All investing comes with risk. Assessing risk is at the heart of all economic activity. Investing in a frontier market, though, starts with the kind of risk usually associated with darkened alleys and jungle safaris. But, for the person looking for a chance to make not only a significant amount of money but be a part of something that will materially improve the lives of countless people, then a frontier or emerging market provides the best opportunity for that to happen.
In Southeast Asia, the risks start with liberalization of the economy by governments used to having complete control. This was true in the early stages of Vietnam's development, and it is true today as the process of equitization, for example, is still in its infancy. Our stock market has the smallest total market cap in the region at $28 billion US, compared to Indonesia's $351 billion or Malaysia's $268 billion.
Access to good financial information, statistics, and research is poor. One has to do a lot of digging to mine informational gold in Vietnam. Moreover, there is an arbitrage in that information that exists between the untrained analysts in the broker community and their foreign clients who cannot extrapolate the information they need to make timely decisions. While that process is improving it still has a long way to go.
Moreover, there is a tremendous amount of inertia in what are known as State Owned Enterprises. These companies grew in a closed environment and for many the switch from privately run firms with no clear metrics or motives for success to those that operate more publicly and can be assessed by the investing public has been difficult. As always, the market eventually sort things out and finds value, but value is, as I said, difficult to assess. When the process moves forward, however, the results can be spectacular for an investors in the Market Vectors Vietnam ETF, VNM.
Making an SOE into a public entity uncovers inefficiencies which create opportunities for massive earnings and profit growth. This was seen with British Airways in the 1980s, and we're seeing that as well in Vietnam. Sabeco, the largest producer of alcoholic beverages in Vietnam, has seen 80% sequential earnings growth in its first two years of becoming publicly traded.
In places like Laos and Myanmar, their governments have only just begun this process and their governments are very loathe to give up control over important industries like communications and travel. While all of these countries welcome, nee encourage, foreign investment, there are still a number of restrictions on ownership of property and stock for foreigners.
The term foreign room is something to get acquainted with when looking at Asian stocks. A stock at or near its foreign room can sometimes carry with it outsized risk due to simple supply shortages keeping prices elevated.
As with any kind of knowledge, the farther one is from the source of the information, the less reliable it is. And that creates a boom and bust cycle in the shallow stock exchanges in both Hanoi and Ho Chi Minh City. This discourages longer-term investment by institutional investors. It is estimated that 78% of retail investors in Vietnam's stock exchanges are purely speculating. The situation in real estate is similar at 64%.
Many Southeast Asian countries are following the path blazed by China, utilizing a weak currency and rapid expansion of bank credit to fuel short-term booms, which eventually burst. Vietnam is working through a very difficult time in which the banking stocks within the VNM ETF needs to both consolidate and write down a significant portion of their assets before the next phase of growth can truly begin.
However, given those things, Vietnam represents a fantastic opportunity and challenge. Emerging market countries (EEM) can expand at blistering rates and sustain them for a while. The unleashing of human potential when allowed the freedom to create nearly always surpasses our expectations.
Everyone knows about China's (FXI) growth path. How about a country like Malaysia (EWM) which has sustained 5-7% GDP growth rates for more than a generation, though with a tremendous amount of volatility? Because of their relatively open economy the recoveries are sharp and explosive. It is no longer an emerging market but an established one. For example, Malaysia grew at an incredible 9+% rate from 1988 to 1997. But, the Asian Financial crisis saw GDP contract 7.4% in 1998. In 1999 it expanded at 6.1% and 8.9% in 2000. The country contracted only mildly during the global recession of 2009 and came back with a vengeance in 2010.
At those rates, one's money doubles every 9-10 years. It is not possible to get those kinds of indexed returns in the West anymore, with the S&P 500 having not made a new high since 1999.
Places like Vietnam are attractive because of their potential to become the next Malaysia or Indonesia. The port city of Vung Tau is one of the fastest growing places in the world with annual per capita earnings growing at 46% in 2011, and is 550% higher than the national average because of its unique combination of geographical proximity to the offshore oil and natural gas fields and Ho Chi Minh City, the country's capital and economic center.
Cambodia is interesting because it is growing at near 6% compounded rate and has a very liberal approach to foreign investment. While there is no market for national securities, it is a highly dollarized economy that is working on a number of basic infrastructure projects in coordination with ASEAN (Association of South East Asian Nations) to connect Bangkok with Ho Chi Minh City through both Siem Reap and the capital of Phnom Penh. Their rubber exports, for example, grew at 170% in 2011. The government runs a budgetary surplus and the banking industry is evolving in a nearly regulation free environment, which is both a blessing and a curse for foreign investors.
It is obvious that there is a tremendous wellspring of investment interest in the region that can easily overwhelm the local infrastructure. Different countries respond to it differently. In order for Intel to build an IC factory in Vietnam they had to, as well, invest in education and training in IT, engineering and the area's digital infrastructure.
The same thing is happening in the lesser developed nations on the Indochina peninsula. Now Vietnam is flexing its investing muscles, pursuing hydroelectric power, rubber, coal and other natural resources in Laos and Cambodia, themselves becoming the source of foreign investment in their neighbors to strengthen the entire area. Much of this is being done under the guidance of ASEAN. For example, recently construction began on an airport in a remote southern province in Laos to serve the Vietnamese company HAG that has a major investment in the area to produce sugar cane and other products.
Emerging and frontier markets offer both the excitement of pioneering with the opportunity for tremendous success. Not every project succeeds, and not every country embarks on a sustainable growth path. Some, like Malaysia, accept a short, sharp downturn every decade, while others will attempt to forestall the pain with mercantilist policies and banking protection and still others will crash and burn before rising from the ruins like Argentina or Iceland after their hyperinflations of the last decade. But in all of these cases the rewards for the right investment at the right time can be worth all the risk.