Asian small caps demonstrated strong performance over the 12-month review period to 31 July 2023, despite the volatility across global markets. The benchmark MSCI AC Asia Ex Japan Small Cap Index returned +8.0% in sterling terms over the review period. The Company’s net asset value (“NAV”) and share price, both in total return terms, increased by 7.6% and 7.3%, respectively.  As your Chair has highlighted earlier in this report, global markets have faced numerous challenges over the review period, including increasing inflation and interest rates (especially in developed markets), concerns regarding a potential global recession and a slower-than-expected China recovery. Nevertheless, Asian small caps have demonstrated remarkable resilience, outperforming their larger counterparts by a significant margin. Over the past three years, the cumulative outperformance of smaller companies in Asia against the large cap index has amounted to a meaningful 38 percentage points (the MSCI Asia ex Japan Small Cap gained 43% in the three years to 31 July 2023, compared with 4.2% for the MSCI Asia ex Japan). 

Heightened market volatility and macroeconomic uncertainty means our investment process gains even greater significance and we believe the unwavering rigour in seeking out quality has proven particularly advantageous over the 12-month period. Our stock selection in India and Indonesia contributed to the positive performance, as both countries enjoyed resilient domestic spending during the review period. India-based engineering and technology solutions company Cyient, has seen a strong recovery in earnings as demand for engineering software and design services bounced-back in the aerospace industry, while margins benefited from management’s restructuring efforts over the past few years. Prestige Estates, a property developer, released robust presales figures thanks to new projects and continued industry consolidation as they look to accelerate growth and become a national player. Similarly, Syngene, a contract research organisation working in pharmaceuticals, biotech and other industries, also benefited from a series of positive earnings reports. The company's strategic investments to expand capacity in biologics manufacturing and discovery services, as well as its solid balance sheet and a low debt profile, contributed to its success over the review period. Shares of Indian downstream oil and gas company Aegis Logistics were especially strong in the last month of the period, as the company released good quarterly results. In Indonesia, Bank OCBC NISP announced robust first-quarter performance, buoyed by asset growth due to an improving economic climate. Other standout performers in Indonesia included Ultrajaya Milk Industry, a more consumer-driven business focused on household dairy products, and fuel distributor AKR Corporindo.  At a sector level, technology, industrials and financials were positives for the portfolio. A stabilising tech sector and rising enthusiasm for generative artificial intelligence (AI) saw strong performance in both Taiwan and Korea. Positive stock selection in both countries aided performance over the 12 months. In Korea, Park Systems, manufacturer of atomic force microscopy (AFM) systems, was the leading contributor to relative results over the year. AFM has diverse applications in advanced science and technology labs, and the size of the addressable market should grow over time given it is still a relatively new field. Leeno Industrial also generated strong returns, with an anticipated recovery in demand driven by AI and testing initiatives. Meanwhile, in Taiwan, Sunonwealth Electric Machine Industry, which manufactures industrial fans and Taiwan Union Technology, which distributes copper-clad laminate, also contributed to relative performance given an improved outlook for growth. In addition, Vietnam’s leading IT group FPT Corporation advanced over the review period on continued strong results with the company reporting a 21% profit jump in the second quarter, driven by a 29% surge in IT service revenues.  Elsewhere, our positioning in several other companies also proved advantageous. Shares of Thailand-based TISCO Financial Group performed well as its conservative lending practices over the past few years proved prescient. Sri Lankan conglomerate John Keells Holdings, which operates in sectors including transportation, consumer goods, retail, leisure, property, and financial services, also advanced as a beneficiary of a recovery in tourism and the overall domestic economy in Sri Lanka following the implementation of significant structural reforms. 

On the other side, your Company’s exposure to China and Hong Kong, both among the worst-performing markets, dragged on performance. Consumer-related sectors bore the brunt of the selling and the property sector continued to languish. Key detractors in China included JOINN Laboratories., a drug testing business, and Sinoma Science & Technology, an advanced materials company focused on green energy solutions. Hong Kong-listed banking group Dah Sing Financial Holdings Limited and drybulk shipper Pacific Basin Shipping were also weak.  Our stock selection and overweight positioning in Singapore also weighed on overall performance. Among the main detractors in this market were investment holding company Yoma Strategic Holdings, a conglomerate operating in Myanmar, property developer Bukit Sembawang Estates and nanotechnology solutions provider Nanofilm. The latter reported weak semi-annual results due to slowing demand and high operating expenses.  Other detractors of note mainly included companies in the consumer discretionary, materials and health care sectors. Malaysian hotel operator Shangri-La Hotels Malaysia Bhd., Indonesia-focused M.P. Evans, which produces palm oil, and Thailand-based Mega Lifesciences PCL came under pressure. In addition, Taiwan headquartered e-commerce operator momo.com underperformed, in part due to disappointing sales growth and broader concerns about the lacklustre pace of digital sales expansion following the easing of lockdown measures.

