap sector has outperformed the large-cap sector for the last two years, which is a trend we expect will continue as the market favours companies with earnings growth,” he says.

“While the recent federal election created short-term uncertainty in the economy and impacted consumer and business confidence, the effect has been modest and we expect consumer sentiment to improve in the coming months on the back of further interest rate cuts.

“We expect the recently announced interest rate cut will be positive for the economy, in particular driving further growth in the housing market and retail sectors. However, further interest rates cuts are needed to drive economic growth above trend over the medium term.”

He expects the loosening cycle will continue for another 12 months with inflation remaining below the Reserve Bank of Australia’s target range of 2% to 3%.

“We note that the market is now pricing in a cash rate closer to 1% in 2017,” says Stott. “This low interest rate environment will be supportive of earnings growth for companies in the small-to-mid cap sector.”

He also sees merger and acquisition activity increasing in the coming year, driven by cheap debt.

“Larger companies are looking for small-cap companies with valuable intellectual property, robust cash flow, and a strong strategic position in their industry to absorb and deliver growth,” says Stott.

Here are the top holdings of WAM Research:

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