2022 Investment Strategy Conference | Thinking Big in Asian Small Caps

Shipping cost has come down dramatically recently, mainly due to the high inventory level in destination countries like U.S. & Europe. Hence, shipping costs may remain low despite the re-opening of China, as shipping cost is primarily demand (in developed markets) driven.

A few reasons:

1. Due to the lockdown, demand and consumption in China have been depressed.

2. Food cost is low, e.g. pork price is an essential component of China’s CPI, yet pork price is in its downcycle this year.

3. While wage growth has been robust in countries like the U.S., China’s wage growth has slowed due to factors such as lockdown, cost-cutting in the internet, property industries etc.

4. The energy price hike was one of the fundamental CPI drivers globally. But China’s energy consumption structure is different – it uses more coal which is more self-sufficient, and the country is also subsidizing the power generators. Therefore the end consumers do not feel as much pain.

Since factor 2-4 will still be valid going into 2023, China’s CPI will likely stay relatively low despite re-opening.

Biggest beneficiaries will be:

▪ Travel-related (airlines, hotels, transportation etc.)

▪ Consumption-related (Macau gaming, catering, offline entertainment, food & beverage, retailers etc.)

In the current environment, we are finding exciting opportunities within Asia. Asian companies have fortified their balance sheets in recent years, potentially providing a buffer against macro concerns such as inflation, interest rates, geopolitical risks, and micro challenges, including constrained capital markets in China amid its ongoing Zero-COVID policy concerns. Additionally, Asian equity valuations are compelling for medium-term investors willing to ride out near-term volatility.

Within Asia, small-caps are well positioned for the following reasons:

▪ Asia small caps offer a large universe of under-owned and under-researched companies.

▪ Fundamental-based stock selection can uncover attractive mispriced opportunities.

▪ Offer diversification benefits without additional risk.

▪ Ongoing technological disruption is making way for new winners, and many such companies start in the small-cap space.

▪ Relatively more domestically focused or regionally oriented than large-caps and thus less exposed to potential shocks to international trade.

▪ Available at very attractive valuations

Fed rate hikes have been impacting investor sentiments negatively for a long time now- almost throughout 2022. Generally, this has caused some caution in investor appetite and sell-offs. This decline in value in equities has given rise to market inefficiencies where long-term opportunities are available now with compelling valuations. Additionally, due to their higher growth profiles, cash reserves and agility, small-cap stocks tend to bounce back faster. So we are optimistic about this space.

Definitely Active. Asia small companies are very under-researched, so there are more substantial alpha opportunities than large cap. Additionally, if you can pick Small cap firms in Asia well and pick the top 5% in the universe, you are better off than large cap. While if you are unable to choose well and pick the worst 5% in the small-cap universe, you could be significantly worse off than in the large-cap. So there is a stronger advantage for managers or selectors with strong bottom-up security selection capabilities.

We’re finding pockets of attractive investment opportunities over the medium to long term. Asian companies are taking advantage of recent trends such as digitalization, direct-to-consumer, environmental imperatives, geopolitical rewiring of supply chains, and new demand in the health and home categories, among others. Moreover, Asia makes up almost 80% of the MSCI EM Index, but the index is highly underrepresented in the broader MSCI ACWI. While MSCI EM contributes nearly 42% to the revenue basket of the MSCI ACWI Index, its weight is just 12% of the index. This means that global index-linked portfolios are under-allocated to Asia, and over time this is expected to be corrected with ongoing structural reforms and new listings.

Inflation and Interest Rates: In this inflationary environment what is important is the ability to pass on costs. The largest companies tend to be middlemen. Your Alibaba, Tencent, etc, they are merely playing a middleman role, they match buyers to sellers or people ordering food to people delivering food. If they want to increase their profit margins, they would become more uncompetitive because they are stuck between two parties. Additionally, many of the large firms in Asia have grown large through debt and have low cash positions. Within the smaller cap names, not saying in general but there are pockets of opportunities with firms that have the ability to pass on costs or are cash rich and able to increase their market share.

Look for tailwinds that can power through a recessionary environment – and the companies that benefit from them. Companies that are both driving and benefiting from the push for greener energy are demonstrating robust earnings, which we expect to power right through a recession amid strong secular tailwinds from the energy transition.