Overview

Asian small caps posted  positive returns over the six month review period whilst proving more resilient than their large-cap peers to a volatile backdrop of concerns around the global economy, geopolitical tensions and US monetary policy developments

Indian small-caps were the best performers by a large margin, boosted by a positive domestic economic backdrop, a buoyant property sector and state election outcomes that strengthened Modi’s ruling government. Taiwanese small caps also performed remarkably well, leveraging off the strength of the US technology giants and rising momentum around the development of artificial intelligence (AI).  In contrast, small caps in China and Hong Kong were among the heaviest losers, bearing the brunt of consumer and property concerns, together with regulatory noise both domestically and externally, with newsflow around more US trade curbs on its biotech and tech sectors. This was despite targeted policy and liquidity support from the central bank and government. 

Portfolio Review

The portfolio underperformed its closest reference benchmark over the review period by 5.2% partly due to the strength of the Indian rally. India is the biggest country position in the portfolio at 19%, though this is less than its weight in the benchmark.

The Indian market is home to many attractive companies with competitive business models, high returns and fantastic long-term growth prospects. We have high conviction in our holdings, which overall performed better than the market average, but we intend to maintain valuation discipline in our purchases.  Prestige Estates posted solid earnings results with pre-sales growth in its residential projects more than doubling year-on-year. We see the business continuing to cement its position as one of the country’s most prominent developers amid a clear trend towards industry consolidation. Engineering and IT services provider Cyient continued to execute well with its operating margins expanding on the back of productivity improvements and utilisation gains, along with healthy order flows. Healthcare diagnostics group Vijaya Diagnostics Centre also added to relative performance, given its superior delivery against peers both in terms of revenue and profit growth.

Elsewhere, with Chinese consumption recovering slower than expected, sentiment towards local equity markets deteriorated further and valuations de-rated. Electric Vehicle (EV) gear maker Zhejiang Shuanghuan Driveline sold-off on concerns over slowing demand for EVs, as did Sinoma Science & Technology Co, an advanced materials business involved in the broader renewable energy supply chain. We remain positive on both companies’ prospects as we expect Shuanghuan to be a key beneficiary of the trends towards electrification, with customer diversification and potential overseas expansion likely to offset any domestic slowdown in sales. Sinoma, on the other hand, is well-placed to benefit from the growth of wind energy capacity globally, supported by the company’s strong technology and research and development capabilities. Renewable energy is a key area of development for the Chinese government and Sinoma has a diversified business that caters to this demand. Some of our other mainland holdings in other sectors also lagged on the back of broader industry concerns. Joinn Laboratories, a company that specialises in drug safety evaluation for the pharmaceutical industry, fell alongside the broader healthcare sector. While we are positive on Joinn’s leading position in the pre-clinical drug assessment space and its solid financial position, the company has been affected by policy uncertainty and the softer domestic funding environment which has led to slower growth in its order book. It is fair to say that investors are now incorporating a higher risk premium for Chinese equities given uncertainty over the broad direction of government policy and the role of the private sector in the economy.  Overall, including companies listed in Hong Kong, our Chinese holdings performed marginally better than the local market.  Meanwhile, from a sectoral perspective, technology was among the best performing sectors through the review period, driven by optimism over AI and a turnaround in the semiconductor cycle. This lifted the tech-heavy market of Taiwan, and our lighter exposure there detracted from portfolio returns. While the market is home to several interesting businesses, particularly in IT, we have been highly selective in our approach and focused on owning only the best-quality small-cap companies that we can find. We are optimistic about the future of technology in Asia and the portfolio is well-positioned to exploit opportunities emerging from the advancement of AI. This includes one of our technology hardware holdings, Taiwan Union Technology, which is among the leading suppliers of high-speed copper clad laminates, a core material used for printed circuit boards. The company is seeing a pick-up in orders from AI-related customers which in turn is driving a change in their sales mix towards higher-margin products. Elsewhere in Singapore, on the other hand, semiconductor equipment maker AEM Holdings’ share price fell after the company indicated that it would adjust its inventory and pre-tax profit downwards for the fourth quarter of 2023. We immediately engaged with the company on this issue and believe it is a one-off incident.

