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FSM Fund Choice: Affin Hwang Select Asia (ex-Japan) Quantum Fund [February 2017] February 2, 2017
In this month’s Fund Choice, we will focus on the Asia ex-Japan region, exploring the “gem-rich” small cap segment and highlighting one of the Asian ex-Japan small cap fund that investors can look into in order to tap into this investment opportunity – Affin Hwang Select Asia (ex-Japan) Quantum Fund.
Author : iFAST Research Team


FSM Fund Choice: Affin Hwang Select Asia (ex-Japan) Quantum Fund [February 2017]

In our Key Investment Themes and 2017 Outlook, we have advocated favourable views on the Asian and EM equity markets, with an expectation that these two regions are poised to deliver over 40% of return by end-2018 (including dividends). In this month’s Fund Choice, we will focus on the Asia ex-Japan region, exploring the “gem-rich” small cap segment and highlighting one of the Asian ex-Japan small cap fund that investors can look into in order to tap into this investment opportunity – Affin Hwang Select Asia (ex-Japan) Quantum Fund.

Why Asia ex-Japan Small Cap

Small Cap Segment to Outperform With Strong GDP Growth Going Forward

After a lacklustre global economic condition in 2016, the global economic activity is anticipated to pick up in 2017 and 2018, with growth rates of 3.4% and 3.6% respectively. The improvement is led by the normalisation of growth rate in the world largest economy, US (the nation’s GDP makes up close to 25% of world’s GDP (based on end-2015 World Bank data), with a forecasted GDP growth rate of 2.1%. With the improving global economic growth, the global trade is likely to be boosted and this will have positive spill-over effect for Asia. Besides that, based on the IMF’s latest World Economic Outlook Report, there is an upward revision in the forecast of GDP growth rate for the emerging and developing Asia. The region’s GDP growth rate was revised up by 0.1%, to 6.4% growth, after multi-years of GDP slowdown (see Figure 1).

FIGURE 1: IMF Forecast of GDP Growth Rate for Asia ex-Japan.

Historically, since 2001, the Asia ex-Japan Small Cap Index has outperformed the Asia ex-Japan broad index when GDP accelerates (defined by 4 consecutive quarters of rising GDP growth). From Table 1, we can see that the Asia ex-Japan Small Cap Index, on average, has outperformed its counterparts when GDP growth accelerates, but underperformed if otherwise. (see Figure 2 & 3) If history is any guide, it could be a prime time for investors to gain exposure into the Asia ex-Japan small cap as the GDP growth for Asia is expected to pick up this year.

Table 1: Returns for Asia ex-Japan Small Cap vs Broad Index.

Return
Asia ex-Japan
Asia ex-Japan Small Cap
Asia GDP Growth Rate Accelerate
6.7%
7.9%
Asia GDP Growth Rate Decelerate
-7.3%
-9.0%

Source: Bloomberg, iFAST compilsations. Data as of 30 December 2016. Returns in MYR terms, dividend reinvested.

FIGURE 2: Return for index during GDP acceleration.

FIGURE 3: Return for index during GDP deceleration.

Exploit Market Inefficiency To Generate Alpha

It is understandable that most of the small-cap companies are under researched due to the issue of limited resources. With the limited resources, analysts from investment banks and brokerage firms do not have the ability to cover the full breadth of the small cap universe. Consequently, the attention will then shift to the larger capitalization stocks with greater liquidity. In 2016, HSBC research showed that 65% of the Asia small-cap companies has only 0-2 research analysts covering the stocks. Since most of the small cap stocks lack analyst coverage which results in higher level of market inefficiency, there is a higher potential for investors to uncover hidden gem within the small cap segment. With limited sell-side analyst coverage, the wiser method to seek out alpha-generating stock is to carry out your own research or leverage on fund managers’ expertise.

On top of that, the small cap segments provide investors with larger selection of companies to invest. As of end-December2016, the MSCI Asia ex-Japan index has only 626 constituents while the MSCI Asia ex-Japan Small Cap Index has 1707 constituents. The greater pool of stocks in small cap segment offers fund manager with broader range of stock to invest in. Also, most of the small cap companies have the characteristics of their stocks being heavily owned by the management and internal personnel, reflecting high insider ownership within these small cap stocks, which is another beauty of this segment. Higher insider ownership by the company management or insider parties ensures that their interests stay in line with that of the company and its shareholders. This will induce the management team to drive the profitability and efficiency of the company, which will likely result in higher future earnings growth for the particular company.

