Mark Dampier: Smaller companies often pay off, especially in Asia

The Analyst

Investing in smaller companies can be an exciting, if a somewhat bumpy, ride. Yet it often leads to long-term outperformance. This has been the case not only for the UK, where there are some excellent smaller companies fund managers, but also around the globe.

Combine the potential of smaller companies with Asia's fast-growing economies and you have a compelling opportunity.

An interesting way of accessing this is through the Aberdeen Asian Smaller Companies Investment Trust. Aberdeen's expertise in managing Asian equities is well known. A focus on good-quality, resilient businesses has helped navigate the volatile markets of Asia exceptionally well over the years. The team, headed by Hugh Young, believe share prices reflect the quality of underlying businesses over the long term. They therefore look to identify the best firms and buy them when the valuation is right.

Aberdeen's approach is consistent across their range of funds. You don't often find a stock held in just one. For example, the 60 or so smaller companies in this investment trust will also be found in either their offshore Asian smaller company unit trust or in the individual country funds Aberdeen manage across the region.

The trust focuses on companies below $750m (£464.3m) in size at the time of purchase, highlighting one of the benefits of the investment trust structure. As there is no money coming in and out of the trust to worry about, the Aberdeen team can hunt more freely for much smaller companies, which are often more illiquid. In contrast, their Asian smaller companies unit trust looks at companies below $2.5bn at the time of purchase.

However, according to Mr Young, the portfolios are currently fairly similar. Indeed, running the two types of funds is complementary: The discipline of having to buy and sell new holdings as money flows in and out of the unit trust forces them to reassess whether they should hold a company in the investment trust too.

The current portfolio trades at a price-to-earnings ratio of about 13.5 times this year's earnings. This is above the MSCI Asia Pacific Small Cap Index, though this index is heavily skewed to Australia where the trust rarely invests. According to Mr Young, this is around the long-term average following a rally in the first few months of 2012.

While the positive start to this year has been beneficial for existing holdings of the fund, Mr Young and the team are finding it harder to unearth new opportunities as valuations are less attractive than they were. The portfolio is currently tilted towards companies exposed to domestic consumption in the region. Consumer businesses make up almost 45 per cent of the portfolio compared to around 13 per cent of the index. Top 10 holdings include Siam Macro (a Thai retailer), Multi Bintang (a brewer) and Godrej (a consumer products business).

At a country level, the team has found excellent opportunities in India, Malaysia, Thailand, and Indonesia; while it is harder to find high-quality smaller companies in China, Taiwan and Korea. Ultimately, the decision on whether to invest is based on the quality of the companies alone, not their location.

When assessing an investment trust, other factors should be considered aside from performance, for example, the amount of borrowing the trust has, otherwise known as "gearing". In a rising market, gearing can add value and in a falling market it can detract. Aberdeen's approach here is prudent, and gearing has typically been no more than 10 per cent.

Another issue to bear in mind is that the share price may not accurately reflect the underlying net asset value of the trust. It may be a "premium" or "discount" according to market sentiment. Currently shares are trading marginally above net asset value meaning they trade at a premium. Investors looking to purchase may wish to monitor this to see if shares fall to a discount prior to buying. Those not wishing to take the additional risk of the share price discount/premium could consider the unit trust instead. Either way, I believe Aberdeen's Asia team is of the highest calibre, and exposure could be an excellent addition to an adventurous portfolio.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk/independent