ASEAN is an often overlooked part of the region amid the significant attention given to China and India. But it is nevertheless a rich source of good-quality small-caps. Some of our ASEAN holdings were among the key contributors to performance over the review period. In Indonesia, logistics and supply chain company AKR Corporindo, a main player in industrial fuel, was boosted by greater clarity around potential acceleration in land sales in the Java Integrated Industrial and Ports Estate. Elsewhere, our Vietnamese holding, FPT Corp, a software services company, continued to deliver impressive earnings. We feature a deeper case study on FPT Corp below.

Since 2022, we no longer have a market cap restriction on new additions to the portfolio though we remain focused on finding smaller companies that are at the bottom quartile of our investible universe. Our intention is to invest in a diversified portfolio of around 50 companies that have an exceptional industry position. To this end, we continue to refresh the portfolio by reducing smaller, legacy positions to those with better growth prospects and clearer earnings visibility.

In the technology sector, for instance, we switched from Korea’s Koh Young Technology to Taiwan-based Chroma ATE, a strong player that excels in the core power testing industry with high entry barriers, growing exposure to exciting industries like electric vehicles, 3D testing and semiconductors. Similarly, we sold our holding in Taiwan-based manufacturer of bicycle and motorcycle chains KMC Kuei Meng International in favour of better opportunities elsewhere.

Meanwhile, we refined our India positioning by selling out of healthcare company Sanofi India and taking profits on other Indian holdings that have performed well. In their place, we introduced three new holdings with attractive growth prospects. Aptus Value Housing Finance offers loans in the affordable housing segment, a growing market with a strong foothold in south India. It fares well against peers in asset quality, loan yields and return ratios, supported by a conservative management team. We also participated in a share placement offered at a considerable discount by Apar Industries. Apar produces conductors, specialty oil lubricants and cables primarily to the power industry. We view Apar as a play on the electrification of the Indian economy and rising investment in transmission and renewables globally, with half of its revenues from India and the rest from exports to the US, Europe and Australia. Finally, we invested in KFin Technologies, a registrar and transfer agent for local mutual funds that should benefit from deepening capital markets in India. As a duopoly, the industry structure is highly attractive with high barriers to entry and significant growth potential.  Elsewhere, in Vietnam we initiated a new holding in Military Commercial Joint Stock Bank (MBB), given its strong profitability metrics, excellent track record in managing asset quality and robust outlook for loan growth. MBB is one of the leading domestic banks in Vietnam and we regard it as well-managed with its prudent culture stemming from its military background, but dynamic enough to innovate and capitalise on opportunities. The bank enjoys a key competitive edge with its lower funding cost, which is a result of its strong brand and quasi state-owned enterprise status. The share prices of banks in Vietnam have generally been weak as a result of an anti-corruption probe in the property sector, which gave us the opportunity to buy a quality franchise at an attractive valuation.

Outlook

The investment climate remains one of sluggish global economic growth, inflationary risks and concerns over the impact of policy moves by major central banks. China continues to be a key source of worry, amid a slow-moving recovery. Against this prevailing uncertain backdrop, the portfolio is well-positioned, exhibiting strong fundamentals and a return profile that should stand it in good stead. Dividend yield, growth and return on equity metrics are higher than the reference benchmark, while the debt-to-equity ratio is comparatively lower also. Our stock-specific insights are derived from our rigorous bottom-up due diligence, backed by our in-house research capabilities and well-resourced team across Asia. The profile of the portfolio also reflects our belief that quality small-cap companies with solid balance sheets and sustainable earnings prospects will emerge stronger in tougher times.  More broadly, we are finding the best opportunities around key structural drivers of growth across Asia. Domestic consumption, especially in the premium segment, is set to grow in line with rising affluence. Infrastructure spending and urbanisation will boost real estate and financials. The rapid advance of all things tech, including AI, means a bright future for both direct and ancillary plays on gaming, internet, fintech, semiconductors and tech services like the cloud and software-as-a-service. ASEAN, meanwhile, has been a winner of the China-plus-one strategy, in which multinationals are moving their supply chains away from China due to geopolitical tensions. Asia is also at the forefront of the green transition with plays on renewable energy, batteries, EVs, its related infrastructure and environmental management. In this context , we see smaller companies as  the more direct beneficiaries of some of these key trends, with the portfolio well placed to deliver sustainable returns for shareholders over the long run. 

Performance table

Discrete performance (%)

Dividend per share (p)

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