Investors and researchers are always on the lookout for undervalued assets in emerging and frontier markets and I have long been curious as to how this process of research and investment works. I also have a burning interest in Vietnam thanks to the fantastic time I spent working there many years ago and so I was wondering if the country still had a bright future, or had the wheels come off its growth story for good. To find out more I spoke with the highly knowledgable Andreas Vogelsanger the CEO of a Vietnamese focused fund Asia Frontier Capital (AFC) who very kindly shared with me his thoughts on South East Asian country.
During our chat he explained:
- His optimism and reasons for investing in the country
- AFC’s strategy for selecting suitable companies to invest in
- How lack of information, a stock market crash and relative obscurity can be used to your advantage
- Some of the pitfalls and problems faced by the firm inherent to Vietnam and other Frontier Markets
A bit of background
When I visited Vietnam fifteen years ago the country was still emerging from its Socialist run economy and was following the Chinese model of allowing private enterprise and pushing an export led economic model, but with the government retaining political control (this process was called Doi Moi and started in 1986). During my time there I was shadowed by Communist party officials in meetings, but the green shoots of private enterprise were springing up fast and everywhere new shops, restaurants and factories were thriving and there was a distinct air of optimism among the people I met.
Here and now
Fifteen years on and Vietnam has a stable economic position and political scene, the stock markets nosedived in 2010, but this is where AFC Vietnam used their intimate knowledge of South East Asia and took what should be a fantastic opportunity, by focusing on investing in medium sized and small companies listed on undervalued stock exchanges (there are exchanges in both Hanoi, the political capital and Ho Chi Minh City, the business capital). AFC targeted an asset class which has been ignored or overlooked by most fund managers, in doing so they hope to hit upon a rich seam of returns. While there has been interest in Vietnam from foreign investors – they have tended to go for larger more established companies, or have been frightened off all together by its frontier market status.
Selecting the portfolio
Andreas went on to tell me how AFC went about selecting companies for their portfolio, a critical decision for any fund. He explained that typically AFC would study the key financials of the company, cashflow, profit margins and balance sheet along with its stock market performance and its price earnings ratio (P/E) and price book (P/B) ratios to judge its future earnings potential.
Companies on the Vietnamese exchanges currently have very low P/E and P/B ratios in comparison to their regional peers; this usually indicates the market expects poor future earnings and a low valuation. However as canny investors know P/E does not tell the whole story, based as it is on past or predicted earnings, it is not always an accurate guide for the future.
If suitable AFC wlll then takes a small stake in the chosen company and this process is repeated until there is slightly oversized portfolio of around 50 companies in total. Where possible the team visit the companies to find out more about their management, operations and creditworthiness, naturally avoiding any which appear to be suspicious. In a frontier market with a relatively small fund (around USD 50 million), it is simply not possible to conduct full due diligence on every firm and by creating an oversized portfolio and taking small stakes the risk is spread more evenly. Andreas also explained that the portfolio is not focused or dependent on any particular sector of the economy, another strategy for risk mitigation.
It is interesting to note that many Vietnamese companies are not happy to receive westerners to their firm’s headquarters, probably down to a suspicion of outsiders and culture of secrecy dating from the Socialist era.
In the longer term AFC hope to see the market grow steadily and the valuations of their companies rise, before divesting as the market peaks while also identifying new opportunities within Vietnam and the wider region.
What’s the Catch?
Of course as in any market there are considerable downsides and risks, Vietnam has like many frontier economies has poor corporate governance and accounting standards, its uneasy relationship with China runs the risk of conflict with its giant neighbour.
In addition there is the risk that government led business reforms may stall or not emerge because of political pressure. The banking sector is also a major worry as non-performing loans are getting too high for comfort – just under 5% in June 2014, but this figure is regarded as potentially higher thanks to poor reporting standards.
Vietnam’s political and economic outlook is good.
- Vietnam’s strong education system (check out its PISA scores), (a positive legacy of communism), augers well for productivity growth.
- A mixture of business friendly government policy, such as a stimulus package for various industry sectors and tax cuts, along with a restructuring of the banking sector should all help firms in the country. Low correlation to global markets offers significant diversification benefits for investors.
- Increasing foreign investment, such as Korean Samsung’s recent USD 5 billion manufacturing investment have all helped, but the country still remains off the radar for many investors which helps keep stocks undervalued.
- Solid growth is predicted for the next few years, estimated to be 5.8% in 2014, along with reasonably low inflation (5.4 %) and rising productivity.
- Stable government, low inflation, a stock market below historic highs so plenty of potential for growth as it recovers, if the market reaches its old highs in the next cycle, a potential return of several hundred per cent is achievable.
The China Factor
Vietnam’s giant northern neighbour is the key external influence on the country. Offering both heavy investment over recent years and with labour costs rapidly rising at home we will most likely see an up surge in the hunt for the next “Chinas” low cost manufacturing centres – Vietnam is sure to be one of them. As a bordering country it has fantastic potential to absorb more Chinese factories and funding to take on some of the work that has become too expensive to do in China.
At the same time the tensions emanating from disputes over the Spratly Islands and associated oil rights in the South China Sea between the two and others like the Philippines threaten long term peace in the region. Vietnam will also resent becoming dependent on China, too much Chinese influence on the economy will not go down well in a country that fought a border war as recently as 1978.
Special thanks to Andreas Vogelsanger for his time on this highly enjoyable interview and article.