Buy small in Asia

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The UK has a thriving small-cap market, but for better growth prospects and diversification you could look away from the UK and towards Asia, which offers many reasonably valued companies. This is not an area where UK-based investors are likely to have much advantage, so a good way to access smaller Asian companies is the Scottish Oriental Smaller Companies Trust. Like its holdings, it offers good value; the trust trades on a discount to net asset value (NAV) of 9.45 per cent, wider than its 12-month average of 6.80 per cent.

Scottish Oriental Smaller Companies has a very strong performance record, outperforming its benchmark MSCI Asia ex Japan over one, three and five years, at times massively. It has also beaten the MSCI Asia (ex Japan) Small-Cap index, both in terms of NAV and share price returns.

That should come as no surprise when you hear that the trust is run by the team at First State, one of the best Asia and emerging markets' managers. First State mainly runs open-ended funds, but from January many of these will soft close, meaning it will become much more expensive to invest in them.

Read more on soft closures

Scottish Oriental Smaller Companies aims for long-term capital growth by mainly investing in smaller Asian companies with market capitalisations under $1bn (£637m). Its managers seek attractively priced, good quality companies with solid long-term growth prospects, and to a lesser extent consider cultural, political, economic and sector factors.

The trust's country weightings do not bear any relationship to regional stock market indices, which means that the trust offers exposure to some countries not covered by its benchmark, including Vietnam and Sri Lanka, which are less developed but potentially faster growing.

Over its last financial year, the trust also benefited from overweight positions in Indonesia and Thailand, the latter on the strength of growing domestic consumption. Other overweights include Singapore, because of the wide geographical reach of many of the city-state's companies.

But the trust is underweight China-related companies because of the lack of credit availability and an uncertain outlook for China's exporters, issues we highlighted in Beware China (4 November 2011).

Scottish Oriental Smaller Companies' largest sector exposure is consumer discretionary, which accounts for nearly a third of assets, and helps to tap into strong domestic demand growth. Financials, also a good proxy for domestic growth, account for nearly a quarter of assets, with 11.8 per cent in industrials and 11.2 per cent in information technology.

The trust tries to contain risk by concentrating on soundly managed and financially strong companies, and reasonable geographic and sector diversification. Holdings are monitored to ensure performance meets expectations and valuations are not excessive. If the holdings do not meet these criteria, they are sold. The trust's managers also meet company management teams.

Susie Rippingall has managed the trust since 2000 after joining the First State's Asian Equities team in 1995, and also running Asian equities at Lehman Brothers Global Asset Management for four years.

A major downside is the trust's rising total expense ratio (TER), which is down to a performance fee. Because the trust has done well, this has been levied for two years in a row, taking the 2010 TER of 1.65 per cent to 2.29 per cent this year.

However, the strong performance means that even with a high fee, you should still make good returns; if you don't, then there will be no performance fee. So, if you are prepared for the higher volatility small-caps engender, then this trust - with its strong record of picking fast-growing companies in a fast-growing region - could be a good buy.

Morningstar, *First State Investments.

Performance data as at 13 December 2011.

TOP TEN HOLDINGS as at 31 October 2011

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