Funds of this type have been among the best performers in both the open- and closed-ended universe in recent years, but Asquith, who heads up the five crown-rated Somerset Emerging Markets Small Cap fund, says many are being forced into larger companies. "Many of our peers are running £2bn portfolios," said the FE Alpha Manager. "You can’t run a 40-stock portfolio in today’s environment at these levels."
"Some investors aren’t getting what they thought they were investing in."
Asquith explains that as funds grow in size, this automatically constrains the number of small companies they can access and means they cannot take advantage of some of the best growth stories in the sector.
Since liquidity is an issue in both emerging markets and smaller companies, Asquith says his universe of stocks is especially small, which led him to close the fund to new money back in May 2011.
The Somerset Emerging Markets Small Cap fund has £57.2m assets under management (AUM), but the overall strategy also includes a US-listed version of the fund, pushing total assets up to $450m.
Asquith soft-closed the fund at $250m.
The biggest small cap emerging markets fund is Aberdeen Global Emerging Markets Smaller Companies, which has $2.7bn AUM. It is one of the best-performing funds in the entire unit trust and OEIC universe over five and 10 years, but much of this stellar performance was delivered when the fund was much smaller.
According to FE data, it has grown from $500m to $2.7bn in less than three years.
Since the Somerset fund’s launch in November 2011, Aberdeen Global Emerging Markets Smaller Companies has returned significantly more. According to FE data, it is up 23.24 per cent, compared with 5.08 per cent from Asquith’s portfolio.
Performance of funds vs sector since Nov 2011
Source: FE Analytics
Over the relatively brief track record, the two portfolios have been similar in terms of volatility. Over two years the Aberdeen fund has an annualised score of 14.25 per cent, while the Somerset fund sits at 14.99 per cent.
However, Asquith points out that over the long-term, larger funds may be forced into sectors or regions where risks are too high, thus damaging overall performance.
He cites Russia as an example of a country he is not investing in, because of the corporate governance risk.
"I don’t have anything in Russia," he said. "I expect that to be a painful position to be in this year because it could have quite a good year. But it’s not just about cheapness – the key risk is corporate governance."
"There is such a small universe of companies in the small cap space [in Russia]. At some point there is a price for that, but on a strategic basis, I’m still loathe to buy companies in Russia."
Asquith says there are four key things he looks for when deciding whether or not to add a company to his concentrated portfolio.
1) Valuation risk – What is the payback period? How long will he have to wait to get any money back?
2) Business risk – Will the company still be around in 10 to 15 years and will it continue to be profitable?
3) Financial risk – Asquith wants the leverage on the balance sheets of companies he invests in to be below 30 per cent
4) Corporate governance risk
On political factors, Asquith says: "There is no quicker way to lose your shirt in emerging markets than to get caught in some Chinese company’s business quirk."
He is cautious about China overall, although he is buying quality cyclicals in the industrials and materials space.
As a manager, Asquith has outperformed his peer group composite over one, three and five years, more than doubling the returns of his peers over the long-term.
Over five years, he has made 79.33 per cent, while the peer group has picked up 35.38 per cent, according to FE Analytics.