Fidelity Asian Values PLC portfolio manager Nitin Bajaj provides a detailed insight into his small-cap value investment approach at a time he’s finding many attractive opportunities and utilising the investment trust’s ability to gear in order to take advantage.

Picking the best from a pool of nearly 19,000 listed companies

Our investment process takes us towards small cap value names in Asia. The three key characteristics we look for while investing are as follows. First, it should be a good business, which means it should have a good product that customers want and are ready to pay for it, so that in the process the business can make good return on capital. Second, it should be managed by honest and competent people. Third, it should be available at a good price, which means it should offer enough margin of safety for accidents, adverse events and mistakes.

Ideas for the portfolio typically come from three separate buckets. First, roughly half come from the Fidelity’s incredible pool of analysts spread across Asia-Pacific in Shanghai, Hong Kong, Mumbai, Singapore, and Sydney who analyse companies across the entire sector and market cap spectrum. The second bucket of ideas is a screen, which filters high return on equity (ROE) businesses available at cheap prices. Finally, there are those that you could term “accidents” that happen due to our curiosity - companies that come on our radar because of being market aware and alert.

Our investment process and discipline help us stay away from bad businesses, bad people and from severely overpaying for businesses. Avoiding costly mistakes as well as making the right investments are the important factors that have helped us deliver attractive returns over the long-term.

Capitalising on the opportunity of mean reversion in the trend of small-cap growth vs value

Small-cap value stocks in Asia are trading at a significant discount to small-cap growth - even greater than the levels seen in 1999-2000. While it is hard to call the precise time when this trend will reverse, we have a high degree of confidence that the odds are against the loss-making, growth businesses that have been in fashion. It will be hard for them to sustain as rates rise and capital becomes more expensive. Whatever happens in the market, we have full faith that the businesses we have invested in will do well over medium to long term.

Views on China

There is a lot of bad press in the Western media about China. One must realise that there is increasing geopolitical tension between China and the West and media on both sides can be biased. What we read in the Western press is very different from what is published in China

Second, having invested in China for nearly a decade, my sense is that the Chinese government has a problem if you do something that harms society, but if you are doing the right thing for society and employees, it lets you be. For instance, its regulations on video games producers may look severe, but you would appreciate that these games are like psychotropic substances for a kid’s mind and to regulate that is not a bad thing.

Finally, when the Chinese government brings in regulations, it does not do so agreeably - it comes down hard with a lot of conviction.

Overall the Chinese government is not fundamentally anti-capitalist. Businesses making a positive contribution to society and “common prosperity” are much less likely to face regulatory pressure. The trust is focused on investing in such companies that are adding value to the society and people’s lives.

Current portfolio positioning, gearing strategy and stock examples

We do not look to make money by making macro calls and our country and sector allocations are an outcome of our bottom-up selection of individual companies. The process we follow focuses on detailed research into a company’s business, its management, its customers and the markets where it operates. In other words, we are buying a business, rather than a stock.

The use of gearing is not overly scientific. When we have more ideas than money, then the trust will be geared. When we have more money than ideas, then the trust will have a larger cash position. In other words, gearing depends on the investment opportunities available, rather than financial engineering.

Shriram Capital is a good example of what we look for in an investment. It is an Indian finance business of which c.80% is financing second-hand trucks to individuals who typically have limited/poor traditional credit records. The assessment of the credit risk is specialist, the asset value very truck-specific and cash collection a critical part of the business. The company is highly beneficial to society, allowing significant growth in entrepreneurship in impoverished groups, and has been built by a management team over several decades. We have become very comfortable with the business, its management and attractive valuation with strong return on equity.

Focus Media Information is another high conviction holding. It is an out-of-home media group in China with an 80% market share. Advertising is expected to grow faster than GDP and out-of-home advertising faster than overall advertising. Customers fund advertising in advance giving the business a good cash profile. Its dominant market share provides scale and so good rates, giving the company lower costs than the competition and we see an especially strong corporate culture. Having identified a “cash-machine” business with dominant share in an above-average growth sector, we are happy to pay just 11x-12x earnings.

How ESG is built into the investment process

ESG has caught investors’ imaginations lately, but this is something which has always been a part of our process. The approach to ESG goes back to the basic thesis of owning good businesses, run by good people at a good price. If a business is contributing positively to society, taking care of its employees and not harming the environment it will be at a lower risk of facing regulatory interventions. However, in some cases, the focus on ESG has shifted from its ethical aspect to becoming commercial. This is not how the trust views it.

The key takeaways

In summary, the process which underpins the trust is not complicated. We invest in good businesses, run by competent and trustworthy people at prices that offer some margin of safety. By maintaining this discipline, with the Fidelity analyst team generating great investment ideas, and with the through-cycle support of the board, we are confident that we can continue to deliver investors long-term outperformance.

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