Major equity markets were mixed this past month while frontier markets generally fared well as the MSCI Frontier Markets Net Total Return USD Index gained +3.7% this month and is now up +22.4% YTD, while the MSCI Frontier Markets Asia Net Total Return USD added +1.9% this month and is up +10.3% for the year.
While frontier markets did well this month, both the AFC Asia Frontier Fund and the AFC Vietnam Fund had a difficult month in August, losing −3.5% and −4.4% respectively and underperformed their respective benchmarks. Further on in this newsletter we look at the reasons for that. The AFC Asia Frontier Fund is now up +71.4% since inception, which corresponds to a healthy annualized return of +10.5% p.a. since inception and this reflects the strategy’s ability to generate consistent long-term returns.
The AFC Iraq Fund returned +1.2% in August, outperforming its benchmark, the RSISUSD index, which went up by +0.2% and its performance year-to-date is −9.6% compared with the RSISUSD index which is down −15.1% for the year.
The AFC Vietnam Fund lost −4.4% in August, underperforming the VN-Index in USD terms which lost −0.2%. The fund is now up +11.3% YTD and +82.1% since inception, which corresponds to an annualized return of +17.6% p.a.
Inevitably, during the course of investing in equity securities, one will encounter times in which some shares or indeed entire portfolios go down, and lose value. These movements in and of themselves are no reason for alarm. We look for the fundamental long-term developments and not at short term volatility in share prices. Cool mindedness is key. Well researched investments are often successful over time, and in such cases lower prices are opportunities to buy in, or add to existing positions cheaply. At the same time, continuous review of the investment decisions on each position helps to avoid losing significantly on individual stocks.
While at times our portfolios may experience volatility, or show underperformance with respect to their benchmarks, using a solid overall risk management policy and a thorough research process to select stocks, we are confident that over the medium and long term we are providing a return well in excess of the average returns in developed markets at a low level of volatility which we have demonstrated over the past 5 years with our AFC Asia Frontier Fund.
The high level of GDP growth in frontier countries in Asia, combined with favourable demographics, under penetrated consumer markets, and developments such as the ongoing urbanization, strong growth of the middle class, and the manufacturing shift from China, will continue to provide opportunities for companies in these markets to deliver sustained earnings growth in the longer run. This is the basis for our confidence to provide consistent returns with low volatility over the medium and long term while we continue to look for new opportunities within our investment universe.
Ahmed Tabaqchali to present at Basra Oil, Gas & Infrastructure Conference
The CWC Group is conducting the Basra Oil, Gas & Infrastructure Conference in Beirut on the 30th-31st October 2017 at the Hilton Habtoor Grand in Beirut, Lebanon. Ahmed Tabaqchali, CIO of the AFC Iraq Fund will speak at the event. For further information about this information see www.cwcbasraoilgas.com.
Launch of an AFC Asia Frontier “Parallel Fund” in Luxembourg
In order to provide better and easier access for our European investors, Asia Frontier Capital is in the process of establishing a “Parallel Fund” of the AFC Asia Frontier Fund in Luxembourg. The launch of AFC Asia Frontier Fund (Lux) is imminent and will be announced in the near future.
The Luxembourg-based fund will invest up to 84% in the existing Cayman Islands-based AFC Asia Frontier Fund and the balance will be invested directly in stocks that the Cayman Islands fund is also holding. We expect that the performance of the Luxembourg based fund will be very similar to the existing Cayman Islands-based fund.
If you have any questions about our funds or would like any additional information, please be in touch with our team at firstname.lastname@example.org.
If you have an interest in meeting with our team during their travels, please contact Peter de Vries at email@example.com.
AFC Asia Frontier Fund (AAFF) USD A-shares lost −3.5% in August 2017. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+1.9%) the MSCI Frontier Markets Net Total Return USD Index (+3.7%), and the MSCI World Net Total Return USD Index, which was up +0.1%. The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +71.4% versus the MSCI Frontier Markets Asia Net Total Return USD Index, which is up +50.0%, and the MSCI Frontier Markets Net Total Return USD Index (+49.1%) during the same time period. The fund’s annualized performance since inception is +10.5% p.a., while its YTD performance stands at +0.6%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 8.98%, a Sharpe ratio of 1.14 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.33, all based on monthly observations since inception.
This was one of the toughest months since the inception of the fund and there were multiple contributing factors for this. The month started on a positive note but continued worries about political stability in Pakistan continued to impact the KSE100 Index which lost −10.4% this month. After the ouster of former Prime Minister Nawaz Sharif in July, any negative news is being given much more weight than earlier. The rising current account deficit has been an issue since the beginning of the year on the back of rising machinery imports and higher oil prices. As mentioned in previous manager comments, these machinery imports are related to the China Pakistan Economic Corridor (CPEC) power projects which will help improve future power capacity and aid economic growth. Therefore, though there could be some short-term pain with respect to the currency, the longer term economic trends and prospects for Pakistan are still positive which is also backed by an incentivized military to improve the security environment.
