When it comes to investing in equities, large-cap stocks tend to attract plenty of attention by virtue of their size. In contrast, the small- and medium-cap stocks often get overlooked — again, by virtue of their size. This, however, does not necessarily mean that small- and medium-cap stocks are inferior in delivering returns. On the contrary, they can achieve significant outperformance like their larger peers, perhaps even better.
Take the example of Nikko AM Shenton Emerging Enterprise Discovery Fund. The fund, which aims to achieve medium- to longterm capital appreciation by primarily investing in SMEs in Asia excluding Japan, has outperformed its benchmark.
For the 12 months ended Oct 31, 2020, the fund has returned 39.7%, including charges. This compares with net total returns of 9.86% for the MSCI Asia ex-Japan Small Cap Index. Over the three-year and five-year periods, the fund has also returned 12.8% and 8.8%, respectively. In comparison, the MSCI index has returned –1.1% and 2.4%, respectively. Since the fund’s inception, it has returned 5.5%, beating the index’s 3.8%.
Grace Yan, portfolio manager of the fund, says the outperformance was driven by the fact that 25% of the fund’s holdings are tracked by five or fewer analysts. As a result of the under-coverage, these stocks tend to trade below their intrinsic value, providing a higher opportunity for upside upon price discovery, she says. “So, I think that is one source of alpha,” she tells The Edge Singapore in an interview.
Yan adds that the fund’s outperformance is also due to its focus on companies that perform well in the area of environmental, social and corporate governance (ESG). According to some studies, such companies do better as good ESG practices lead to a more transparent organisation with more effective management practices. These, in turn, enhance the bottom line and, therefore, the share price performance of the companies.
Yan points out that although SMEs are perceived to have poor ESG policies and practices, that is not always true. “That’s why we incorporate ESG into our research process and philosophy to ensure the companies do care about the community and corporate governance at large,” she says.
Finally, Yan says the fund’s outperformance is due to its rigorous stock selection. The fund prefers to invest in companies that have strong fundamentals, including those with high ROE and net cash position, she says.
“I think that’s particularly important, especially this year, because of the Covid-19 situation. A lot of companies have issues with cash flow and are unable to borrow money. So, companies which have excess cash on their balance sheet should be able to continue to grow and invest, despite the kind of credit crunch that’s happening,” she explains.
Given that small- and medium-cap stocks have lower analyst coverage compared to their larger peers, how does the fund conduct research on these stocks? Yan says she has a team of 19 analysts across Asia whom she can depend on to meet the management of a company that they may potentially invest in.
Each analyst covers a sector or two. Yan herself covers the China consumer and internet sectors. “So, that’s why I spend a lot of time in China,” she says. “I’ll probably meet them twice or thrice a year.” Of course, with the Covid-19 pandemic still restricting travel, Yan says she now relies on conference calls.
Bubble tea factor
One of the fund’s holdings that has contributed to its outperformance is little-known Taiwan-listed Sunjuice Holdings. The company is the fund’s top holding at 2.4%. Yan says not much research has been done on the company and only one local analyst covers it.
Sunjuice is a manufacturer of customised concentrated fruit juices, juice powder and juice granule. The company, founded in 1998, sells its products to juice producers, dairy manufacturers and confectionaries. For instance, Citrosuco, Brazil’s largest global producer of orange juice concentrate, is one of its customers. The company’s processing and production facilities are located mainly in China.
In FY2019 ended December 2019, Sunjuice’s revenue rose 9.3% y-o-y to TWD3.52 billion ($165 million). Earnings rose 24.8% y-o-y to TWD550.7 million as net margin widened to 15.6% from 13.7% a year ago. As at Dec 31, 2019, the company has net cash of TWD19.9 billion.
As at Dec 7, 2020, shares of Sunjuice are up 37.6% to end at TWD303.50. That closing price translates to 14.6 times earnings and 71.4 times book value. The stock has an indicated gross yield of 2.04%.
Yan says many people think juice manufacturing is not a particularly attractive industry given its low barriers to entry. “But actually, the difficulty lies in consistency and reliability. So, the company must make sure everything is well handled and monitored. It has high standards in food manufacturing, process and design,” she explains.
One example of consistency is fruit-based bubble tea drinks which is one of the hottest F&B fads now, according to Yan. As she explains, a mango on its own will taste different from another mango. But a mango cheese milk bubble tea drink using Sunjuice’s products always tastes the same. “And that is important because they can create a product so consistently,” she says.
On the ESG front, Yan says Sunjuice is an advocate of sustainable farming. For instance, the company leases land in China and engages the landlords to work in its fruit farms. The company also does not use pesticides although this means the company must allocate other resources to control pests and weeds. “But the chairman’s philosophy is that in order to grow quality fruits, the environment needs to be taken care of,” she says.
Sunjuice also promotes gender equality. Yan says the company is transparent on its remuneration policies by regularly publishing salary information between male and female employees. The company also provides enhanced maternity benefits for its female employees who have their second child, she adds. “There’s a very good corporate culture there,” she remarks.
In addition, Yan notes that Sunjuice does not face any problems in receiving payments from its customers. About 50% of sales is cash on delivery, she says while the company is selective in extending credit to its customers. “So, their bad debt is very low,” she says.
Bottom-up approach
Looking at the fund’s sector exposure, Sunjuice appears to be indicative of the type of stocks it invests in. The fund’s top sector exposure is to consumer discretionary stocks at 20%, according to its October factsheet. This is followed by information technology at 18.9% and consumer staples at 15.1%.
From a geographical perspective, the fund’s top country exposure is China at 26%. This is followed by Taiwan at 20.9% and South Korea at 19%. The fund’s exposure to Singapore stocks is just 2.7%.
Nevertheless, Yan says these statistics are merely a reflection of the fund’s bottom-up approach. “The country and sector weights are really a function of where we find the best ideas. So, it is not like we take a top-down view,” she says.
Also, the way the fund has determined its investing universe plays a part. According to Yan, the fund defines small- and medium-cap stocks as companies that have a market cap of between US$200 million and US$5 billion (between $263 million and $6.6 billion). These stocks must also have an average trading volume of three million shares over a three-month period. As a result, the fund is heavily skewed towards North Asia equities because the region has the largest amount of such stocks, she explains.
Interestingly, the fund has a sizeable holding of cash or derivatives of 16.5%. Yan says the excess cash was the result of the fund having pared down its exposure to stocks affected by the trade war between the US and China. The fund had also taken profit amid the volatility arising from the lead-up to the US elections as well as the Covid-19 pandemic, she adds.
So, where would the fund potentially redeploy the excess cash? Among other opportunities, Yan says the fund will plough it back into other holdings it already has. “One of my ex-bosses always tells me that rather than looking for new ideas, the best ideas are already in your hand. That’s why you own them, right?” she explains.
Yan’s interest and expertise in small- and medium-cap stocks were nurtured right from the start of her career. She began at Deutsche Asset Management covering these stocks in the South Korean and Taiwanese equity markets for about five-and-half years.
Thereafter, she moved to Nikko Asset Management where she has been for the last seven years, covering China small- and medium-cap consumer discretionary and internet stocks. In late 2017, Yan became the fund manager after her predecessor had retired. “It has always been an area that I’ve been interested in and passionate about,” she says.
