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Innovation Ignites Alpha in Asia

Small companies provide an opportunity to invest in Asia’s innovation edge and entrepreneurial spirit at an early stage. 

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Overview

  • Educated workers, evolving capital markets and a vast consumer market have helped create a robust innovation ecosystem that nurtures both small and large companies across markets and sectors in Asia.
  • Finding innovative companies early in their lifecycle can add alpha to portfolios – a bottom-up and active process is key to idea generation and risk management.
  • Our showcase of innovative smaller companies highlights the depth and diversity of opportunity. 

At its best, innovation can drive rapid revenue growth, superior competitive positioning and create an economic moat for businesses. Within the innovation cycle, there is a key component. Smaller companies are often both the source of innovation and the bridge that enables emerging and fast-growing countries to transition to higher-value added economies and compete at a bigger scale.
 
Many smaller companies, which we generally define as US$1-5 billion in market capitalization, operate in nascent and fast-growing industries. In some countries, they may lack access to capital which can make them more competitive, innovative and capital-efficient than their larger peers. 

In Asia, the innovative potential of smaller companies has changed dramatically in the last decade thanks mainly to three developments: the growth of a large, highly educated, well-trained workforce, with more engineers, PhDs, and filed patents than any other region; the entrenchment of a sizable venture capital and public equity markets; and the emergence of Asia as the world's largest addressable consumer market. These three factors have supported a strong R&D spend that has helped create a robust innovation ecosystem in Asia which nurtures both small and large companies across markets and sectors.



As this ecosystem has evolved, so too have investment opportunities. For example, secular opportunities in sophisticated industries, from automation and digitalization to entertainment and healthcare, are set to supersede growth from high-volume basic industries. In our view, investors can capture these secular growth trends most effectively by gaining exposure to innovative small-cap companies that will come to dominate these new industries.

Teeming with growth

Small companies have always been an integral part of the Asia’s economy and as capital markets have deepened, the investment universe has grown considerably. A significant proportion of this growth has come from China. Between 2007 and 2022 the number of Chinese small caps surged, most notably in the innovative sectors of information technology, from 180 to 932, and healthcare, from 127 to 574 (see Figure B). In these two sectors, the universe has nearly twice the number of growth stocks than the MSCI China Index.

In many ways China is a natural home for small cap opportunities. Among urban employment, 88% work in small, privately-owned, entrepreneurial companies and China’s small-cap universe has grown to become one of the largest globally, with over 5,000 companies.1

Small companies have always been an integral part of Asia’s economy and as capital markets have deepened, the investment universe has grown considerably.

Small-cap specialisms

While innovative small caps can be found across all sectors and industries in Asia, they tend to reflect the different stages of development of the various economies. For example, in South Korea, Hong Kong and Singapore, we see innovation driven by aging populations, in areas such as biopharma and factory automation. In countries like India, Indonesia and Bangladesh, we find innovation among small companies providing both basic banking and private banking services. 

In China, smaller companies benefit from the tailwinds of seemingly unstoppable trends, such as Chinese consumer upgrades and hyperconnectivity (see Figure C). These trends are associated with income growth, technology, manufacturing, and energy self-sufficiency, as well as market share opportunities and gains in complex supply chains previously dominated by foreign players.

Managing risk and reward

Over the past decades, we have witnessed many innovative companies rewarded for the product and service ideas that are meeting the new demands of a region of rising wealth in Asia.
 
Innovation, however, can also bring challenges as it sometimes captures investor interest on the basis of little more than speculation and excitement. We take the associated risks seriously and view our in-depth due diligence process as a key component of our ability to mitigate risk. We stick to a consistent philosophy and strategy, keeping in close communication with companies and remaining resolute amid short-term volatility.

In our experience, finding innovative companies early in their lifecycle can be a critical source of alpha; we often establish contact long before an IPO and the company potentially entering an exponential growth phase as getting to know company management has been a key part of our investment process.

We believe a bottom-up process is particularly suited to Asian small caps. This involves visiting companies on-the-ground – headquarters, factories, stores, and talking to management, suppliers and customers – as well as investigating financials.

In an economic downturn or when financial conditions tighten, small companies generally find it harder to access capital compared to large companies. Seeking small companies with strong balance sheets, superior cash generation capabilities and low leverage ratios can effectively address these potential funding challenges and underlines the importance of fundamental research.

Over the past decades, we have witnessed many innovative companies rewarded for the product and service ideas that are meeting the new demands of a region of rising wealth in Asia.

Forward looking exposure

We believe small companies provide an opportunity to invest in Asia’s innovation edge and partner with minority shareholder-friendly entrepreneurs at early stages. Yet the region’s benchmarks do not adequately reflect its potential. As active investors focused on Emerging Markets and Asia, we believe they are too backward-looking. Many of the exciting trends we see today will be reflected in the major regional benchmarks only in years or decades to come.

