Small cap stock investing ideally gets the investor into the next big thing (an Alibaba for instance) at an early stage, well before it's on a sharp growth track and over-analysed in the daily media.
The fund manager identifies strong potential structural growth and places a bet.
Small caps also have some attractive aspects for investors. They are nimble and can adopt quicker to changing market conditions than large cap peers. They are also growing from a smaller base than large caps: a $50m company is more likely to double revenues than a $5bn one.
Investments in small companies come with specific risks. They have lower liquidity than mid- and large caps, and often lack proven business models. Bottom up analysis is important. Because small caps have less analyst coverage, independent data and analysis is lacking. Fund managers doing due diligence rely mainly on the actions of company management to deliver on growth plans.
Against this backdrop, Fund Selector Asia compares the JP Morgan Eastern Smaller Companies Fund with the Templeton Asian Smaller Companies Fund. Germaine Share, research analyst at Morningstar, provides a comparative analysis.
Investment strategy review
Both funds are benchmarked to the MSCI AC Asia ex-Japan Small Cap Index (USD) and have a focus on growth stocks.
However, according to Share, the JP Morgan fund, which is managed by Joanna Kwok, sometimes invests in special situations or cyclical recovery stories, which isn’t the case for the Templeton strategy. The latter is managed on a day-to-day basis by Chetan Sehgal and Vikas Chiranewal but led by Mark Mobius.
The JP Morgan fund is the more diversified of the two, with over 100 names in its portfolio. In contrast, the Templeton is more concentrated on 70-80 names, Share said.
Both have sizeable exposure to the consumer sector, which was the top sector for both funds.
The biggest differences in allocation are Templeton's significantly higher exposure to defensive sectors (20.1%) compared to JP Morgan (12.9%) and less exposure to sensitive sectors (25.9%) compared to JP Morgan (36.9%).
In terms of investment horizon, Share said that the JP Morgan fund has a higher turnover in its portfolio with a shorter one-to-three-year horizon. In contrast, the Templeton fund has a longer-term horizon of about five years.
In terms of analyst support, the JP Morgan fund doesn’t have dedicated analyst support. According to Share, Kwok draws on small cap ideas from JP Morgan’s single country small cap strategies and also works with brokers.
In contrast, the Templeton fund benefits from having the support of a huge analyst team, with 50 analysts globally.
Sector comparison (%)
Source: Morningstar. Data as of 30 November 2015.