Why are Asian smaller companies different?

- Asian smaller companies have bucked the wider global trend over the past 12 months, outpacing their global peers
- Asian smaller companies share many of the characteristics of smaller companies elsewhere – diversity and fast growth
- However, stronger Asian economies and broader opportunities have given them an edge

It has been a tough period for small caps across the world. Confidence has been dented by a weaker economic environment and rising interest rates. Many saw double-digit losses in 2022 and have continued to slip in 2023. The exception has been in Asia, where small caps continue to outpace their global peers and larger rivals.

What explains this recent strength? In many respects, Asian smaller companies share the same characteristics as their peers around the world. Notably, they have the same diversity and vibrancy of their international peers. The small cap benchmark is very different to its large cap equivalents. Those main indices will tend to be concentrated in Samsung, TSMC and the Chinese internet companies. In contrast, the small cap benchmark for the abrdn Asia Focus fund (MSCI AC Asia ex Japan Small Cap Index) is a rich blend of technology and industrials, consumer discretionary and healthcare, across a breadth of smaller and more dynamic markets.

Equally, as with elsewhere, many fund managers in Asia show a preoccupation with the top 1,000 companies, ignoring small companies and some of the smaller markets completely. They are generally poorly covered by analysts, leaving plenty of opportunity for mispricing and creating fertile ground for active managers.

A runway of growth

Partly, Asian smaller companies’ recent strength has been a function of the problems they have avoided. The construction of the small cap indices has been an important factor. China is a far smaller weighting in the small cap indices, at only around 10%. As such, the problems in the Chinese technology sector and the crackdown from central government have barely registered. Equally, they tend to be more local or to operate within regional hubs, which has insulated them from some of the problems in the global economy.

However, Asian smaller companies have natural advantages as well. Asian economies are in a notably better place in the economic cycle and have side-stepped many of the problems in the West. Inflation is benign, even in countries that have been prone to higher inflation, such as Indonesia and India, giving Asian central banks more flexibility. Asian economies also have low debt levels, helping accelerate their growth.

The reopening of China has perhaps not been the galvanising force across the region that many hoped. Nevertheless, it is undoubtedly recovering, and countries such as Thailand are seeing the benefits of Chinese tourism and spending resuming. The region is also seeing some benefit from international companies’ adoption of a ‘China-plus-one’ strategy, diversifying supply chains across the region to leave themselves less vulnerable to disruption. This has boosted India, Vietnam, Thailand and Indonesia.

For companies that operate within those economies, it gives them larger addressable markets, fewer barriers and a greater runway of growth. While Western smaller companies must battle with weaker domestic markets, Asian smaller companies have a natural tailwind.

The Asian smaller companies sector is also notably cheaper than some of its peers around the world. Smaller companies elsewhere saw a significant rally during the pandemic, which had left some looking over-valued. Asian smaller companies did not see this boom and subsequent bust. We estimate that valuations are around 18% below their 10-year average in price to earnings terms.

Careful stockpicking

The sector still needs careful curation. There are pockets of high valuation – parts of the IPO market have been over-heated, for example. However, we focus on quality companies with strong balance sheets, cash reserves, and prudent accounting. We look for strong management teams, that run their businesses in harmony with the environment and society. The companies within our portfolio will often be net cash, leaving them enough capacity to pay attractive dividends, while retaining sufficient capital to invest.

Historically, the trust has tended to have more in ASEAN and India. More recently, we have added more to China given the revival in sentiment and a change in our mandate that allowed us to invest in slightly larger companies. That said, the trust remains underweight China relative to the mainstream Asian indices and we retain some caution on the market.

We find technology to be a rich source of opportunities, with real diversity within the sector. We also hold an allocation to consumer-facing companies, which continue to benefit from a rising middle class across the region. We have less in the more cyclical energy and materials sectors. Property has also been a difficult area.

Korea’s Park Systems is a typical holding: it specialises in atomic force microscopy – an emerging imaging field – which has a number of growing applications within advanced science and technology labs. All of the major semiconductor companies are clients. It has high research and development spend, is profitable and well-managed.

Perhaps most importantly, Park Systems, like all the Asian smaller companies in the abrdn Asia Focus portfolio, are driven by their own idiosyncratic factors. At a time when the macroeconomic environment is uncertain, even in Asia, it is reassuring to own companies whose destiny is in their own hands.

Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

Important information

Risk factors you should consider prior to investing:
• The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
• The Company may charge expenses to capital which may erode the capital value of the investment.
• The Company invests in smaller companies which are likely to carry a higher degree of risk than larger companies.
• Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
• Specialist funds which invest in small markets or sectors of industry are likely to be more volatile than more diversified trusts.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

Other important information:

Issued by abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Authorised and regulated by the Financial Conduct Authority in the UK. An investment trust should be considered only as part of a balanced portfolio.

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