Asia’s unexamined small caps are a sea of opportunity

Added 20th May 2015

Asia’s unexamined small caps are a sea of opportunity

“The number of small-cap companies are increasing. Some local brokerages are bringing in new initial public offers in Korea. New companies are definitely coming up in Hong Kong and China, and India has so many small-caps,” Csellak told Fund Selector Asia.   

That creates potentially more undiscovered gems for small cap investors willing to do the on-the-ground research because many small caps do not have analyst or financial press coverage. But at the same time screening through the vast universe of small caps poses a research challenge. 

Screening process

Uncovering quality companies at an early stage is the investment team’s approach, said Csellak, who manages the Manulife Asian Small Cap Equity Fund.

“The fund does have a kind of valuation bias to it. But we are definitely not value investors, we are growth investors. We like to buy growth at a discount and some stocks offer growth at a reasonable price.”

The team uses both qualitative and quantitative screening to narrow down the universe.

“We see whether there is a case for re-rating, or a catalyst for growth or some growth driver that is not already priced in.”

They regularly meet the management of potential investee companies. Each analyst or portfolio manager visits 25-30 companies every month, she said.

For the quant screen, she looks for the lowest price-to-book small cap stocks in the region. Generally, companies with a price-to-earnings growth multiple of five and below are attractive. 

“We understand this will vary across different industries. But it is a nice starting point for screening.  We find it is a useful tool.”

Under-researched segment

One hurdle in small-cap investing is the lack of broad analyst coverage. The brokerages in Asia simply cannot provide standard research on a majority of the tens of thousands of potential opportunities. 

Also, analysts from brokerages tend to join asset management companies, Csellak said. That means brokerages in Asia tend to lose experienced analysts.

“We have seen quite a few small-cap analysts on the sell side [brokerage houses] joining our competitors on the buy side. So you do not have the experienced level of research on the brokerage side.”

As a result, constant interaction with companies is required to understand the impact of any corporate development on investments.

“We are investing in an asset class which is in the process of growth. We see companies on a regular basis for new updates. A lot of our companies also get in touch with us.”

Key challenges

The small cap asset class is characterised by volatility and lack of liquidity.

Because small companies have less awareness than analyst-covered equities, they tend to be traded less, which results in liquidity issues.

Liquidity could also be an issue when the US Federal Reserve hikes interest rates, an event expected to happen this year. 

Small caps in China, for example, are particularly vulnerable because they could be hit the hardest if the whole market reacts.  

“The US rate hike is a concern because it could have a kneejerk reaction. Liquidity is clearly driving China [stocks]. 

In Part II of the interview, Csellak shares views on investment ideas.

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