F&C's Asia specialists stay focused on small caps and soft commodities

Speaking at a briefing in London today (4 July 2007), two leading Asia specialist fund managers reaffirmed their belief that despite a decade of outperformance the greatest stock opportunities in the region are still to be found among small and mid cap stocks.

However, according to Citywire AAA-rated Mark Williams, manager of the F&C Pacific Growth Fund, and Peter Dalgliesh, manager of the Pacific Assets Trust plc, stretched valuations mean that selectiveness is more important that ever.

"Small caps have been able to exploit fragmented areas of the market where competition is less intense and grow to a scale at which they can generate formidable barriers to entry, thereby protecting their margins and profitability. With a population and a potential customer base of 1.2bn China has been and continues to be the principal playground for smaller companies, with many untapped areas of growth. One area of the market where we continue to see opportunities is within the soft commodity space," said Williams.

"The prices of soft commodities have risen significantly in the recent past, compounded by rising competition between food and fuel for the first time. By this I mean, with increasing demand for biofuels as an alternative to fossil fuels, traditional food stuffs are being used as a source of fuel. Equally, as developing countries have become more affluent so too have we seen a rise in the consumption of meat, driving up the demand for corn to feed livestock," said Williams.

According to recent statistics China's meat consumption has risen by 50% over the last 15 years but is still some 25% below that of the developed market average, which provides scope for further price appreciation. In the short term, recent droughts, particularly in Australia, has constrained the supply of corn, exacerbated over the medium term as increasing urbanisation across Asia's cities has marginally destroyed farmland, further pressurising agricultural product prices upwards.

The supply and treatment of water also present good growth opportunities.

Dalgliesh, who has invested in Hong Kong-listed China Water Affairs in his Pacific Assets Trust, half of which is invested in small and mid cap stocks, said: "Expanding urbanisation, industrialisation and affluence across Asia has seen the demand for clean water increase. Companies like China Water Affairs, which is Chaired by a former Chinese Ministry of Water Resources official, are not only benefiting from the increase in demand but they also stand to benefit from any future increase in tariffs which have stayed flat for the past five years. In addition, the shortage of water should also boost profits for water treatment companies such as Tianjin Capital, which is located in the heavily industrialised north-eastern region of China, an area earmarked in the government's latest five year plan for further economic growth."

The move towards alternative energy is also boosting demand for palm oil and the cleaner coal derived fuel dimethyl ether or DME. Both Dalgliesh and Williams have invested in palm oil across their portfolios, including leading Malaysian palm oil player IOI Corporation and China Energy which makes DME, mixed with LPG and used for domestic gas.

However, according to Williams, while it is tempting to see Chinese growth as a wave to ride, active fund management and shrewd stock picking are vital.

"There are pockets where stocks seem overvalued, such as the domestic Chinese A share market, and therefore investors, such as ourselves, must tread with utmost caution. Being able to meet regularly with company management and having the resources to constantly monitor various areas of the market, is indispensable to investment in the fast developing economies of Asia," he concluded.