Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Small caps stay agile amidst China crackdown
As a far-reaching regulatory crackdown rolls through Asian markets, Elizabeth Soon, portfolio manager for PineBridge, leans on one key lesson from her thirty years in equity markets: volatility brings opportunity.
“People become fearful when markets fall and they sell, but they become fearless during a bull market even when valuations don’t justify it,” Soon says. “We think it should be the opposite. During volatile periods, active investors like us are well positioned to accumulate high quality companies whose prices have come down at more attractive levels.”
Soon joined PineBridge from Standard Life Investments in 2008 and is the portfolio manager for PineBridge’s Asia small cap and focused funds, including its new Asia ex Japan Small Cap Genesis Fund. The fund looks to capitalise on the upswell of companies accelerating their R&D to commercialize new inventions, and uses PineBridge’s proprietary Lifecycle Categorization Research (LCR) framework – which categorises those companies from “exceptional growth” to “mature” – in order to tune out market noise and evaluate positions objectively.
“We’re neither growth nor value biased. We’re not about market timing, top-down macro or high-frequency trading. We’re bottom-up fundamental based investors,” Soon says. “Our high-conviction portfolio is driven by valuation below market, undiscovered stocks, triggers that drive the stock that aren’t yet recognized by the market, and management strength that will deliver sustainable earnings over a long period.”
While Soon believes Asian markets “aren’t dissimilar” to their Western brethren – their diversity offers exposure to “virtually any sector” – she notes that nearly 95 per cent of listed companies in APAC ex Japan are small caps, with the breadth of the market making it almost impossible for analysts to cover in any depth and creating lucrative mispricing opportunities for clued-in active managers.
“Anywhere that change is occurring there is potentially a mispricing opportunity, and this can be at any point in a company’s lifecycle,” Soon says. “An established company that is investing in sustainability improvements will be able to deliver better value to its shareholders over time. An up-and-coming company that has a research edge may overtake its competitors and grab market share. Identifying these companies early before the market recognizes their worth is key.”
Of course, some of those companies may have characteristics that aren’t as common in the West; many listed companies are family-owned and -controlled, while state-owned enterprises play a “significant role” in many Asian economies. Benchmarks can be highly concentrated (A single company comprises one-fifth of the Korea Composite Stock Price Index) and the transparency of regulations vary as well; financial centres like Hong King and Singapore usually align their regulations with those of developed markets to maintain their competitiveness, but in some areas the process is more centralized, with less industry input and visibility. In this space, it helps to have boots on the ground.
“We believe having a team of analysts and investment specialists in Asia is key to anticipating these changes, understanding their impact, and positioning the portfolio accordingly to mitigate any risks or capture opportunities,” Soon says.
“And because fundamental bottom-up research is the bedrock of our investment philosophy, having a presence in Asia enables easier access to management within the Asia time zone and particularly in small caps where understanding industries and businesses is critical in the due diligence process.”
While many investors have grown leery of China in the face of its recent regulatory crackdowns on a number of sectors, Soon expects the outlook for its small caps – and those within the wider APAC universe – will grow rosier; new free trade agreements will make the burgeoning Chinese consumer market more accessible to other Asian nations, while Chinese companies will bring in more direct investment by diversifying their manufacturing locations and finding cheaper production inputs. And while geopolitical risks loom, Soon says that she’s focused on quality companies that will thrive “regardless of the diplomatic climate, and through economic cycles”.
“Digitalization has accelerated during the pandemic and will remain pervasive in daily life. Major Asian economies like China, Korea, and Japan have already set net-zero carbon goals, and others are moving into green energy sources,” Soon says. “We believe all these efforts will create opportunities up and down the value chain… As these themes unfold, we could see profound change in the global economic order. We believe agile and forward-looking smaller companies are well positioned to capture and grow these opportunities into the future.”
