Capturing alpha in Asia ex-Japan small caps in stormy markets
Despite continuing trade tensions and macro-economic drags, Asia remains the fastest-growing region in the world1, and its rapid technological development and adoption, a large population with rising incomes, and growing intra-regional trade are set to drive its continued economic ascendance.
Active stock pickers at PineBridge Investments (PineBridge) see plenty of opportunity in the largely under-researched Asia ex-Japan small cap equity market to find companies that can capitalize on these long-term growth drivers. These include companies involved in infrastructure, automation, energy and the environment, and consumption. They tend to be more regionally focused and niche, and therefore, more resilient against global demand shocks.
“The Asia ex-Japan small cap space is a big pond with a lot of fish, and interestingly, not many fishermen,” says Siddhartha Singh, investment director, Asia equities, at PineBridge Investments.
“As technology changes business models, the ownership of the profit pool in an industry changes hands. New winners are emerging in a region that is large but relatively uncrowded,” adding that Asia ex-Japan small cap valuations are reasonable after having fallen last year, and operating margins are estimated to increase.
Operating Margins Are Forecast to Continue Rising (in %)
Source: Bloomberg, as of 9 May 2019. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Past performance is not indicative of future results. Any forecast presented herein are valid as of the date indicated and are subject to change.
STOCK SELECTIONS DRIVES OUTPERFORMANCE
When casting its net for opportunities, PineBridge follows a rigorous bottom-up approach to stock selection, seeking the best-quality companies across countries, sectors and market cycles.
“We believe investment opportunities exist across the entire market spectrum and at every point in the economic cycle. We focus on the dynamic nature of companies over their life-cycle in order to select highly distinctive, alpha-generating stocks irrespective of whether they are part of benchmarks. The strength of the business model, the people running the business, and the valuation to be paid are the three most important criteria that drives our conviction,” explains Singh.
Despite being the worst-performing markets in the region last year, China and Hong Kong were overweights in the PineBridge Asia ex Japan Small Cap Equity Strategy. Nevertheless, these markets were the best contributors to performance. Singh says this demonstrates that good stock selection can trump market fluctuations.
LOOKING BEYOND MACRO
While global markets remain jittery, at PineBridge, this does not register as a worry, but as potential opportunity. Singh cites an example where investors could have missed an extraordinary opportunity if they focused only on the macro.
“During the global financial crisis in mid-2007 to mid-2008, Apple launched its first and second generation iPhones, which benefited a number of original equipment manufacturers and suppliers in Asia. However, focusing solely on the financial crisis would have led to a missed opportunity. Therefore, we focus more on understanding companies rather than just the pure macro backdrop,” says Singh.
With global markets likely to remain volatile in the short term, any earnings deterioration or share price declines are viewed as a chance accumulate good quality names as long as their basic earnings franchise is not fatally damaged.
Price-value gaps will eventually correct, and investors could use this opportunity to build their allocations to Asia small caps, he says.
Explore the opportunity in high-conviction investing with PineBridge Asia ex Japan Small Cap Equity Strategy, please visit PineBridge's strategy page.
1 IMF, as of March 2019.
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Last updated 4 March 2019.