As is typical towards the latter stages of an economic recovery cycle, US and European small caps have attracted significant interest from international investors in recent years. However, Asian small caps have not enjoyed the same degree of attention – perhaps partly due to some common misconceptions about the asset class. Here we set out seven reasons why adding Asian small caps can benefit investors’ long-term strategic asset allocation.
Reason 1: Distinct asset class
Asian small caps are a distinct asset class offering access to an entirely different segment of the Asian equity market compared to large caps. The MSCI AC Asia ex-Japan Small Cap index is well-diversified, and comprises approximately 1700 stocks that have zero overlap with the MSCI AC Asia ex-Japan index constituents which have a higher concentration of large caps.
Exhibit 1: Sector Exposure: MSCI Asia ex-Japan Small Cap vs. MSCI Asia ex-Japan
Source: MSCI, BNP Paribas Investment Partners, as of 31 March 2017
Reason 2: More defensive
Asian small caps are more defensive than large caps. For example, some may be surprised to learn that since 2000, the volatility of listed Asia ex-Japan small caps has been lower than that of both Asian large caps and US and European listed small caps.
Exhibit 2: Annualised Volatility (Based on Weekly Total Return Performance, rolling 52-week, in USD)
Source: Bloomberg, BNP Paribas Investment Partners, February 2017
Reason 3: Greater domestic focus
In eight out of the ten Asia ex-Japan countries represented in the MSCI indices, listed small caps comprise more internally-focused businesses that target key growth areas within the domestic economy, and are therefore less dependent on external demand for growth.
Exhibit 3: Domestic Revenue Exposure
Source: FactSet, UBS Quant Research, data based on last reported financials as of 3 April 2017
Reason 4: Undemanding valuations
Asia ex-Japan small caps are trading at 14x price-to-earnings and 1.4x price-to-book, based on fiscal year 2017 Bloomberg consensus earnings estimates. This is an undemanding valuation relative to Asian large caps (13.2x P/E for the MSCI AC Asia ex-Japan Index) and global small caps (more than 20x P/E for the MSCI AC World Small Cap Index).
Reason 5: Attractive dividend yield
The last 12 month trailing dividend yield for the MSCI Asia ex-Japan Small Cap Index was 2.3%. In a world of elusive yield, a dividend of more than 2% can be considered attractive.
Reason 6: Good growth prospects
Smaller companies have the potential to be tomorrow’s leaders. These ‘emerging franchises’ – well-managed, young, solid businesses – have the capacity to deliver above-average earnings growth prospects and strong share price performance. And with many companies under-analysed and under-owned, Asian small caps provide experienced stock pickers with an opportunity to generate alpha as fundamentals are not always fully reflected in share prices.
Reason 7: Strong economies and demographics
Asian small caps operate in the region with the world’s highest GDP growth rate, where a number of economies will see further positive structural reforms. Meanwhile the young demographics of India, the Philippines and Indonesia, together with the consumption power of nearly 50% of the world’s population on emerging Asia’s doorstep, should support domestic consumption growth in the decades to come.
Published on 19 April 2017
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
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