KUALA LUMPUR, May 18 — Malaysia’s top-performing fund manager is adding to holdings of the nation’s small-cap stocks, betting that a bull-market rally will continue as earnings improve and valuations trail larger peers.

Kenanga Investors Bhd. favours exporters and builders as the US economy recovers and Malaysia boosts spending on infrastructure, Chief Investment Officer Lee Sook Yee said in an interview. The FTSE Bursa Malaysia Small Cap Index is valued at 10.2 times estimated earnings, a 39 per cent discount versus the FTSE Bursa Malaysia KLCI Index of the biggest stocks.

Smaller companies are involved in more diverse industries with better prospects than larger peers, which are dominated by banks and commodity producers, Lee said. Profits at companies in the small-cap measure will increase 21 per cent in the next 12 months, compared with a 3.5 per cent gain for the KLCI, analyst estimates compiled by Bloomberg show.

“Small caps will continue to outperform the narrower KLCI index and lead the recovery,” said Lee, who helps oversee RM5.6 billion. “Even after the outperformance, we continue to see value within this space.”

The small-cap index rose 0.1 per cent at 9.26am local time, poised for the highest close since April 27. It has gained 10 per cent this year, more than three times the KLCI’s 2.9 per cent gain.

Lee said exporters are benefiting from the weaker ringgit as well as being “indirect proxies” to the recovery in both the technology industry and US consumer confidence.

Currency drop

Inari Amertron Bhd., the semiconductor packager whose main client is US-based Avago Technologies Ltd., is among the best performers on the small-cap gauge this year, with a 41 per cent advance. Malaysian Pacific Industries Bhd., a semiconductor company which gets 29 per cent of its revenue from the US, has jumped 48 per cent.

Malaysia’s currency has fallen 6.1 per cent against the dollar in the past six months, the second-biggest drop after Indonesia’s rupiah, helping to boost overseas earnings for exporters. The US labour market has continued to strengthen with data last week showing the fewest jobless claims in 15 years, while the Nasdaq Composite in April topped its 2000 dot- com-era high.

The Kenanga Growth Fund, set up for long term capital growth and to outperform the KLCI, has returned 21 per cent annually in the past five years to beat 87 peers with assets of more than US$100 million (RM360 million), according to data compiled by Bloomberg. Kenanga’s top holdings include builders IJM Corp. and Gamuda Bhd.

IJM, whose net income doubled in 2014 from a year earlier, has risen 8.4 per cent this year. Gamuda, which is helping to develop Malaysia’s first mass rail network, posted a 33 per cent increase in 2014 net income.

Government spending

The government plans to spend RM48.5 billion on development this year, including the Pan-Borneo Highway and other transport links. Malaysia cut its 2015 economic growth target in January to 4.5-5.5 per cent from an earlier projection of as much as 6 per cent, citing the damping effect of an oil price slide. Oil-related contributions make up almost 30 per cent of Malaysia’s annual state revenue.

“The larger cap stocks within the KLCI consist of mainly banks, plantations and oil and gas names, and the current macro environment doesn’t favour those few sectors aforementioned,” Lee said. “On the other hand, the small cap universe consists of companies with very diversified business sectors and some of them offer superior earnings growth profile.”

Malayan Banking Bhd. and Tenaga National Bhd., the nation’s two biggest listed companies by market value, have gained less than 2 per cent this year. IOI Corp., an oil-palm planter, has fallen 11 per cent in the period after reporting a 75 per cent slump in second-quarter net income.

The gauge of smaller companies entered a bull market last month after rebounding more than 20 per cent from its December low. The measure has since dropped 2.6 per cent from its April 21 high.

“The small-cap index has had a good run year-to-date,” Lee said. “As long as macro conditions remain intact, any corrections are more likely to represent a mid-cycle consolidation rather than a trend reversal.” — Bloomberg