Market sentiment was further impacted when President Trump made some negative geopolitical comments about Pakistan’s role in the region. How much of these words can be put into action and the impact it can have on the country is debatable as Pakistan has aligned closer with China over the past few years. The end of the month saw further negative news flow as the country’s largest bank, Habib Bank, could potentially be fined USD 630 mln by the New York State Department of Financial Services for non-compliance related issues. As of writing, the bank has reached an out of court settlement and will pay a fine of USD 225 million which will have a significant impact on its profits for this year but this amount of fine puts the bank’s balance sheet in a relatively better position compared to paying the whole amount of the fine. The fund has never held this bank in its portfolio but holds another bank which has declared better results than its peers in the second quarter and has outperformed the index on a relative basis this year.
Though there was negative news flow in Pakistan during the month, economic indicators such as auto sales and private sector credit growth continued to be positive and both have shown double digit growth so far this year. The KSE100 Index is now down 22% from its peak in May 2017 and valuations have opened up across sectors and we believe given the longer term positive trends in the country, this could be a time to look at certain opportunities given the fear in the market.
Vietnam saw weakness during the month given the good run it has had so far this year while economic indicators such as manufacturing growth and retail sales continue to be positive. The Central Bank (State Bank of Vietnam) is looking to push further credit growth and has increased its credit growth target to 20-21% in 2017 from the earlier plan of 18%. This is being done with the hope of meeting a full year GDP growth of 6.7% in 2017. Higher credit growth is positive for the banks in the near term but in the longer run if pushing credit to meet GDP growth targets is a common theme, we would remind ourselves of the previous NPL cycle the Vietnamese banking sector went through and has only started recovering from.
The Sri Lankan index, the Colombo All Share Index, corrected by 3.7% this month on the back of weak quarterly results of most consumer related companies. This is not a surprise as the country has faced a drought and floods in the past few months which has impacted consumer incomes especially in rural areas. Further, the VAT increase from 11% to 15% has also led to price increases at a time when consumer incomes are stretched leading to weaker consumer spending. However, valuations for many companies in Sri Lanka are still attractive on a bottom up basis.
Mongolia’s economic situation continues to markedly improve, driven by rising prices and exports of coal and copper from the country, as well as improving FDI. This led to GDP growth of 5.3% during the first half of the year and 6.1% in Q217. However, since mid-July coal exports have slowed dramatically at the main border with China, Gants Mod. China has increased the processing time for customs which led to a 160km traffic jam on the Mongolian side of the border. There are rumours that China has done this in order to leverage Mongolia into expediting the approval of construction of a railway from the Tavan Tolgoi coal basin to the Chinese border, which would ultimately benefit Chinese companies, but would also add much needed stability to the Mongolian economy and likely attract further FDI. On 7th September the Mongolian Parliament voted to remove Prime Minister J. Erdenebat after the ruling Mongolian People’s Party was defeated in the July Presidential election. A new government is now expected to be formed within 30 days whereby we would expect to see the subsequent advancing of specific resource projects. The biggest positive contributor to performance this month was Mongolia where the fund’s holdings in the resources and consumer sectors performed well on the back of improving economic sentiment.
The best performing indexes in the AAFF universe in August were Mongolia (+13.4%), Bangladesh (+2.5%), and Laos (+1.1%). The poorest performing markets were Pakistan (−10.4%) and Sri Lanka (−3.7%). The top-performing portfolio stocks this month were (like last month) all from Mongolia: a coal mine (+42.8%), an oil exploring company (+20.7%), a concrete company (+19.2%), followed by a junior oil and gas exploring company from Papua New Guinea with +17.6%.
In August, we added to existing positions in Mongolia, Pakistan, and Vietnam. We added a leather company from Mongolia to the portfolio and exited three positions in August: a Pakistani hospital group, a Pakistani food company and a gold mining company we received from a corporate action (Mongolia) but which has its assets in the United States. Additionally, we partially sold two food and beverage companies in Mongolia.
As of 31st August 2017, the portfolio was invested in 118 companies, 1 fund and held 3.7% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (8.1%) and an investment company in Myanmar (3.2%). The countries with the largest asset allocation include Vietnam (27.0%), and Pakistan (20.4%). The sectors with the largest allocations of assets are consumer goods (29.5%) and financials (14.8%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 15.15x, the estimated weighted average P/B ratio was 2.71x, and the estimated portfolio dividend yield was 3.93%.
