Why small-and-mid cap stocks offer appeal

by **Cals** Sun 15 May 2016, 18:30

Saturday, 14 May 2016

Why small-and-mid cap stocks offer appeal

DESPITE the poor performance across Asia’s equity markets in 2015 and the continued impact of the global economic slowdown on regional stock market performance, South-East Asian economies continue to show promise for long-term equity investors. UOB Asset Management (M) Bhd CEO Lim Suet Ling shares her economic outlook in a Q&A:

South-East Asian equities went through a bear market last year. Why do you believe equities continue to hold long-term value for investors?
South-East Asian stocks tumbled into a bear market in 2015 and suffered outflows when the US Federal Reserve contemplated raising its benchmark short-term interest rates. The risk-off stance where risk sentiment turns negative affected performance across South-East Asia’s equity markets with the Morgan Stanley Capital International (MSCI) South East Asia Index falling to 20.8% in 2015. However, over the last 10 years, South-East Asian small-and-mid cap stocks have delivered strong growth and attractive risk-reward for investors.
The MSCI South East Asia Small Caps index delivered a compounded annual growth rate of 14.1% during this period. To add to their appeal, South-East Asian stocks have bounced back from last year’s lows with the MSCI South East Asia Index up 9.6% year-to-date as at March 31, 2016.

As a long-term investor, UOB Asset Management sifts through the short-term volatility to identify long-term capital appreciation opportunities for our clients. Our long-term outlook for small-and-mid cap South-East Asian stocks is supported by the Asean region’s attractive growth prospects. The asset class is benefitting from the region’s rapidly rising income levels, stronger foreign direct investment inflows and higher private consumption.
In addition, small-and-mid cap stocks are benefitting from South-East Asian governments’ monetary and fiscal stimulus, which should insulate these stocks further from the global economic slowdown which is driving slower export growth.
Small-and-mid cap stocks usually offer investors a different risk-return profile relative to large-cap stocks. What risks should investors look out for when investing in small-and-mid cap stocks?
Our view is that small-and-mid cap stocks usually have the potential to deliver greater capital appreciation because smaller companies are often able to increase their profits at a faster rate than larger firms. They are also often priced inefficiently or have modest analyst coverage, making the small-and-mid cap market fertile picking ground for undervalued stocks.
However, investing in small-and-mid cap companies pose challenges and risks as well. Investors should be aware that these stocks tend to have shorter track records, higher share price volatility and thin trading volume. For this reason, it is essential that investors rely on experienced and active fund managers to help them select equities in the small-and-mid cap space. What active fund managers bring to the table is the experience and expertise to identify risk-adjusted investment opportunities within these companies.
Active fund managers also ensure that there is diversification within the portfolio and that investors are compensated adequately for assuming the risk associated with this asset class.
What sectors should investors look to hold as part of their South-East Asian small-and-mid cap equity portfolios and why?
We favour companies from the consumer sector that offer good franchise value and steady income. We also like the utility and construction sectors where we see evidence of decent yields, visible recurring income and a pipeline of high-value projects that can generate regular earnings.
Given the expectations for increased infrastructure spending in the region, we favour infrastructure-related sectors at the moment.
It is estimated that the region will need to invest at least US$110bil annually in power, transport, telecommunication and water and sanitation until 2025 to accelerate economic growth and improve productivity across the region.
We also favour consumer staples and consumer discretionary sectors as the anticipated economic growth in the region is translating into rising income levels and a growing middle class, which will ultimately boost consumption levels. Besides consumer staples and consumer discretionary sectors, we are also in favour of consumer-related sectors such as the automotive and property sectors.
How do you expect the Asean economies to perform in the coming years and how will the region’s small-and-mid cap stocks fare over the medium to long term?
We believe that the Asean region offers medium and long term investment opportunities, driven by the region’s positive growth trajectory, favourable demographics, improved competitiveness and rising level of foreign direct investments.
Growth in the Asean region is projected to outpace the growth of developed economies over the next five years. Growing income and accumulated wealth will give rise to a new and savvy group of consumers who will in turn attract global firms to market their goods and services in the region.
With rising income and standards of living, the Asean consumer will be an important contributor to the region’s overall economic growth. Over the longer term, the region stands to benefit from the Asean Economic Community’s goals of improved productivity, mobility of capital and an increase in cross-border trade flows.
Fuelled by the region’s encouraging growth drivers, we expect the region’s small-and-medium sized companies to sustain their momentum and deliver high revenue growth over the medium to long term.