Legend Biotech
Biotech

A Chinese biotech company recognized that antibody-based therapeutics could potentially treat disease. Today it is a leader in cell therapy and immuno-oncology. The company created a hugely innovative process to treat a deadly form of cancer that involves extracting, modifying, multiplying, and reinserting immune cells, and has entered a licensing agreement with a global pharma giant. 

Silergy
Integrated Device Manufacturer (IDM)
 
When one of China’s largest semiconductor companies started out it created a virtual IDM business model that set it years ahead of its competitors. This enabled the company to collaborate with semiconductor foundries, fabless companies and outsource semiconductor assembly and test (OSAT) houses to solve challenges in technology, manufacturing and business. Today it has industry-leading process technology to design innovative designs mixed- signal and analog power management integrated circuits that are used in industrial, consumer, computing and communications.

Bandhan Bank
Microfinance

An Indian microfinance and mortgage lender launched a series of digital initiatives to capitalize on the growth of smartphone penetration in India’s rural areas. The initiatives included completely paperless and contactless account opening process, and upskilling customers to increase adoption of digital banking. They translated into tremendous growth for the company, which continues to expand its footprint.

EcoPro BM
EV Batteries

South Korea’s largest producer of cathodes for EV batteries was born out of the vision to develop eco-friendly core materials and parts to improve air quality. The cathode is the single most expensive component of a battery cell, and cathode materials, such as lithium, nickel and cobalt, are the core materials that determine a battery’s voltage, energy density, lifespan, output. The company develops next-generation materials that addresses volume limitations and cost competitiveness. 

Zhejiang Shuanghuan Driveline
Renewables and Robotics

This Chinese company makes both EV auto parts (electric drives) and robotics components (RV reducers), benefitting from secular penetration opportunities in both electric vehicles and factory automation in China. As a key supplier to a tier one EV Original Equipment Manufacturer (OEM), the company’s EV business has grown steadily. More recently, the company made a breakthrough in RV reducers, which are a major component in robots. Given China’s aging demographic shifts and increasing wages, more robotics and automation solutions are used in today’s factories. Across both areas of the business, localization opportunities give Chinese manufacturers in complex manufacturing a chance to move up the value chain and take market share from foreign counterparts. 

Morimatsu International
Complex Manufacturing

This Chinese industrial company is a leading provider of complex equipment, process systems and digitalized engineering solutions. Initially it provided core pressure equipment and integrated solutions to mainly the oil and gas chemical industry, but in recent times has successfully broadened out to pharmaceuticals, power battery raw materials, electronic chemistry and other fields. The company focuses on continuous innovation in complex being amongst the first Chinese players to break into an arena historically dominated by western world competitors. manufacturing to serve different downstream industries in large scale projects, successfully being amongst the first Chinese players to break into an arena historically dominated by western world competitors.

1 CEIC, as of October 27, 2021

Definitions

Alpha Alpha, a commonly quoted indicator of investment performance, is defined as the excess return on an investment relative to the return on a benchmark index.

Leverage ratio A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans) or assesses the ability of a company to meet its financial obligations.

MSCI China Index The MSCI China Index is a free float–adjusted market capitalization–weighted index of Chinese equities that includes China-affiliated corporations and H shares listed on the Hong Kong Exchange, and B shares listed on the Shanghai and Shenzhen exchanges.

It is not possible to invest in an Index.
 
Holdings are subject to change. 

As of 30/09/2023, accounts managed by Matthews Asia held positions in Legend Biotech, Silergy, Bandhan Bank, Ecopro BM, Zhejiang Shuanghuan Driveline and Morimatsu International. This information is presented solely for illustrative purposes and is not representative of the results of any particular security or product.

Matthews Asia Innovative Growth Fund current top 10 holdings. Current and future holdings are subject to change and risk.

Matthews Asia Small Companies Fund current top 10 holdings. Current and future holdings are subject to change and risk.

Matthews Asia Sustainable Future Fund current top 10 holdings. Current and future holdings are subject to change and risk.

Matthews China Small Companies Fund current top 10 holdings. Current and future holdings are subject to change and risk.

Matthews Emerging Markets Discovery Fund current top 10 holdings. Current and future holdings are subject to change and risk.

Matthews India Fund current top ten holdings. Current and future holdings are subject to change and risk.

The information in these case studies is presented solely to illustrate Matthews Asia’s investment process. It should not be considered a recommendation to buy, sell or hold the security discussed (the “Security") nor a representation as to whether the Security is currently held. The statements above are based on the beliefs and assumptions of our portfolio management team and on the information that was available to our team at the time such statements were made. Although we believe that the expectations reflected in these statements are reasonable, we can give no assurance or guarantee that these expectations will prove to be correct.

 

IMPORTANT INFORMATION

The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investing in small- and mid-size companies is more risky and volatile than investing in large companies as they may be more volatile and less liquid than larger companies. Past performance is no guarantee of future results. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.

 

 



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