Gabriel Sacks and Xin-Yao Ng, Co-managers, abrdn Asia Focus plc.
A number of major growth themes have been dominating global equity markets – from Artificial Intelligence (AI), to the energy transition, to near-shoring. Larger companies have often been seen as the real beneficiaries of these structural growth trends – from the US technology giants to Asian titans such as TSMC and Samsung. In reality, small caps are a vital part of the ecosystem for many of these long-term trends – and yet their growth profile remains under-appreciated by investors.
This is particularly evident in AI. To date, the US technology giants have grabbed headlines, along with the well-known European and Asian semiconductor groups. These are great companies, but their growth trajectory is well-understood by markets. Yet there are beneficiaries all the way down the supply chain that have been overlooked by investors. Many are to be found among Asia’s smaller companies, particularly in Taiwan and South Korea.
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There has been a strong recovery in the global technology cycle, with rising demand for semiconductors and technology equipment. TSMC has announced plans to expand its capital expenditure by around 7% in 2024, which helps feed the whole supply chain. In the abrdn Asia Focus portfolio, we hold companies such as Taiwan Union Corporation and Sunonwealth to capture this trend. Both companies are seeing an acceleration in demand as well as a shift to higher value products, which is driving an improvement in margins. Even though the large cap companies such as TSMC are the key enablers of this growth, the impact on these smaller companies is even more pronounced, making them a more direct play on artificial intelligence.
Near-shoring
Near-shoring (or re-shoring, or friend-shoring, or ‘China plus One’) is a phenomenon whereby global companies diversify their supply chains away from China, with the aim of ensuring continuity and certainty of supply. It is happening across Asia, creating new pockets of growth.
This trend is still in its early stages, but the beneficiaries are already emerging. Vietnam, for example, is seeing a new wave of foreign direct investment, as companies set up manufacturing centres there. This has knock-on effects for the growth of the consumer economy as well. Indonesia is becoming a crucial link in parts of the commodity supply chain. Against this backdrop, we hold companies such as AKR. This is primarily a fuel distribution business, but it has a large industrial estate linked to one of the country’s deep-sea ports that is becoming a large industrial and logistics hub. . As metals and refining businesses expand in Indonesia, the company is well-placed to benefit.
Near-shoring is also an important new driver for the Indian economy. The Indian government is putting incentives in place for industries to set up manufacturing there whilst removing logistics bottlenecks via large investments in infrastructure. The ‘Made in India’ narrative is taking hold, with tangible increases in capacity and rising manufacturing across the country, particularly in areas such as electronics and renewable energy. Healthcare and biotechnology suppliers are also moving to India, with many of the beneficiaries being local smaller companies.
Regional consumption
Asia’s consumption story may have taken a pause during Covid, but it remains a long-term growth theme as the region’s middle class grows and spending patterns shift. We are even starting to see some improvement in China, where, until recently, consumer spending has been subdued. The country’s households have had plenty of firepower, but little inclination to spend.
This is changing in selected areas. One of those has been domestic travel. Our portfolio includes a travel platform called Tongcheng Elong that is connected to Tencent’s WeChat app and supported by travel giant Trip.com. We also hold AutoHome, which helps connect car dealers with buyers of cars. It is the leader in its market and, alongside many Chinese companies, remains very cheap. ChaCha Food, which makes nuts and seeds, is a leader in niche consumer goods and another favoured holding.
Small and mid-caps
These structural growth themes ensure that many of these smaller companies have a longer pathway of growth, and that their destiny is firmly in their own hands. However, they are often overlooked. Asia remains out of favour and allocations to Asia by international investors are at their lowest level in a decade. Across Asia, small and mid-cap companies have performed well but their strength has come from earnings growth, rather than rising valuations. Asia is one of the few regions across the world where small caps have materially outperformed large caps over the past 3-5 years.
It is also worth noting that small caps have some inherent strengths. They can access niche markets, tied to domestic and global economic growth, while swerving problematic geopolitics. Just as they have often been over-looked by investors, these companies are generally not in the headlights of policymakers, which gives them greater freedom to grow.
In our view, Asian smaller companies remain a compelling route to access some of the most enduring and exciting themes in the global economy. They generally come without the baggage of larger companies and may provide more concentrated exposure. Most importantly, they come at realistic valuations that may under-estimate their long-term growth.
Disclaimer
Company/Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
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