This emerging markets fund outperforms by finding ideas in small- and mid-cap companies

Published Wed, Mar 1 202311:30 AM ESTUpdated Wed, Mar 1 20237:22 PM EST

A keen appreciation for ideas that fly under the radar helped one emerging markets fund outperform during the pandemic. Since starting at the Matthews Emerging Markets Small Companies (MSMLX) fund in 2020, Vivek Tanneeru said he has kept his focus on small- and mid-cap companies to generate alpha (returns above a benchmark). The MSMLX, which has about $409 million in assets under management, has a five-star rating on Morningstar. The fund is highly rated for a reason: Not only is MSMLX in the top 4% of funds in its category over the last year, it's in the top 1% of funds among peers across 3-, 5- and 10 years. This year, it's up 3.5%, better than the 2.4% gain in its category, and about in line with the S & P 500. Although Tanneeru has a relatively short tenure at MSMLX, which he joined during the early days of the pandemic, the portfolio manager has been with Matthews Asia since 2011, bringing with him a successful track record. For example, his Matthews Emerging Markets Sustainable Future fund (MASGX) is also given five stars at Morningstar. Part of that achievement comes from Tanneeru's appreciation for on-the-ground research. Prior to the pandemic, Tanneeru said his firm held as many as 4,000 meetings a year with companies, and he expects Matthews will eventually get back to that volume of meetings now that travel has resumed since the middle of 2022. "Roughly half of the small-cap companies in our universe do not have research coverage. So, they're not actively covered by the sell-side researchers," Tanneeru said. "That really opens up opportunities for people that are willing to do the legwork, willing to go meet these companies on the ground." That due diligence could easily result in a fount of ideas for investors. Tanneeru, who said he has worked across four continents in his career, said that focusing on small-caps help him find well-run companies that are tapping into the exuberant consumer growth in Asia, as well as cutting-edge technologies developing in emerging markets. "Throughout my career, I've looked at small and mid caps as a really good way to source ideas that are able to add performance," he added. Pandemic winners The MSMLX has outpaced its peers over the last three years. In 2022, it fell 16.8%, a decline that was still better than the nearly 20.9% fall in its category, according to Morningstar. In 2021, it jumped 22%, sharply outperforming the 0.4% gain among peers. In 2020, it soared 43.7%, far better than the 17.9% that was seen in the category. Matthews Emerging Markets Small Companies sports an expense ratio of 1.36%, and average annual 3-year returns of 15.7%, 5-year annual returns of 7.7% and 10-year returns of 6.9%, according to Morningstar. Among the winning stocks that helped the fund outperform lately were beneficiaries of economies reopening post-pandemic. Whether in India or the Philippines, consumer discretionary names got a dramatic boost as Covid restrictions were eased. In 2022, the biggest winners in the portfolio included hotel operator Lemon Tree Hotels and retail mall operator Phoenix Mills , both in India. MSMLX started buying Lemon Tree Hotels during the depths of the pandemic, and had a 4% allocation to the stock in September 2022, making it the fund's fifth-largest position at the time, according to Morningstar. Last year, after India eased Covid restrictions and consumption rebounded above 2019 levels, the stock soared 84%. The fund also bought shares of Phoenix Mills, a real estate investment platform with some attractive properties. The company has partnerships with large pension plans, such as the Canada Pension Plan Investment Board , as well as other sovereign wealth funds such as Singapore's GIC . In 2022, the stock jumped 43%. "India and Indonesia were two of the laggards when it came to reopening post Covid. So, as discretionary spend picked up in both those economies, that space really did well," Tanneeru said. One stock Tanneeru is particularly bullish on now is Legend Biotech . As of January 2023, the stock was the only U.S.-listed name among MSMLX's top 10 holdings, taking up 4.1% of the portfolio. A cell therapy company developing treatments for multiple myeloma, a type of blood cancer, Legend has operations in China and the U.S., and a collaboration agreement with Janssen Biotech. LEGN 1Y mountain Legend Biotech in past year "There are some products available from competitors here in the U.S., but in my mind, Legend has probably the best in class product," Tanneeru said. The sponsored ADRs are down about 5% in 2023 after rising 7% last year. 2023 and beyond Tanneeru, who came to Matthews after stints at Pictet Asset Management in London, the World Bank and Arthur Andersen, continues to range far afield searching for outperformance. The London Business school grad is planning to trim some of his exposure to India, which had been overweighted in the portfolio. In September, MSMLX had a near 30% allocation to the country, above the 15% allo