Besides that, the larger capitalised companies are usually associated with higher level of business risk due to its globalised business structure. These large multi-national companies may be vulnerable to a rise in geopolitical tensions as well as a rise in protectionism. With the new elected US president Trump’s advocating protectionism policy, there is an increasing risk for most of the multi-national company due to a surge in tariff between countries. In contrast, small cap companies’ operations tend to be more domestic in nature. Therefore, the business revenue and profitability of these small cap companies will not be negatively affected by the increase in tariff. In addition, a number of the Asia ex-Japan countries tend to have larger consumer bases, where their domestic economies are the main driver of the countries’ GDP. As a result, investing into the small cap companies in this region will help one to tap the opportunities of the domestic drivers.

Why Affin Hwang Asia ex-Japan Quantum Fund

Benchmark Agnostic, Actively Managed Fund

In order to exploit the market inefficiency in Asia ex-Japan small cap segment, actively managed fund with experienced investment team is preferable. Hence, for this month’s Fund Choice, we have decided to recommend the Affin Hwang Select Asia (ex-Japan) Quantum Fund. The fund’s objective is to seek consistent capital appreciation over medium to long-term by investing into growth companies within the Asia ex-Japan region (market capitalisation of not more than USD 1.5billion at the time of acquisition).

The Affin Hwang Select Asia ex-Japan Quantum fund adopts a bottom-up stock picking strategy. It focuses on seeking companies with potential growth through a stringent internal stock selection process. Hence, the fund is benchmark agnostic, which means that the portfolio’s allocation will not fully mimic the benchmark’s allocation.

As of 30 December 2016, the fund has high exposure to Malaysia (38.6%), followed by Singapore (16.4%), Philippines (11.4%) and Indonesia (11.3%). Comparing the fund’s country allocation with its benchmark, there are obvious differences in their geographical allocation. The fund held significant overweight positions in Malaysia and Singapore (5-year average of 30% and 19% respectively) while having an underweight position in China (5-year average of 2.6%) for the past few years (see Figure 4 & 5). On the other hand, the benchmark index has always been heavily skewed towards North Asia (China, Taiwan and Korea), having close to 60% within this region. Moreover, while the exact allocations for Malaysia and Singapore are not shown in the index, they are included in the “Others” segment, which makes up 17.8% of the index’s geographical allocation as of 30 December 2016. Even with the assumption that Malaysia and Singapore make up 17.8% of the overall index’s allocations, the combined percentage of the “Other” segment is still relatively lesser as compared to the fund’s allocation to Malaysia and Singapore, which stood at close to 50% based on the fund’s historical allocation.

Based on Figure 6, one would notice that Malaysia and Singapore small cap stocks, as represented by the MSCI Malaysia Small Cap Index and the MSCI Singapore Small Cap Index, underperformed the MSCI Asia ex-Japan Small Cap Index for the past 5 years (as of end-2016). However, Figure 7 showed that the return from the Affin Hwang Asia (ex-Japan) Quantum Fund outperformed the MSCI Asia ex-Japan Small Cap Index. (see Figure 7) This is mainly due to the superior stock picking skill of the fund manager. The fund significantly outperformed the benchmark index despite the fact that the fund overweighted the underperforming countries and underweighted the outperforming country for the past 5 years. Hence, the fund manager’s superior stock picking skill is the key highlight for the outstanding performance of this fund.

FIGURE 4: Country allocation for Affin Hwang Select Asia ex-Japan Quantum Fund (2012-2016)

FIGURE 5: Country Allocation for MSCI Asia ex-Japan Small Cap Index

FIGURE 6: Small cap segments' performance

FIGURE 7: Affin Hwang Select Asia ex-Japan Quantum vs MSCI Asia ex-Japan small cap index

Superior Track Record

In the past fifteen years, the MSCI Asia ex-Japan Small Cap Index underperformed the broad index (see Figure 8). However, although the Asia ex-Japan small cap segment was not performing during the past 15 years, the Affin Hwang Select Asia ex-Japan Quantum Fund, which invests in this small cap universe, delivered a handsome return that outperformed not only its benchmark (see Figure 7), but also the broad index (see Table 2), its peer and most of the Asia conventional funds.

