JP Morgan Asset Management has outlined plans to launch its third Greater China fund, but this latest product is differentiated by being focused purely on small- to mid-cap companies.

The open-ended JF Greater China Smaller Companies Fund will be targeted at Hong Kong retail investors, although the firm has not ruled out investment from institutions or large corporations.

The new product will invest in 60 to 90 stocks with a market capitalisation of between $200 million to $2 billion, the majority of which will be listed in Hong Kong. It will also look at offshore-listed Chinese companies, primarily in the US, and selectively in Singapore and London as well as China B-shares.

The share of market exposure will roughly be 50% to China and a third each to Hong Kong and Taiwan.

However, the fund will not invest in China’s A-share market. The company already has two such funds through its QFII quota:  the JF China New Generation Fund (down 7.4% year-to-date and down 0.9% since inception in August 2009), and JF China Pioneer A-share Fund (down 9.9% year-to-date but up 161% since inception in 2006).

JP Morgan already has two Greater China products: the JF Greater China Fund (down 4.2% as at August 31) and the JF Greater China Absolute Return Fund (up 5.2% as at August 31).

There are 55 Greater-China-focused fund classes in Hong Kong, according to research house MorningStar. Value Partners China Greenchip leads in terms of year-to-date performance at 15.35% and 44.82% in terms of one-year return.

However, JP Morgan believes there are only two comparable products to its new fund: Guotai Junan Greater China Growth (up 2.5% year-to-date) and market-leader Value Partners China Greenchip.

Terry Pan, head of retail business at JP Morgan Asset Management, says the rationale of the new fund is to expose return-hungry Hong Kong investors to the Greater China growth story through a universe of more than 1,800 small and mid-cap companies.

“Most of these companies are under-covered by equity analysts in brokerage houses,” he says. “It requires strong local relationships and expertise to understand the individual business models of these companies, identifying the potential winners from the rest of the herd.

“2010 has generally been a difficult year for investors, with prominent themes being fixed income and emerging markets. But ultimately [Hong Kong] people are looking for return. At a time when investor confidence is not there, they want to find return in areas they are more familiar with [such as equities].”

Emerson Yip, managing director of JP Morgan AM’s Greater China team, points out that its new fund will not be benchmark driven, but will offer diversification benefits by moving away from Greater China index heavyweights.

Playing on China’s domestic demand priorities, Yip adds: “We believe small- and mid-caps can offer higher exposure to key subsectors within our major investment themes of Asian domestic consumption and infrastructure, such as food and beverages, specialty retail and healthcare.

“Smaller companies, which tend to be more leveraged to the domestic economy, can benefit from this sustainable growth trend.”

Evidently, though, investing in small, growth-orientated companies comes with added risk, given their capital needs and the fact they are predominantly not state-backed. Fraud is also considered a stronger possibility, while management depth tends to be shallow, as does liquidity in such stocks generally.

“We are trying to minimise the risks by having a diversified portfolio approach, with the types of ideas spread over three markets and different sectors,” says Yip, who also highlights the in-house resources at his disposal.

JP Morgan Asset Management has five fund managers in Hong Kong, plus two regional small-cap specialists based in the city. It also has eight fund managers in Taiwan and 24 through its China International Fund Management joint-venture.

The fundraising period for JP Morgan’s new product runs from October 4 to October 29, with the investment launch set for November 1. Minimum investment is either $2,000 or HK$1,000 monthly. There is an initial charge of up to 5% of net asset value (NAV), a redemption charge of up to 0.5% of NAV and an annual management fee of 1.75%.