Factsheet AFC Asia Frontier Fund – August 2017
Factsheet AFC Asia Frontier Fund (non-US) – August 2017
AFC Asia Frontier Fund Presentation (English)
AFC Asia Frontier Fund Presentation (Chinese-Traditional)
AFC Asia Frontier Fund Presentation (Chinese-Simplified)
AFC Iraq Fund Class D shares returned +1.2% in August, outperforming the RSISUSD index which went up by +0.2% as the market halted the multi-month correction that took the index to a decline of -15% YTD and -39% from the February high. The fund is now down -9.6% YTD, which is an outperformance compared with the RSISUSD index which lost -15.1% in the same time period.
The equity market traded in a tight range following the July sentiment turnaround, in which extremely depressed bank valuations drove locals to step up and absorb foreign selling as discussed here last month. Turnover continued to be low in-line with the last few months while foreign activity was mostly subdued with some re-emergence of selling in banks in the last few days but, at least for now, that has lost its ability to depress the overall market.
Turnover Index and RSISUSD Index
(Source: Iraq Stock Exchange (ISX), Rabee Securities, AFC)
(Note: Regular trading and excludes transactions by insiders
and strategic holders whether local or foreign)
However, the most significant development to highlight is the broadening of the realignment of interests of regional players in dealing with the root causes of the conflict, i.e. the deep economic and political disenfranchisement, that were such fertile grounds for the rise of extremism. It was argued here in the past and a main theme behind the launch of the AFC Iraq Fund, that after the military resolution, these would be long-term solutions which will involve significant investments in infrastructure to bring much-needed development and create prosperity.
The first to emerge is the Iraq-Saudi Arabia alliance, currently under negotiation, in which Saudi Arabia is to take the lead in funding the reconstruction of the liberated areas, i.e. the western part of the country from Mosul, spreading into Anbar and beyond. The significance is not simply the resumption of diplomatic links with Saudi Arabia that were severed in the first Gulf war in the 90’s, but the economic revitalization of the liberated areas first through trade and then reconstruction. Anbar, including the surrounding areas in Nineveh and Salah Ad-Din, disenfranchised since 2003, have long been the seat of resentment and a source of extremism, thus their rehabilitation would go a long way towards the return of stability to the country. While it is still early days with no announced details of the alliance, apart from the flurry of visits and the news that the UAE would join in funding, yet the first steps taken so far are significant for the liberated areas. They started with opening of the Iraq-Saudi Arabia border crossing, the Iraq-Jordan border crossing and finalizing security measures to secure the highway connecting Baghdad to Amman. Another major trade artery being secured is that linking Iraq to Jordan’s port of Aqaba. The resumption of trade-links with their associated economic activities provide a huge boost to the local economies which should contribute meaningfully to the healing process. The reconstruction, even if the alliance is more modest than hoped for, will build upon and magnify the economic revival until it becomes self-sustaining.
While the Iraq-Saudi Arabia rapprochement might be portrayed as part of the Iran-Saudi Arabia rivalry, it is more logical to view it as part of this realignment of regional interests as supported by the recent thawing in the relationship between the two that started with a handshake between their foreign ministers in early August at the Organisation of Islamic Co-operation’s gathering in Istanbul, confirmed by Iranian pilgrims attending the Hajj for the first time in two years and by reports that the two could exchange diplomatic visits after the Eid holidays.
The Kurdish Regional Government of Iraq (KRG) concluded a series of agreements with a number of Exploration & Production (E&P) companies operating in the region (DNO ASA, Genel Energy & Pearl Consortium). The agreements settled: (1) outstanding receivables of about USD 1.5 bln in return for increased field ownership & relief on certain obligations; and (2) a USD 2.2 bln legal liability in return for cash and increased acreage. The deals provide the companies with increased financial and strategic flexibility to ramp-up production while addressing investor concerns on the Kurdish Region of Iraq (KRI). In return, the settlement will have a positive effect on the KRI economy crushed by multiple financial crisis since 2014. At the same time reports have circulated that the KRG is settling a dispute with the Central Bank of Iraq (CBI) by returning about USD 2 bln to the CBI, from about USD 5 bln of commercial banks’ deposits held at the CBI branches in the KRI frozen by the KRG since 2015. While, there are many views on the proposed KRI referendum later in September, the settlement with the CBI argues for a grand bargain in the making between the KRG and the Federal Government of Iraq (FGI). Arguably, the oil settlements were made possible by flexibility gained by the entry of Rosneft in the KRG through: (1) a long-term forward oil sales deal part of a total USD 3 bln forward sales agreements signed with a number of oil traders in February; and (2) a deepening agreement on E&P in June, which together would support the view that a KRG-FGI bargain has international support or mediation.