Much the same as we have said in previous reports, market volatility creates price disconnects, which require managers to focus on fundamentals. We have a long-term approach to investing and favour businesses with clearer earnings visibility and stronger fundamentals, focusing on quality companies that are well placed in structurally growing areas, such as healthcare and technology. This approach also helps us mitigate downside risks to growth from inflationary pressures. As such, over the period we have reduced or exited positions where we felt there was less certainty in a company’s earnings trajectory or where those earnings could be less resilient to current macro headwinds. Keeping in line with the Company’s focus on quality, we purchased shares in Taiwan’s Sinbon Electronics, which makes cables and connectors for niche markets. The company supplies products and applications to sectors including green energy, industrial applications, automotive, medical equipment as well as communication and electronic peripherals. In a highly fragmented industry, its competitive edge lies in its capabilities to manufacture highly customised products for its diversified customer base, as well as its well-entrenched partnerships with its suppliers and clients. Although its shares were under pressure after the release of its 2023 first half results, we view it as a beneficiary of long-term structural trends such as the Internet of Things, 5G applications and electric vehicles, as well as growing demand for renewable energy, supported by solid order visibility over the next two to three years. The company operates a cost pass-through model which ensures healthy margins and cash-flow. Another key purchase was Autohome, a dominant Chinese auto platform with more than 60 million daily active users. It trades at attractive valuations, with just the cash on its balance sheet representing more than 75% of the Group’s total market value, and we see latent potential for consumer spending to pick up in China as the economy re-opens. Autohome has an asset-light business model, delivering comprehensive, independent and interactive content to automobile buyers and owners. Its core business benefits from the powerful network-effect characteristics of a classifieds business and it is the number one player in the market.  Its original generated content drives high-quality user traffic, which in turn results in advertising and lead generation. It is also expanding into new areas of business, such as autorelated financing for example and used car sales. As covered in our interim report, we added other Chinese companies to the portfolio including seeds & nuts producer ChaCha Food. With well-established brands, the company has high potential for growth as the largely fragmented snacks industry in China presents a consolidation opportunity. As an aside, we engaged with the company over the period to gain visibility on its risk management policies on key environmental, social and governance (ESG) topics, and to encourage the company to issue its first ESG report. We came away with a positive impression given ChaCha’s comprehensive ESG practices in its daily operations, as well as its efforts to improve disclosure and business integration. We also added Kerry Logistics, one of Asia’s largest integrated logistics providers. With its diversified customer base, we believe it is well placed to benefit from supply-chain relocation, ecommerce growth and intra-regional trade in Asia. Against these purchases, we exited Pacific Basin Shipping, given the lack of visibility and momentum on shipping rates (despite the compelling supply and demand dynamic). The industry is likely to enter a significant capex cycle, which could also affect shareholder returns. Elsewhere, we sold Douzone Bizon, due to concerns over execution and an uncertain growth outlook, and divested from eCloudvalley Digital Technology, owing to poor disclosure and a slowdown in growth. Other sales included Absolute Clean Energy, IPH, Nazara Technologies and Tatva Chintan Pharma; small positions that we didn’t feel compelled to scale up. 

We expect global market sentiment to remain volatile in the short term, given concerns regarding global growth, monetary policies in the US and other developed markets, as well as developments in China, where macroeconomic data remains soft. Having said that, at the time of writing the Chinese government has begun another round of easing measures which should increase support to the economy at the margin. While we are yet to see more impactful policy action, there are still good opportunities to invest in small cap stocks that trade at attractive valuations and that provide exposure to pockets of growth within China’s domestic market. 

 Elsewhere, other Asian economies are benefiting from diversification in global supply chains. Companies are adding alternative sourcing locations, increasingly adopting “China plus one” or “plus two” strategies. We have kept a large allocation to India in the portfolio, where we have exposure to a diverse set of companies operating in a number of high-growth industries. India is in the early stages of a cyclical upswing, and enjoys a demographic dividend, meaning it is well-placed for sustainable long-term growth. The region will also gain from growing demand for AI-related apps and chips, especially in the semiconductor and consumer  electronics segments. 

 Resource-rich Indonesia has a sizeable and dynamic domestic market with rising post-pandemic consumer demand. There is a more limited universe of small caps compared with elsewhere, but we believe the portfolio is invested in well-run businesses with vast long-term potential. Vietnam, meanwhile, has become a key player in manufacturing – benefiting from diversification in the global supply chain and numerous free-trade agreements. The country is on a growth track, and we continue to like the long-term macro story. On the other hand, we do see some near-term political risk in some parts of the region, with political uncertainty in Thailand and general elections for both India and Indonesia in 2024. Outside of Thailand though, we generally expect political stability with a continuity in policy-making which provides a positive backdrop for the corporate sector.

 In summary, we continue to believe Asian small caps offer significant value. There are attractive opportunities around the structural themes of aspiration, building Asia, digital future, going green, health & wellness and tech enablers.

 Overall, we have been nimble, taking the opportunity to raise the portfolio’s earnings visibility and reduce exposure to names where this visibility is less certain. As a result, we continue to favour quality Asian small-cap companies with solid balance sheets and sustainable earnings prospects that can emerge stronger and position the portfolio well in tough times.  While performance of small caps in the region can be volatile, given our in-house research capabilities, investment management focus and bottom-up analysis, we expect to deliver for our shareholders in the long run.