FIGURE 8: MSCI Asia ex-Japan broad index vs MSCI Asia ex-Japan small cap index (2002-2016)

In comparison with the benchmark, the MSCI Asia ex-Japan Small Cap index, the fund delivered a better 5-year annualised return with relatively lower level of volatility. As a result, the fund achieved a Sharpe ratio that is significantly higher than the benchmark. (see Table 2).

Table 2: Performance assessment for Affin Hwang Select Asia ex-Japan Quantum Fund vs Benchmark.

Fund
5- Year Annualised Volatility (%)
5-Year Annualised Return (%)
Sharpe Ratio
MSCI Asia ex-Japan Small Cap Index
11.4
12.8
0.9
MSCI Asia ex-Japan
10.8
12.9 
0.9
Affin Hwang Select Asia ex-Japan Quantum Fund
9.9
15.6
1.3

Source: Bloomberg, iFAST compilsations. Data as of 26 January 2017. Returns in MYR terms, dividend reinvested.

The Affin Hwang Select Asia ex-Japan Quantum fund also outclassed its only peer on our platform, the RHB Asian Growth Opportunity Fund, in terms of volatility and return. As of 26 January 2017, the fund recorded a 3-annualised return of 12.0%, which is significantly higher than its peer’s 5.75%. As a result, the fund achieved a higher risk adjusted return as measured by Sharpe ratio.

Table 3: Performance assessment in comparison with peer.

Fund
3- Year Annualised Volatility (%)
3-Year Annualised Return (%)
3-Year Sharpe Ratio
Affin Hwang Select Asia ex-Japan Quantum Fund
9.4
12.0
1.0
RHB Asian Growth Opportunities Fund
10.1
5.8
0.3

Source: Bloomberg, iFAST compilsations. Data as of 26 January 2017. Returns in MYR terms, dividend reinvested.

In comparison with other Asia ex-Japan conventional fund, the fund had slightly underperformed one of our recommended funds, the CIMB-Principal Asia Pacific Dynamic Income Fund- MYR. However, during the past three years, the fund has significantly outperformed other Asia ex-Japan conventional funds in terms of 3-year annualised volatility and return, which result in higher excess return per unit of risk. (see Table 3)

The outstanding performance of the Affin Hwang Select Asia ex-Japan Quantum Fund was attributed to the superior stock picking skill of the fund manager. On top of that, with the splendid portfolio management and risk management skill, the fund manager was able to keep the risk of the fund even lower than other Asia conventional funds.

Table 4: Performance assessment in comparison with other Asia conventional funds.

Fund
3- Year Annualised Volatility (%)
3-Year Annualised Return (%)
3-Year Sharpe Ratio
Affin Hwang Select Asia ex-Japan Quantum Fund
11.1
12.0
0.9
CIMB-Principal Asia Pacific Dynamic Income Fund - MYR
10.4
12.7
1.0
Kenanga Asia Pacific Total Return Fund
12.1
9.4
0.6
Asia Pacific Equity Income
15.6
9.1
0.5
Pheim Asia ex-Japan Fund
13.3
5.1
0.3
AmCumulative Growth
12.8
7.6
0.4
Average (Conventional Asia ex-Japan Funds)
11.7
7.5
0.7

Source: Bloomberg, iFAST compilsations. Data as of 26 January 2017. Returns in MYR terms, dividend reinvested.

CONCLUSION

Given the historical positive correlation between the performance of small cap segment and GDP growth, together with the expectation of improving global economic growth, the outlook for Asia ex-Japan small cap segment remains attractive.

For investors who want to have exposure to the Asia ex-Japan small cap segment, they can consider investing into the Affin Hwang Select Asia (ex-Japan) Quantum Fund. The fund has shown its ability to outperform the benchmark and its peer with lower level of risk, thanks to the fund manager’s expertise in stock picking and risk management. Interested investors can consider to include the fund into the supplementary part of their portfolios, with not more than 10% allocation of their overall portfolios.

 


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