VCVOF: Vietnam Stocks Have Fallen More Than 25% Off Their Highs, Time To Examine This CEF
Summary
- Vietnam's economy has been one of the best performing in the world in recent years.
- Unlike many developed markets, the best way to obtain exposure to their share market is via an active manager.
- VinaCapital is developing a long improving track record of managing this CEF.
- It generally trades at a discount of near 20% to NAV and that discount has scope to contract further.
Introduction
For those not familiar with the VinaCapital Vietnam Opportunity Fund (OTCPK:VCVOF), the fund manager's website is an excellent resource to get further info after you read this. The US listing here has low liquidity versus the main London listing, an average day would see circa 30,000 shares trade. Investors should cautiously take that into account. I have previously traded its main London listing (VOF.LN) where liquidity is far greater.
Attractive economic fundamentals for Vietnam
It is hard to come across other economies near the size of Vietnam's where economic growth has been so strong in recent years. For Vietnam that has meant economic growth reliably printing above 6% over the last 5 years.
Over this period, they have kept inflation under control. This has been a welcome relief for investors who got burnt by the inflation volatility between 2008-2013.
Their younger, lower cost manufacturing labour force is seen as particularly attractive. On a relative basis to China, this has assisted in attracting FDI into the country. This can be a longer-term structural trend, which may even benefit further from trade wars between US & China in the shorter term.
From a political point of view, Vietnam seems to be escaping some of the instability that is affecting parts of the West. Debates over extremist political parties, migration, and any associated racial tensions haven't disrupted reforms taking place from the Vietnam government. Given the country's history, it is easier for the younger workforce to believe that they may enjoy a more prosperous future than their parents. They rank highly globally in terms of consumer confidence surveys. This area needs to be monitored, however. Some social unrest is evident due to concerns the government is being too open with investment coming from China.
The tourism industry is growing rapidly and will continue to make a greater contribution to GDP in the years ahead.
Overall, the country has been in a sweet spot for economic growth and inflation stability. This has probably led to some over-exuberance in the share market topping out in January 2018.
A short and volatile stock market history
New prospective investors in Vietnam should glance back further than the last 5 years. Not doing so would lead to under appreciating the risks of investing there.
For a start, the stock market only began in the year 2000. This means that there has been a slow progression in transforming the market in terms of the typical ownership stakes of companies. Earlier days saw few listings & illiquidity. A recent trend though of IPOs of SOEs and encouraging foreign investment has seen the market reach a new level of maturity. It is still, however, classified as a frontier market, but one day hopes to be included in the MSCI Emerging Markets Index.
It is a reason to expect higher volatility than in other markets, which was certainly a feature around 2008. There was a global bear market in equities at the time, but the fall in the main Vietnam index from peak to trough of more than 80% is steeper than most can handle!
Getting inflation under control
Such a steep fall firstly reflected over exuberance in the bull market and also was pricing in the terrible economic fundamentals that lay ahead after 2007. The below chart tells a lot of the story.
Source: Vietnam Opportunity Fund 2011 Annual Report
It was similar to many emerging market cycles that investors have become accustomed to. Too much hot money, surging FDI leading to excessive credit growth. A huge real estate and stock market boom and bust followed.
When the 2008-2009 global financial crisis occurred suddenly, Vietnam's booming export story took a turn for the worse as its trading partners slowed down. Weak trade balances, currency weakness, and non-performing loans all came to the surface. Such pressures also saw inflation spiral out of control as you can see from the above chart.
The last 5 years stands in contrast though to the prior period. I mentioned at the beginning the robust economic growth in this recent period. It has also been characterized by inflation coming in at under 5% during this time.
How did Vietnam achieve economic stability and can it continue?
Vietnam appears to be in a better position to avoid the boom and bust cycle that occurred around 2008 and resultant inflation and currency instability. After the huge run up in credit growth leading to this, steps were later taken to work through non-performing loans and improve the banking sector. They also are addressing the inefficiency of SOEs. An improving stock market has allowed the privatisation of many SOEs and this trend is expected to continue.
The battle to remove the risk that bad debts could have on the overall economy is far from won. There is reason to be optimistic though that the extent of the irresponsible lending from the banks and the wasteful spending by SOEs that occurred during the last boom won't be repeated.
With the strong growth seen in Vietnam over the last few years, it is natural to see FDI buoyant again. Thus far, it doesn't appear likely to help cause the problems that it did around 10 years ago.
Source: www.theglobaleconomy.com
What are stock valuations like?
In January 2018, the Vietnam stock market became one of the hottest markets around, and it is fair to say earnings multiples got ahead of themselves. The trailing P/E was around 20, a number of high profile large IPOs came to market, and the impressive return figures of 2017 were making headlines. That is normally not a comfortable environment to invest in and it isn't surprising to see the market decline by more than 25% since then.
That in itself still brings the trailing P/E to under 16 times, which may not be low enough to tempt you to invest in a developing market. Although you should treat earnings forecasts with a little grain of salt, I think it is worth noting here that most analysts are quite bullish on EPS growth. Over the next 2-3 years, some analysts have EPS growth running at circa 16-18%. The VinaCapital Vietnam Opportunity Fund is optimistic on future stock returns. A point that is made by VinaCapital is that you are buying the market on a PEG ratio of below 1.
