Asia small and mid caps in focus

Asia small cap companies offer a unique and under-researched opportunity set and Raymond Wong, Portfolio Manager in the Asia Pacific Equities Team, explains why that’s something for every investor to pay attention to.

29 out 2020

Asia small and mid caps – in 60 seconds

  • Asia small and mid caps are under-researched, offer investors a selection of focused themes, and can complement large cap portfolios.
  • Small and mid cap companies in Asia can give investors exposure to long-term fundamental trends, like premiumization and innovation.
  • An active investment approach, supported by boots-on-the-ground research can uncover under-appreciated small and mid cap opportunities and potential long-term winners.

COVID-19 hit car sales in China but the luxury sector held up comparatively well in 1H20.

Overall auto sales dropped 19.9% y-o-y, but sales of luxury models grew 1% y-o-y, according to data from the China Association of Automobile Manufacturers (CAAM)1.

Asia small and mid cap success stories

China Meidong, a company running mid- to high-end car dealer services across China, was one company to benefit from resilient demand in the luxury auto space, reporting a 23.5% increase in revenue in 1H202 .

A major success story within the Asia small and mid cap space, China Meidong is well exposed to the premiumization trend in Asia, i.e. growing demand for premium products, which we believe is underpinned by the growing middle class and consumers’ desire to trade up for better quality goods and services.

Innovation is another investible trend playing out in Asia, and a number of successful small and mid cap companies are leading the innovation trend, such as S&S Tech, a Korean company manufacturing semiconductor materials, which is now developing the next generation materials for EUV (Extreme Ultra-Violet) lithography.

We believe that by focusing on long-term dynamic trends in Asia, like premiumization and innovation, it is possible to find other small and mid cap success stories, but there are many more reasons why the small and mid cap asset class in Asia is worthy of a closer look.

Three reasons why Asian small and mid caps are worth a closer look

We see three key factors in particular:

1. The sector is under-researched

The Asian small and mid cap space has been under-researched - particularly since MIFID-2 came in - and we believe this presents a significant opportunity for alpha generation. 

Estimates show that only 6.1% of the MSCI Asia ex-Japan Small to Mid Cap benchmark index is covered by 20 or more analysts, as shown in Exhibit 1.

Exhibit 1: Analyst coverage of companies by number of stocks (%)

Source: MSCI, Jefferies, as of August 2020.

That’s significant because it means that a large part of the universe isn’t covered and we believe that stocks with low analyst coverage tend to outperform, as shown in Exhibit 2.

Exhibit 2: 3 Years’ Performance (%)*

Source: Factset Alpha tester, MSCI, Jefferies as of Aug 2020. Note: Based on average stock performance

2. Investors can play more focused themes with small and mid cap strategies

Large cap companies tend to be spread across different business lines, while small cap companies can be more focused on specific areas.

For example, Samsung Electronics, one of Asia’s biggest large cap companies has semiconductor, consumer products and smartphone businesses.

That might be fine for investors looking for exposure across these businesses.

However, if an investor wanted to play a more focused strategy on semiconductors, it may be better to focus on smaller companies dedicated to the semiconductor space.

In addition, investing in these structural themes at an earlier stage means investors can benefit from a longer runway of growth.

3. Small and mid caps can complement large cap portfolios

The Asian small and mid-cap universe is a very different subset of companies compared to the large cap space.

If you pick the top 10 funds in Asia ex-Japan and look at their top 10 holdings, you’ll most likely find that at least half are the same companies.

However, if you take the top 10 funds in the Asian small cap space, you’ll tend to find that the stock selection between them will be very different.

The Asia small and mid cap universe has more than 3,000 stocks, so if you are picking what you believe are the best 40-80 stocks, you will end up with a different basket from competing funds and a different risk profile from the large-cap universe.

Asian small and mid caps - an opportunity for active investors

The fact that Asian small and mid caps are under-researched alone opens an opportunity for active investors. 

But we believe there’s more to it than that, and strategies with the following attributes may be best set to perform in the space:

  1. On-the-ground insights: multi-lingual researchers prepared to put their ‘boots-on-the-ground’ and do bottom-up research in Asia, can find insights from surveying target companies, their suppliers, competitors, and industry experts that would be hard to come by from desk-based research.  
  2. Stable and experienced research team of 19 investment professionals with an average 17 years’ industry experience, of which 10 with UBS.
  3. Quality-first approach: rigorously vetting target companies through on-the-ground research findings and an extensive checklist can help narrow down the wide Asia small and mid cap opportunity set into a ‘quality-first’ portfolio of high-conviction names.

Focus on performance

Our strategies, which incorporate the above elements, have a long track record in the Asia small and mid cap space.

Source: UBS Asset Management, October 2020

So we think that there is much that is attractive about the Asia small and mid cap space for investors and actively-driven Asia small and mid cap strategies may serve as an effective complement to an Asia large cap portfolio, or perhaps as a more liquid alternative to private equity investing in early-stage companies.

And with growth in Asia expected to outperform more developed markets for the foreseeable future and with a whole range of long-term fundamental trends, like innovation, premiumization, and the growth of the Asian consumer, with room still to run, we think there are compelling reasons to allocate to Asia now, so contact us to learn more about our Asian small and mid cap strategies.

For more insights into the global small cap investing universe, read our in-depth report ‘Smaller companies, larger returns’ here.


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