Acorn's push into Asian small caps

Acorn Capital is an Australia-based specialist funds management group who took the plunge into the most colourful and speculative of sectors – Asian small caps – just over a year ago.

It’s probably a good indicator of how relatively lucrative this business can be to note that in its first year of operation the fund returned a mighty 22.49%, and that performance was in a year where emerging markets were supposed to be struggling.

More important perhaps for the fund is that Douglas Loh, head of equities at Acorn, and his Melbourne-based perpetually travelling investment team comfortably beat their benchmark … the MSCI ex Japan Asian Small Caps index, which rose about 20.65% over the same period.

For many investors, Asian small caps as an investment sector might seem just too adventurous, but then again throughout this series of interviews (see Platinum and Aberdeen) we are seeking managers who believe they can add value in areas which are often too difficult for the ordinary retail investor. As a new fund with just $16 million under management, we might reasonably expect the fund to be very nimble in picking up opportunities.

James Kirby: The first thing that comes to mind when an investor thinks of Asian small caps is the word ‘volatile’ … and I know they can be rewarding. But how do you deal with the dramatic swings we associate with these markets?

Douglas Loh: Well, it’s volatile ... yes, there’s no denying that, and as an investor or as a fund manager you just have to accept that. The point I would make is that we are coming in with a clear rationale looking for the best companies to hold. We reinvest in these companies and we are long-only; we don’t do any shorting.

When you look at the volatility our benchmark, the MSCI ex Japan Small Cap Index, some of that volatility comes from the fact that it can be used as a ‘trading index’ in the market … but that is not what we are doing.

JK: Why should I put money with you – or any fund manager – rather than the index itself through an index fund or an ETF?

DL: We have a team out there on the ground examining these companies, meeting these companies, and do you know that we rarely come across other institutional investors in this space?

Likewise, with the companies themselves, they are often very good family owned well-run companies with low leverage and good returns … but they have little experience in meeting outside investors.

Sometimes when we go in the first time they are very sceptical; they think we might be private equity or trying to steal trade secrets or something like that. So you have to understand the subtleties of the world we invest in. We build relationships, and when you get to know the companies, the relationship gets better and better … that’s why they take our calls.

JK: What’s your definition of a small cap stock in this widely diversified market that stretches from northern China down to the Philippines?

DL: Actually, from this perspective it’s not very different to Australia, we are looking at stocks with a market capitalisation in the range of $50 million to $1.2 billion.

JK: I expect the Australian-based investor would be getting something very different than the ASX. Do any of your companies pay dividends?

DL: They do … I would say we have an average dividend yield of perhaps 2.7%, which is quite good and improving. As a practice we reinvest these dividends.

JK: How do you approach the region in terms of allocating the money. Tell me first about how you do it in terms of geography?

DL: Our biggest market would be China and Hong Kong, though we do not really invest directly in China. We like to use Hong Kong because in that market you get quality standards in terms of corporate governance and compliance. That is 38% of our fund. The next biggest is Taiwan with about 20%, then Singapore and South Korea have around 10% each, and then it gets into smaller portions.

JK: And how big can one company be in your fund?

DL: Well often the key stocks might be 3%, though we are prepared to let them run up to around 7% on occasion if it is worth it to us?

JK: Tell us about the key holdings you have right now ?

DL: Well, we are looking for the best companies and as you can imagine there is a remarkable range of activity across the portfolio. We started this fund only a year ago with a huge amount of work before we commenced. As you know, we had run Asia-focused funds for many years [Loh was been head of Asian equities since 1998].

We screened about 5,000 stocks, and through a range of filters we got that number down to the current level of roughly 60 to 80 stocks.

JK: Can you be more specific and tell us some of the key stocks? What has been most important to you … what do you really like just now ?

DL: Certainly. Well a company that comes to mind is Xiangyu Dredging Holdings, which is involved in land reclamation activities that is a key holding in the portfolio. We also are keen on Singapore-listed Singapore Precision Engineering, which is a company involved in very precise industrial engineering work which includes working with diamonds.

One of our most interesting stocks in recent times is Overseas Education Ltd, a listed private school in Singapore. We were one of the very first institutions into that stock; now we find it is being widely followed by fund managers and brokers.

When you are working in this area you have to be patient and build relationships, you also have to enter areas where others don’t play….but often you find they come in after you.

JK: Thanks Douglas.