Emerging markets may seem risky enough for most investors, but there is an argument for turning attention to the emerging market small-cap universe as global economic activity ignites.
In general, emerging market smaller company stocks have not seen the same level of outperformance as their developed market peers and a number of managers are arguing that they are due for a re-rating. The emerging market smaller companies universe is broad at 1,778 stocks, as measured by the MSCI Emerging Market Small-Cap index. This covers roughly 21 emerging markets countries, with Taiwan as the largest weighting at 20.78 per cent, followed by China at 18.58 per cent, South Korea at 17.32 per cent, South Africa at 8.43 per cent and Brazil at 6.2 per cent.
Nick Mustoe, manager of the Invesco Perpetual Global Smaller Companies fund, says that he is increasingly turning his attention to this part of the global smaller companies market. “In the next 12-24 months, this part of the market will become very relevant,” he said. “There has been real weakness in these markets this year with currencies and share prices very weak. It’s an area we’ve been looking at more actively.” In particular, he has been looking at certain parts of Asia and Latin America, where share prices have been hit hardest.
Julie Dickson, head of equities at Ashmore Investment Management, says that smaller companies are most exposed to the engines driving growth in emerging markets such as consumer staples and infrastructure: “There are lots more consumer stocks and industrial materials. Small caps are a much more precise way to target economic growth in these countries.”
As with developed market smaller companies, Ms Dickson says there is not as much analyst coverage and therefore there are greater opportunities for those with the resources to research them. However, she says that liquidity can be challenging and needs careful monitoring. Mr Mustoe agrees that investors need to be mindful of liquidity, but adds that it is improving as capital markets develop in emerging markets.
However, investors keen to get exposure to emerging market smaller companies still have relatively few options available. Among the main global smaller companies funds, the F&C Global Smaller Cap Equity fund has no exposure, with manager Catherine Stanley saying that this part of the market remains too illiquid for the open-ended fund. Emerging markets appear in the closed-ended version, however. The dedicated emerging market smaller companies funds all tend to be offshore or closed-ended.
This is an exciting part of the market, and could be a key beneficiary of the improvement in global economic growth, but it remains difficult to access. Investors can either trust the asset allocation decisions of a global smaller companies manager or invest through an offshore or closed-ended fund.
Cherry Reynard is a freelance journalist