Emerging Market Doesn't Equal Small Cap, Anymore

When you see ‘emerging markets’ and ‘small cap’ in the same sentence do you automatically think it’s redundant? While it may have been so once, it’s time to revise your thinking. With the largest IPO in history–Industrial & Commercial Bank of China–brought to market in Hong Kong and Shanghai in the last week of October, and raising nearly $20 billion, emerging markets no linger necessarily means small cap. That’s one of the reasons behind the launch of a new mutual fund, Templeton Emerging Markets Small Cap Fund.

“If you look at the universe of emerging markets stocks, it numbers about 17,000 names around the world. The big portion of those names cannot be purchased by our normal global emerging markets funds because the liquidity of many of these companies is too small, and the companies themselves are too small–but there’s a lot of value out there in these smaller companies,” says Mark Mobius, by phone from Kuala Lumpur, Malaysia. He is CEO of investment management at Franklin Templeton and a portfolio manager of the new fund, along with Tom Wu and Dennis Lim.

Not many vehicles that invest in small caps in emerging markets exist. “These are companies with a market capitalization of less than $1 billion,” explains Mobius. “I don’t know of any other open-end fund in the U.S. that’s small cap emerging markets–there may be, but I don’t know of any.” One reason why is that now you can differentiate the capitalization of emerging markets companies. “Everybody up to now thought, ‘Emerging markets are small cap, because if you compare them with the U.S., by definition they must be small caps. That was probably true back in 1987 when we started the first emerging markets fund, basically these companies were all very small… now things have changed and you’ve got very big companies in emerging markets.”

The fund will hold “probably 50 or 60 companies at the beginning,” according to Mobius, and then more companies as it gathers assets. “The nice thing about a fund like this is that you can go into countries that normally wouldn’t be available to us; for example I was just in Romania. There, the companies are so small they wouldn’t be eligible for the global funds but they’re eligible for the Small Cap Fund. I was also in Croatia; we did have one pharmaceutical company in our global funds but we recently sold that,” because it was bought by a U.S. pharmaceutical company. “There are other companies there but they’re just too small for our global funds. The Emerging Markets Small Cap Fund “just opened us up to other countries that normally would not be viable.”