Suddenly that sounds a bit better, and it can become more attractive if you can fish out the companies that are better value. VinaCapital has been quite successful in this in recent times, as they have avoided some of the expensive larger companies on the market.
Choosing an ETF or CEF?
I have already touched on the fact that there has been many SOEs privatized in recent years. The stock market is evolving and a lot of investment opportunities are from obtaining stakes in companies prior to a trade sale or IPO. VinaCapital is active in this area and market conditions can dictate how they may exit a stake.
By the time an ETF may look to invest in a stock, it may be that an opportunity prior to IPO has passed. An ETF trying to mirror an index may end up participating at IPO and forced to buy expensive assets. Late 2017 and early 2018 witnessed such a trend and was followed with a sharp fall in the market overall. Some popular IPOs were particularly hit hard during the market downturn in 2018.
The closed-end structure is also an important advantage. You don't want to be dealing with large applications or redemptions if markets become volatile and liquidity is lacking.
To illustrate some of the flexibility that this CEF has, here is their asset class breakdown as of June 30, 2018.
Source: Vietnam Opportunity Fund 2018 Annual Report
Over the last 5 years where there has been a trend in the market towards new listings, the fund is performing well overall from taking this approach.
Source: Vietnam Opportunity Fund Monthly Factsheet as at end November 2018
Why the VinaCapital Vietnam Opportunity Fund?
VinaCapital was founded in 2003, which is not that long after the stock market began in Vietnam. In total, they have about US$1.8 billion in AUMs across a range of asset classes. They previously had a larger exposure to real estate within this CEF but have reduced exposure over the last few years as that sector has recovered strongly.
I consider their size and vast experience across a range of sectors a distinct advantage that suits the developing nature of Vietnam's stock market.
They take an active approach, being willing to construct a portfolio quite different to the indices, and take concentrated positions at times. This is evident from the below chart which shows some changes made to sector allocations between FY2017 & FY2018.
Source: Vietnam Opportunity Fund 2018 Annual Report
Below shows their top 10 listed equity positions as at June 2018.
Source: Vietnam Opportunity Fund 2018 Annual Report
The 2018 Annual Report link just above is very useful in gaining an insight into the above positions. They devote a page to each one and are also comprehensive in outlining their macroeconomic outlook.
Management interests now better aligned with shareholders
One of my main concerns when investing in CEFs is the fee structure and whether management shows an inclination to charge too much.
I think this was an issue with this fund in the early days and with other Vietnam funds that got launched around the same time.
A key factor that has helped improve the fee structure of this fund is the continuation vote that occurs every 5 years. The fund was under plenty of pressure leading up to the vote that occurred in 2013. It saw a discount to NAV of greater than 40% in the years prior to this. Behind the scenes, management had to work hard with agitating shareholders to come up with an agreement to keep the fund going.
Although we currently still see a large discount of nearly 20%, it has been a good decision to continue with the fund since that vote in 2013. Having this vote has been the catalyst for numerous initiatives.
The fund has bought back a huge number of shares during its life at a large discount to NAV. The base management fee was originally 2% per annum. Now, it is 1.5% for up to US$500 million of the assets, then 1.25% between US$500 and US$1,000 million, and 1% for US$1,000-1,500 million etc. If the fund size managed to double from here to over US$2,000 million, the base fee would be just 0.5% on the amounts above this. The performance fee has now come down from originally 20% to 12.5% of outperformance, based off a hurdle rate of a nominal 8% per annum return.
Another initiative has been the distribution policy, where it now pays out circa 2% of the NAV in dividends each year. These initiatives, track record, and prospects for Vietnam can slowly lead to the discount to NAV of around 20% in recent years to contract further.
Risks
Perhaps one of the biggest risks currently is ironically that most of the news coming out of Vietnam is generally positive. That may sound strange, but I have generally done better buying into an emerging market story when the news flow is negative. The theory being that the bad news is already over reflected in prices.
Whilst some have suggested they may benefit from trade wars between US and China, this is by no means certain. Issues that manifest themselves to slow down global growth could be felt more deeply in the Vietnam economy. The last major global economic downturn hit their export-led industries hard.
Resultant volatility in currency markets can also pose risks for Vietnam, as can any increasing tensions with China. These risks may be mitigated to some extent by the fund's bias to listed stocks that benefit from the growing domestic consumption story.
Strong economic growth of late brings about its own challenges. For example, meeting infrastructure requirements will be difficult. Also, any sense that wealth inequalities are widening could upset the current high levels of consumer confidence. Excessive credit growth is another risk that could occur on the back of strong economic growth.
Conclusion
As much as we would like to think the more recent economic stability is a sustainable trend, you don't have to go back far in time to see the risks when that is not the case. Given that historical volatility, I am only contemplating this fund as a partial accumulation in the short term. That is, perhaps invest around half of what I would like to initially, a dollar cost averaging approach in a way. I have started this process with the London exchange listing of the stock. If the market falls another 10-20% in 2019, I would then likely put the rest of my desired position size to work. For some that may seem like I am sitting on the fence. When you take a look at the long-term chart of the Vietnam stock market though, you can perhaps understand given the volatility.
Author's note: Data from the article are present as of January 6, 2019.
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Comments (9)
I dipped a toe in a few months back. While down a bit it has held up well compared to some Chinese stocks in general.
