Investors turn to small-cap stocks to beat pricey KLCI

By Chan Quan Min

While still charting new highs, trading on the local bourse this year to date has been far less lively than in 2013. Investors have reason to tread cautiously — a nearly six-year-long bull market has made blue chips expensive. Buying into smaller less visible counters is one strategy to boost returns; another is to stay invested in only the most reputable companies.

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Bursa Malaysia is the undisputed world’s longest-running equity rally, according to data compiled by Bloomberg. But after riding high for close to six long years the local bourse is evidently losing momentum.

More than a month into the second half of the year, there is little chance of the stock market matching up to last year’s stellar gains.

The world’s longest-running bull market got a boost last year from a relief rally that followed the closely contested May 2013 general election and extended well into the new year. It is now August 2014 and the market is lagging.

But that is not to say the market has stopped charting new highs. So far this year, the KLCI has stayed above the 1,800 mark save a few short weeks between January and February. The index hit an all time high of 1,896 points just last month on July 8.

Investors are noticeably losing interest but experts say there is still good money to be made, just less of it. They emphasise the need for investors to be selective and pick the right stocks.

Investors getting cautious

Trading on the local bourse, in recent months, has been cautious. Compared to last year, investors are clearly not buying and selling shares with the same fervour.

The average daily trading volume of the FTSE Bursa Malaysia Kuala Lumpur Composite Index or FBM KLCI is lower by about 16% this year compared to last year’s daily average. And retail investors are not holding on to their shares quite as long.

Patrick Wong, a remisier at Hong Leong Bank’s HLeBroking told KiniBiz many of his clients are no longer buying stock to keep. “I’m noticing quite a lot of day trading,” he said last week. “My clients prefer active stocks.”

Wong’s clients could be turning away from blue chips because they have become too expensive.

Kenanga head of research Chan Ken Yew last month warned that the stock market could be “approaching overbought territory.” He added that FBM KLCI component stocks are trading near their “ceiling valuations.”

Consensus estimates by major research houses has the FBM KLCI rising by no more than 3% in the near term, Chan told reporters in a press briefing. If so, investors “might as well turn to the money market,” which also returns around 3% risk-free, he said.

Chan is not alone in his views. Maybank head of research Wong Chew Hann also last month warned of “elevated” blue chip valuations. “The KLCI is unlikely to re-rate significantly,” he said.

The benchmark blue chip index “underperformed in the region in the first half (1H14) largely due to its outperformance in 2013, which led to valuations sustained at high levels,” Wong said.

He added that blue chips “should scale higher in the second half (2H14) riding on global liquidity which is likely to say elevated.”

One major source of global liquidity, thought to be supportive of emerging market economies, is the US Federal Reserve’s quantitative easing programme. Bond buying under the programme is gradually being wound down and could end completely in a matter of months.

In its place, the European Central Bank could potentially make a large-scale injection of cash, Wong said. And despite the end of quantitative easing, international finance will still have access to cheap money. Wong and many of his peers do not expect the US to raise interest rates until mid-2015.

Investors are however advised by Wong “to do some switching into stocks whose outlook has improved.” They include heavyweights such as Tenaga Nasional Bhd, Axiata Group Bhd, Sime Darby Bhd, Gamuda Bhd, Genting Malaysia Bhd and UMW Oil & Gas Bhd.

Banking stocks do not excite

Banking stocks, which dominate the FBM-KLCI, are not attracting investors. According to a Maybank IB Research report, “Malaysian banks fail to excite” fund managers “due to a lack of strong catalysts and premium valuations to the region.”

“The investors we met during our recent marketing trip to Singapore and Hong Kong have largely given Malaysian banks a miss… Investors remain wary of rising inflation and the impact on consumer demand.

“Much of the interest in banks revolved around the CIMB-RHB-MBSB merger instead,” said Desmond Ch’ng, an analyst at Maybank’s research arm.

There is however one bright spot for investor’s looking for exposure to the banking sector. Ch’ng’s top recommendation in the sector is Alliance Financial Group (AFG) with an estimated 12% upside for its “strong fundamentals, high leverage to rising interest rates, strong capitalisation and attractive dividend yields.”

Consumer loans, accounting for just over a half of all loans, is “expected to moderate amid rising living costs” while there is a good possibility of a “pick-up in corporate loans,” said Ch’ng.

Given lacklustre prospects for most Bursa Malaysia heavyweights, some experts advocate a change to small and mid cap stocks for investors who do not mind taking on more risk.

Small cap stocks can perform

So far, second liners on the local bourse are outperforming the blue chips this year. To-date the FTSE Bursa Malaysia Small Cap index is up 22% against the FBM KLCI’s measly 0.6% since January.

From the May 2013 general election the FBM Small Cap index is up a stunning 61% compared to 11% for the FBM KLCI.

“While small-mid caps have trounced the large caps’ year to date returns in all sectors under our coverage in the first half (1H14), we reckon market conditions will still support further outperformance,” said UOB Kay Hian head of research Vincent Khoo.

In a report two weeks ago, the research house named Barakah Offshore Petroleum Bhd, Deleum Bhd, Hong Leong Industries Bhd, Malaysia Resources Corporation Bhd (MRCB) as good second liner investments, all promising returns well above 10%.

MRCB was singled out as an “emerging developer” with “multiple catalysts” such as upcoming developments in choice locations, property disposals to Quill Capita REIT and favourable lease terms for the Eastern Dispersal Link (EDL) in Johor.

Kwasa Land Sdn Bhd, a wholly-owned subsidiary of the Employees Provident Fund (EPF), earlier this year awarded MRCB development rights to a major portion of a new township on former Rubber Research Institute land in Sungai Buloh. The entire development has a projected gross development value (GDV) of RM50 billion.

In the same report, UOB Kay Hian told investors to be “selective in stock picking.” Investors are advised to steer clear of “companies trading at high multiples” or situations where speculators “bid up unproven conceptual stocks without perusing the strength of their business models.”

Andrew San, an assistant investment manager on the Asia Pacific (ex Japan) equities team of Aberdeen Asset Management, also emphasised the need for individual investors to understand the business they are buying into.

San’s employer, a foreign fund manager with a strong presence in the country, invests in a concentrated portfolio of companies with a trustworthy management.

Despite the rich valuations, Aberdeen in staying “in the market,” San shared with KiniBiz in a telephone conversation. “We don’t hold cash to time the market,” he said.

Investors should not lose interest in the market simply because prospects are not what they once were, San told KiniBiz. Downturns, he said, is an “opportune time to look at businesses” to “see how they fare” in adversity.

San advises investors to continue to monitor share prices for the right moment to strike.

While doing that, investors might find themselves considering other asset classes. They may consider fixed-income investments such as corporate bonds and managed funds, which coincidentally is the focus of tomorrows article in this four-part series.

Yesterday: Where to put your money: stocks, bonds or property?

Tomorrow: Are bonds worth the investment?