Etiqa plans to raise EM small-cap exposure

Etiqa, Maybank’s insurance arm, is looking to boost its allocation to emerging-market small- and mid-cap equities in the second half of the year as it expects a correction in the coming months.

Mid- to small-cap equities have proved to be popular in recent times in emerging markets, says Chris Eng, head of research in Etiqa’s investment management division, speaking on a panel at AsianInvestor’s Asian Investment Summit last week.

Eng points out that over the past 12 months, investors have been piling into small/mid cap equities, which pushed valuations into “astronomical” levels, Eng says.

He notes that there has been some retracement in valuations over small/mid cap companies, with downward pressure to continue until the second half of the year. That would then be the time to go back into the equity class, Eng suggests.

Etiqa is restricted to an equity asset allocation of 20%, while fixed income can be up to 80%, although that exposure has come down to 70% over the last 12 months.

Eng’s optimism on EM small- and mid-caps was echoed by Peter Ryan-Kane, Asia-Pacific head of portfolio advisory at Towers Watson, but he recommends buying into non-listed companies. Fundamentally, in emerging markets – especially smaller economies – indices and listed stocks are not a good proxy for small-caps’ economic growth potential, he said, speaking on the same panel.

“If you look at the banks, telcos and other companies, clearly they are going to grow as the economy grows. We kind of all know that,” noted Ryan-Kane. “But the really productive parts of the economy are mostly held privately.”

But accessing private assets is not easy, given the legal constraints on foreign ownership in much of Asia, he adds. Social constraints, such as families’ unwillingness to sell parts of companies, also limit what investors can buy.

Ryan-Kane also advises against allocating to EMs through exchange-traded funds (ETFs), given that indices tend to have biases for large countries or large-cap stocks, which could have an adversely big effect on the market.

“Having a conversation that we lost 6% of our money because something went backwards because we owned 6% of it [through] an index is not a fun conversation to have,” he explains.

ETFs make more sense for mature markets, where the index constituents would be more diversified, he says. “Just buying beta works in a market like the US where you have got 2,500 listed stocks and you can own 800 of them [through ETFs]. You also know that you’re going to get pretty low tracking errors.”

In the meantime, Eng sees potential upside in emerging Asian debt over the short-term, fuelled by an unstable political environment in some Asian markets and potential interest rate rises, which have helped drive down prices and boost yields.

Etiqa favours sovereign bonds, as well as Chinese state-owned enterprises in non-cyclical sectors such as infrastructure, utilities and oil & gas, as opposed to riskier assets including property and banks. “[But] we are not prepared to pursue [such assets] all the way to extremely low yields,” he adds.

Another panelist took a relatively bullish view on Chinese property. Despite negative news pushing down mainland real estate prices, property developers remain in a surprisingly good position, says Christopher Lee, head of corporate ratings for Greater China at rating agency S&P.

Of the 200 Greater China companies analysed by S&P, 50 are property developers. This would have suggested that the sector is reaching “a sort of a saturation point”, Lee says. “But [saturation] doesn’t seem to happen, and a lot more domestic listed property developers are still coming to the market.”

Many such companies have already refinanced their debt this year and have also been proactive in liability management, he adds.

However, credit quality in the industrial sector has deteriorated. With demand for industrial equipment and other capital equipment declining due to the slowing Chinese economy, credit quality within the sector has also deteriorated steadily over the last 12-18 months, says Lee.

The story is similar for the mining sector, he adds, where margins and cash flows are still under pressure, despite declining pricing power and continued cost cutting.