Look through volatility to reap Vietnam's rewards

Investing in frontier markets means putting your money into economies whose exchanges are considered to be even less developed than emerging markets. The risks, from less liquid trading to limits on the foreign ownership of companies, reflect this. But if you can tolerate these risks, investing in frontier market equities can deliver strong growth and diversification.

One of the largest frontier markets is Vietnam, which made up almost a third of the MSCI Frontier Markets index at the end of July. Vietnam's economy has transformed over the past few decades into a high growth, dynamic, manufacturing powerhouse. Secular trends which have driven progress include high levels of foreign direct investment with, for example, recent announcements of more investments from Lego, Apple (US:AAPL), and Samsung (KR:005930). Increasing urbanisation, a growing middle class and wealthier consumer base, and technological progress have also driven progress.

A key growth driver is state infrastructure spending. Huge levels of government investment are set to be deployed over the next five years on projects such as highways and ring roads. Steel and construction businesses such as Hoa Phat, one of the 10 largest holdings of funds such as Vietnam Enterprise Investments (VEIL) and VinaCapital Vietnam Opportunity Fund (VOF), are likely to benefit from this.

And the country's latest economic figures are enough to make governments of developed countries green with envy. As developed countries contended with anaemic growth and potential stagflation, Vietnam's economy grew by 7.7 per cent in the second quarter of this year. And while western economies sweat over soaring prices, Vietnam’s year-on-year consumer price index inflation was 3.1 per cent in July.

Ways to get exposure to this market include investment trusts Vietnam Enterprise Investments, VinaCapital Vietnam Opportunity Fund, and VietNam Holding (VNH). These trusts have posted heady returns over three and five years, but their performance has been weaker over the past 12 months in what has been a volatile market. Macro headwinds and concerns about Vietnam's real estate sector are having an impact.

The trusts are all trading on double-digit discounts to net asset value (NAV). As they have good records of outperforming the MSCI Vietnam index, this perhaps surprising unpopularity suggests that if you invest in them you could be well positioned to benefit from the country’s potential future promotion to emerging markets status. QuotedData senior analyst Matthew Read said that the discounts “should narrow over time as investors understand the market and these vehicles better”.

<box out> Political questions

Geopolitical tensions between China, Taiwan and the west have worsened this year, and Vietnam could in theory be caught up in the middle of all this. The US is its biggest export market, and China and Europe also take a significant amount of its goods. But as has happened previously, such as under the presidency of Donald Trump, future tariffs and penalties imposed on China by western nations could benefit Vietnam and boost its manufacturing further.

Matthew Read at QuotedData does not expect that "sabre-rattling" by politicians will spill over into anything materially negative for Vietnam from an investment perspective.

And while Chinese lockdowns are having an impact on the supply chains of Vietnamese companies, Vietnam has highly diversified trading links. It has a long list of free trade agreements, foreign investment continues to come into the country and secular trends are very much in its favour. 

Also see How to invest in Asia without China (IC, 26.08.22)

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High risk exposure

This is not to say that all is rosy. While Vietnam has had a much better pandemic than China, there have been complaints from foreign investors about the impact of strict lockdown and quarantine rules. The World Bank also noted in its latest report on Vietnam that capital adequacy at banks is low and there is an underperforming education system. The latter point could be an issue as more high-tech opportunities from multinationals such as Intel (US:INTC) land in the country. 

And there are limits on the foreign ownership of stocks which could hinder the share price growth of many Vietnamese companies. This arguable also makes getting exposure to Vietnam via an index tracking fund such as Xtrackers FTSE Vietnam Swap UCITS ETF (XFVT) less attractive. Active funds can be selective about which companies they hold and how much exposure they have to them.

But Craig Martin, chairman of Dynam Capital, which manages VietNam Holding's investment portfolio, argues that "the liquidity of the Vietnam stock market is improving and is three to four times where it was pre-pandemic".

Concerns have emerged this year due to allegations of fraud and corruption in Vietnam’s real estate sector. There have been reports of stock market manipulation and mis-selling, with property companies trying to raise funds on bond markets from private investors after the central bank tightened lending policies.

This could also have implications for the banks. The World Bank noted that “some banks have high exposure to the real estate sector via shared ownerships or group holdings, raising concerns over contagion and potential problems within the real estate market and banking sector”.

So you might be justifiably wary about the level of real estate holdings in Vietnam funds. These recently made up 27 per cent of VinaCapital Vietnam Opportunity, 23 per cent of Vietnam Enterprise Investments, and 16 per cent of VietNam Holding’s assets. Certain commentators have drawn parallels with the collapse of China’s property boom in an ignoble mix of corruption and debt.

But while there are similarities between the Vietnamese and Chinese property sectors, there is nowhere near the same level of debt associated with the sector in Vietnam or the same material concerns on property developers and liquidity risks. The real estate holdings in these trusts don’t look exposed given that they aren’t involved with raising debt from private investors.

Andy Ho, managing director of VinaCapital, which runs VinaCapital Vietnam Opportunity Fund’s investments, says: “Our portfolio hasn’t been impacted by this at all, as the property companies we invest in don’t raise bonds on the retail markets. Our property holdings have low debt to equity ratios.”

The managers of the other two Vietnam investment trusts were similarlybullish on their property holdings when asked about the issue by Investors’ Chronicle.

The higher demand for goods and services which follows on from higher incomes is reflected in the growth of private banks in Vietnam which, unlike China, is not dominated by state-owned institutions. Banks are Vietnam Enterprise Investments’ and VietNam Holding’s biggest sector allocations, and financials are the VinaCapital Vietnam Opportunity Fund’s second-biggest sector weighting.

Vietnam Enterprise Investments’ deputy portfolio manager, Thao Ngo, expects “strong banking growth in the country to continue, with stable net interest margins and improvements in net fee income. The trust’s biggest holding VPBank is a pioneer in digitalisation, and we think it is the most impressive retail bank in Vietnam.”

Growing consumption also fuels retail growth. Martin and his colleagues are “bullish on the retail sector”. “Phu Nhuan Jewelry is a good example of a business we are particularly keen on – this has around half of all the branded retail jewellery business in Vietnam,” he adds.

Trusts are divided on the merits of public versus private equities, however VinaCapital Vietnam Opportunity has over 40 per cent of its assets in unlisted equity, private equity, and “public equity with private terms”. Ho says that the trust “has more opportunities than we can handle in this area. It is not like regular equity picking”.

But Dien Vu, manager of Vietnam Enterprise Investments, is “seeing more opportunities in listed markets compared to unlisted, as valuations in liquid markets are cheaper than private equity offers”.