After several years of returns in Asian stock markets being driven by large-cap growth stocks, emerging markets in Asia are showing signs of a rotation towards value and small caps, something which has put investment trust Fidelity Asian Values (FAS) in a sweet spot.

With its value style and small cap focus, the trust now looks primed to deliver. Performance hasn’t exactly been stellar over the past three to four years as the value investing style has been out of fashion for much of that period. Despite such pressure manager Nitin Bajaj has stayed true to his value philosophy and the style is now in demand.

TRADING BELOW VALUE OF ASSETS

The fund’s performance has improved significantly in recent months. Despite this achievement, the shares, which initially re-rated to trade at net asset value after the value rally began last November, are now back on a discount (1.2%), creating a buying opportunity.

Analysts at broker Stifel say that this ‘seems strange as the fund’s performance since the start of the market rotation remains strong’. They point out that value funds in other sectors have sustained their positive re-rating, continuing to trade close to NAV post the November market rotation.

At the end of February, the look-through price to earnings ratio for the portfolio was 11 times compared with 16 for its MSCI AC Asia ex-Japan Small Cap benchmark, which makes the investment trust look very attractive.

GOOD QUALITY COMPANIES

The Stifel analysts say the portfolio looks cheap despite being invested in companies which are arguably better quality than the benchmark.

One example is KEI Industries, which makes electrical cables for homes and to connect with the grid. Among the attractions of the stock highlighted by Bajaj are cash on the balance sheet, around 15% annual revenue growth over the last decade and over 20% return on invested capital.

Despite that, KEI stands on around 12 times earnings, while its main listed competitors Havells and Polycab trade at close to 50 and 35 times respectively.

BENEFICIARY OF ECONOMIC RECOVERY

Among the top holdings in Fidelity Asian Values’ portfolio are Indian banks Axis Bank and HDFC, both of which have surged since the value rally gripped global markets five months ago.

After a 7.1% contraction last year, the International Monetary Fund forecasts that India’s gross domestic product could soar by 12.5% in 2021 as its economy bounces back, something which should act as a strong earnings tailwind for both banks and other holdings in the investment trust’s portfolio such as lender Shriram City Union Finance.

The trust has 24.5% exposure to India overall. Indian analysts have predicted 2021 could end up being the year for small and mid-cap stocks in the country, fuelled by the economy’s revival, strong retail investor interest and a number of smaller companies recently beating market expectations.

The anticipated return of inflation in Asia should also act as a tailwind for the value stocks in the portfolio, while its high exposure to financials – making up 15.6% of the portfolio – should also see it benefit should interest rates move higher during the year, something which is seen as likely to happen.

CHINESE OPPORTUNITIES

The second highest allocation in the trust is to China, which makes up 20% of the portfolio. Although rather volatile, Chinese small caps have been stellar performers in the past year and a half if the MSCI China Small Cap index is anything to go by, having generated a 12.3% return year-to-date and a 64.6% return in the year to 31 March 2021.

Many China equity fund managers have touted the potential of smaller and lesser-known Chinese stocks, arguing that they’re the ones driving innovation in the country and are a key part of its economic shift away from manufacturing into more high-tech sectors.

NO GEARING

The trust doesn’t employ any gearing which means it isn’t borrowing cash to have extra money to deploy in the markets. Manager Bajaj has avoided leverage as he does not have a clear forecast of the repercussions of a severe economic downturn brought about by the pandemic, something which heightens his caution.

There are risks with the trust and Asian small caps in general, particularly if countries like India go back into extended lockdowns again. But overall, as the global market looks towards the inevitable economic recovery and the clear outperformance of small caps at the moment, particularly in emerging markets, Fidelity Asian Values is an almost perfect place to capture that upside.

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