This Top-Performing Small-Cap Manager Is Betting Big on China

Although the San Francisco-based Tanneeru is relatively new to the Small Companies fund, he has also managed the $225 million
Matthews Emerging Markets Sustainable Future
fund (MASGX) since that Morningstar bronze medalist’s 2015 inception. That fund’s all-cap strategy has a heavy dose of small- and mid-cap holdings, he says, to underscore his small-company chops.

The Small Companies fund is heavily focused on China, but Indian companies represent 18% of its assets, with
Bandhan Bank
(BANDHAN.India), the country’s largest microfinance lender, and
Shriram Finance
(SHFL.India), a small enterprise financier, the fund’s No. 1 and No. 2 holdings, respectively. Both have strong balance sheets and cost-of-funds advantages which could help them grow in the medium term. Tanneeru calls them “very attractively valued.”

He views China—which, at 27.8%, represents the largest share of the fund—as one of the few markets, including the U.S. and India, where small companies can grow exponentially in a short time. As the world’s second-largest economy, it has a massive consumer base. “If you have the right product and the right strategy, there is potential for growth. To me, that is the primary attraction of China,” he says.

Geopolitics are always a risk, but he doesn’t expect tensions to seriously escalate between the U.S. and China. “China didn’t get to where it did over the last 35 to 40 years without being pragmatic,” he says. China’s small-cap companies were largely unaffected during the country’s recent crackdown on the frothy technology, education, and real estate sectors, he adds.

Tanneeru looks for innovative companies, particularly in biotech and medical devices, and those focusing on consumer goods and services. Taking a page from his Sustainable Future fund, he believes choosing well-run companies that provide necessary services will benefit both consumers and investors.

To find those companies, he works closely with Matthews Asia’s team of eight analysts and fellow co-managers Jeremy Sutch and Alex Zarechnak, employing quantitative screens to find companies with consistent, profitable growth that are good stewards of capital. The bottom-up stockpickers study private, high-quality companies to know management teams, product pipelines, capabilities, and competitive positions. It’s a collaborative and iterative process, although Tanneeru has final say.

The team looks for companies with strong balance sheets that can fund their own growth, whether those with “massive cash positions” or a product or service so attractive, they can raise capital even in stressful economic times. The fund doesn’t hedge currency risk, which Tanneeru says is too challenging and expensive. Instead, it seeks higher returns as a way to manage the risks of emerging market investing.

The Small Companies fund can invest across emerging markets, but Tanneeru is heavily overweight China versus the index, at 27.8% versus 9.5%, respectively. He says that the country is home to the best opportunities, and that Chinese companies have underpinned the fund’s outperformance.

The No. 3 holding,
Legend Biotech
(LEGN), exemplifies Tanneeru’s philosophy and process. The company partnered with
Johnson & Johnson
(JNJ) to develop a multiple myeloma therapy that allows immune cells to more effectively target that cancer. The Food and Drug Administration has approved the therapy for use in certain patients.

“The CAR-T therapy is among the world’s most efficacious and safe treatments of its kind,” he says. Since purchasing Legend Biotech not long after its initial public offering in 2020, the stock has tripled, he adds.

He’s also excited by No. 5 holding
Full Truck Alliance
(YMM), a leading freight marketplace in China that specializes in intercity transportation. It has created a digital platform to optimize routes by matching available truckers and businesses, benefiting truckers and reducing heavy-truck emissions.

Tanneeru isn’t surprised by China’s current tepid economy, noting the government didn’t provide the same massive stimulus Western governments did during Covid, nor does he expect the current stimulus injections to be substantial. Once China’s economy rebounds, he expects companies such as Full Truck Alliance to benefit.

Outside of Asia, Small Companies is adding Latin American holdings, including No. 7 holding
YDUQ3 Particiapaceoes
(YDUQ3.Brazil), a Brazilian educational company. It offers undergraduate classes and has a medical college business. During Covid it invested heavily in distance learning, and Small Companies bought it in late 2021 when prices slumped. Valuations rebounded in the past few months after strong first-quarter earnings.

Tanneeru is optimistic about emerging markets, noting countries such as China and India aren’t experiencing the same inflation problems as in the West, while countries such as Brazil appear to be managing their inflation targets after a round of aggressive interest rate hikes.

He recognizes outlooks may remain tough in emerging markets, including China. That’s why the Small Companies fund focuses on risk management and being able to pick stocks at cheap valuations that can compound.

“I think it will take a little while for some of the animal spirits to come back,” he says. “But I do expect that to happen.”

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