The surge in artificial intelligence (AI) infrastructure spending and Australia’s prolonged productivity slump are fuelling a revival in small-cap industrial stocks
James Barker and Jack Briggs, portfolio managers at the Sydney-based specialist investment manager, said the June quarter marked a turning point for the sector, with small industrials outperforming the Small Ordinaries by 5.1 percentage points as market leadership shifted away from resources.
“That rotation matters because it suggests the market is turning back towards fundamentals rather than commodity price momentum,” Barker said.
The shift comes as Australia grapples with one of its weakest productivity periods in decades. Productivity growth averaged minus 0.2% a year between FY21 and FY25, while productivity fell 0.7% in FY25 alone.
“When output per hour worked is flat, a company can only grow revenue by employing more people,” Barker said.
“Costs rise in step with sales, margins compress and growth becomes something a business has to buy rather than something it generates.
“Artificial intelligence is the most credible circuit breaker available and that smaller companies are structurally better placed to capture the benefit than large incumbents.”
While AI adoption remains relatively low, with only about 12% of businesses in Australia using the technology, Briggs said the data point to the size of the opportunity still ahead.
“And because smaller companies don’t carry the legacy systems and restructuring drag that slow larger businesses down, the margin gain from AI adoption falls disproportionately to them,” he said.
Ellerston Capital said the opportunity extended beyond AI adopters to the smaller companies building the infrastructure required to support the technology boom.
Its strategy holds Southern Cross Electrical Engineering and GenusPlus Group as direct beneficiaries of the AI infrastructure build-out, while SKS Technologies and Mayfield Group sit within its wider coverage universe.
On the adoption side, Briggs pointed to software company Vista Group, arguing that the market mistakenly believes generic AI models can replicate the value created by its proprietary data and deeply integrated workflows.
“The companies that convert AI adoption into operating leverage will simply grow faster than the economy around them,” Briggs said.
Barker added that Australia also stands to benefit through two distinct channels from the global AI investment cycle.
“We won’t own the platforms, but we do own the two legs that follow; the build out itself and the productivity gain from adoption,” he said.
“Both are investable and both sit in the same part of the market. This is a rare case where Australia is not simply a price taker in a global technology cycle.”
