UBS Asian Small Cap Equities, an award-winning strategy

Raymond Wong, Portfolio Manager for the award-winning UBS Asia Equity Small Cap strategy tells us 4 benefits of investing in this asset class.

30 Mar 2021

A win for UBS Asian small cap equity strategy! 

The strategy won “Best in Class” for the APAC small mid cap equity category in the 2020 BENCHMARK Fund of the Year Awards.

In a Q&A with Raymond, we asked him for his thoughts on the sector.

What’s the opportunity set for Asian small cap equities right now? Is this a good time to invest?

Asian small cap companies offer investors a unique opportunity set.

Small and mid cap companies in Asia can give investors exposure to long-term fundamental trends, like premiumization and innovation in these fast-growing markets.

At the same time, demographics trend younger in some of these markets and the middle-class is expanding rapidly, giving local companies both talent and a ready market for innovative services and products.

Asian small cap companies lagged in the general rally of 2020. As the economic recovery becomes more broad-based, this should benefit smaller companies which were hurt more in the downturn.

What are the advantages to investing in small companies versus large companies in Asia?

The Asian small and mid cap universe represents more than 3,000 companies, in growing and dynamic markets.

  • Higher alpha opportunity (ie. Performance over the general market). The small and mid cap companies are under researched by sell-side analysts, which provides more opportunities to outperform by exploiting knowledge inefficiencies. Smaller companies in Asian markets tend to attract scant analyst coverage, creating a less efficient market for smaller caps. Over the last 10 years, almost half of the fastest growing Asian companies had very limited or no analyst coverage at all. Not even 50% off the small/mid cap index is covered by five or more financial research analysts, a sharp contrast to the larger universe where the coverage is over 90%.

Overall, less researched stocks consistently delivered stronger performance over the last three years. For investors with local, boots-on-the-ground expertise, this can be an advantage

Stocks with fewer analysts covering them delivered stronger performance (MSCI Asia ex JP SMID) – 3 years performance (%) Based on average stock performance

Source: Factset alpha tester, Jefferies as of August 2020. Note: Based on average stock performance. Asian large caps and small caps as represented by MSCI Asia ex Japan and MSCI Asia ex Japan SMID respectively

Best equities house awards

UBS Asset Management won two Best equities house awards in 2021 from Morningstar and Fund Selector Asia.

In 2020, it also picked up a Singapore Group Award Equity from Lipper Fund Awards.

  • Higher growth given they are growing from a smaller base. The law of large numbers would imply that large companies tend to see slower growth due to their size. Through smaller companies, investors are able to invest in structural themes at an earlier stage and benefit from a longer runway of growth.
  • Diversification compared to Asian large cap funds. Most of the largest Asia ex-Japan funds focus on a much smaller number of large cap companies, with a fair amount of overlap in top-ten holdings between these funds. However smaller cap funds tend to look more dissimilar given the large and diversified universe.

Asia small and mid cap equities:
4 benefits for investors

#1 Higher alpha opportunity
#2 Higher growth
#3 Diversification
#4 Better focus

  • Better focus on promising segments of industries and markets. Large cap companies tend to be spread across different business lines, while small cap companies can be more focused on specific areas. For example, a large IT company may be involved in semiconductors, mobile phones, and other business lines while a smaller IT company may focus on manufacturing semiconductor components only.

Is ESG/Sustainability relevant or important to smaller companies?

We believe sustainability is important to smaller companies just as it is for large.

Although some Asian markets have been slower to adopt sustainability reporting standards than European and US markets, sustainability awareness is growing quickly in Asia.

Over the past few years, all major Asian stock exchanges have implemented ESG reporting as a listing requirement.

Investors are increasingly using ESG databases as a quick way to screen for better quality companies.

However these databases tend to have less coverage of small and mid cap companies (due to the same reasons as why these companies are under-researched) and small and mid cap companies may also have less resources dedicated to investor relations and ESG marketing.

This is another area where having boots-on-the-ground analysis is an advantage.

Our team enhances external ESG reporting data with our internal proprietary quality assessments of companies to ensure a better understanding of the companies we are investing in and to ensure we do not miss a good quality company that may have a weak ESG database score due to their lack of resources for investor education.

Why do you have a big underweight in Real Estate and a big overweight in Consumer sectors?

The real estate sector is one where larger companies have an advantage due to their scale, balance sheet strength and ability to get lower-cost funding. The smaller real estate companies may be riskier and thus we have generally been underweight in real estate.

We are overweight to the consumers sector as we believe we can find interesting opportunities in line with trends we are focusing on, like :

#1 Wallet share shifting toward discretionary consumption

As countries move from lower income (~USD 1,000 per capita) to middle income (~USD 5,000 per capita), consumers tend to upgrade their purchases from basic goods to higher quality and discretionary goods and services, as has been the experience in developed markets.

Markets such as India, Indonesia, and Philippines are all poised to transition to mid-income levels in the coming years. We expect that growth rates for categories such as home improvement, education, leisure & entertainment and health care services should accelerate, while growth rates for basic staples should start to plateau.

The shift in consumer habits as income grows

Source: Goldman Sachs Research, as of December 2019

#2 Premiumization

Apart from change in wallet share, we also expect changes within the same category as Asia sees a rapid increase in the number of high- and middle-income households.

Our research across industries and sectors shows that Asian consumers in higher income brackets are willing to pay a premium for better quality products and services.

In markets like China, these consumer trends are visible across segments such as beer, dairy, spirits, cosmetics, condiments, branded foods and four-wheelers.

In India, the premium home and personal care segment is growing at 2x the overall category growth rate, while the share of premium 2 wheelers is also rising.

In general, we believe that players providing premium products and services should continue to gain market share and benefit from this trend.

Could you please give an example of a small-cap stock that was unloved and misunderstood initially but have now grown to be a mid or large cap stock?

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 during the pandemic.

A major success story within the Asia small and mid cap space, China Meidong is well exposed to the premiumization trend in China, 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.

Another fast-growing company was China condiments supplier, Yihai, which we added several months after its IPO. At that time, the company saw low trading volume and was underappreciated as a condiments supplier to fast-growing hotpot chain Haidilao.

Then in 2018, Haidilao also launched its IPO and its expansion pipeline became clearer. The company also focuses on R&D to create new products independent of Haidilao's business and the take-home sauces/packs and instant hot pot helped the company benefit during the pandemic when people preferred to cook at home.

About Raymond Wong

Raymond Wong is a Portfolio Manager and Analyst within the Global Emerging Markets and Asia Pacific Equities team. He is a Portfolio Manager for Asian equities and the UBS Asian Smaller Companies Fund. He is based in Singapore.
As an analyst, he covers Asian small/mid-cap stocks and Japanese autos/auto-parts, energy, shipping/shipbuilding and trading companies.

Prior to joining UBS Asset Management in 2008, Raymond was an analyst / portfolio manager with Spencer House Capital Management. He started his fund management career at John Govett (renamed AIB Govett), and subsequently at various other fund management firms, where he focused on Japanese investments for long-only and absolute return/hedge funds.

Raymond has been in the Asia Pacific financial services industry since 1998, including roles as a securities regulator and as a management consultant.

Raymond Wong

Portfolio Manager Asia Equity Small Cap

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