While these developments will not have an immediate impact on the equity market, never the less, combined with their positive impact on the economy, they should add fuel to the expansionary economic effects produced by the reversal of the forces (escalating costs of war & collapsing oil prices) that crushed the economy and squeezed liquidity over the last 3 years. Ultimately, with a time lag, this will be reflected in increased liquidity in the equity market.
The mantra of “a change of direction is at hand with the opportunity to acquire attractive assets that have yet to discount a sustainable economic recovery” is still worth repeating and so is “the recovery will likely be in fits and starts with plenty of zig-zags along the way as liquidity is still scarce with a time lag before it can filter down into the economy.”
As of 31st August 2017, the AFC Iraq Fund was invested in 14 names and held 3.3% in cash. The fund invests in both local and foreign listed companies that have the majority of their business activities in Iraq. The countries with the largest asset allocation were Iraq (96.2%), Norway (3.1%), and the UK (0.7%). The sectors with the largest allocation of assets were financials (50.9%) and consumer staples (24.4%). The estimated trailing median portfolio P/E ratio was 9.84x, the estimated trailing weighted average P/B ratio was 0.95x, and the estimated portfolio dividend yield was 4.19%.
The AFC Vietnam Fund returned returned -4.4% in August with an NAV of USD 1,820.85, bringing the net return since inception to +82.1%. This represents an annualised return of +17.6% p.a. The August performance of the Ho Chi Minh City VN Index in USD was -0.2% while the Hanoi VH Index gained +2.6% (in USD terms). Since inception, the AFC Vietnam Fund has outperformed the VN and VH Indices by +39.2% and +40.8% respectively (in USD terms). The broad diversification of the fund’s portfolio resulted in a low annualized volatility of 9.20%, a high Sharpe ratio of 1.89, and a low correlation of the fund versus the MSCI World Index USD of 0.30, all based on monthly observations since inception.
In August, we saw a broad correction early in the month. While blue chips, led by banks, recovered strongly and small- and mid-caps underperformed with their indices declining by about 3% in August, many of our stocks also corrected strongly over the month which provided us with a nice opportunity to reduce our cash position and to invest in the most attractively valued companies in our portfolio. We also decided to exit a small-cap position which we had since the beginning of the launch of our fund, at an attractive price level.
HCMC Index and Advance/Decline Ratio
As in previous years, during periods of extremely weak market breadth (advance / decline ratio), it is next to impossible to escape losses with a broadly diversified portfolio, as we are running. The real astonishing and disappointing development was the divergence of the majority of stocks and index heavyweights like for example Asia Commercial Bank, which rose by more than 10% in August, and which cannot be bought by foreigners since the foreign ownership limit has been reached for years. On the positive side, such sharp corrections without any negative economic news offer great bargain buying opportunities, and hence we used some of our cash to increase the position size in all of our most attractively valued stocks.
Meanwhile, the weakness in the USD has taken pressure off of any meaningful depreciation in the Vietnamese Dong, although seasonal weakness towards year end is quite likely. We rightly pointed out a top in the USD index in early 2017 and the following weakness in the greenback helped emerging market stock markets immensely this year. It now looks like the USD is oversold on a medium-term basis and is testing important support levels, and it therefore will be interesting to see where currencies are heading in the coming weeks.
USD Index versus Vietnamese Dong – 5 years
Whatever the future direction of the USD holds, the volatility in the USD is certainly much higher than in the Vietnamese Dong, which has moved less than 10% over the past 5 years. Other major currencies including the Euro and Japanese Yen have been even more volatile with fluctuations of between 30-40% over the past five years.
Although emerging markets performed well in 2017, they are still undervalued versus developed markets, which are trading at pre-crisis valuations and most indices are already higher than 10 years ago. Both frontier and emerging markets would have to rise about 50% to match those valuations, not to mention the current valuation of our portfolio, which would have to rise another 50%, just to catch up with the current valuation level of Vietnamese large caps.
Despite many uncertainties, one can clearly the optimism in the long term for Vietnam, which is also the reason why we launched the AFC Vietnam Fund a few years ago.
In August 2017, industrial production reached 8.4% compared to 7.3% in Aug 2016. Total industrial production in the first 8 months of 2017 grew at 6.7% YoY which shows an ongoing improvement in Vietnam’s economy.
FDI continues to be the most important topic in August. Total FDI disbursement reached USD 10.3 billion, increasing 5.1% YoY. Through 20 August 2017 pledged FDI reached USD 23.4 billion, expanding by 45.1% YoY.
Export values continued to grow impressively, by 17.9% in August, one of the fastest export growing countries in the world, to USD 133.5 billion. Value of imports was USD 135.6 billion, leading to a slightly smaller trade deficit of USD 2.1 billion in comparison to 1H2017.
The headline CPI in August increased to 3.35%, meanwhile the core CPI stood at 1.31%. The low CPI helps to stimulate domestic consumption. Furthermore, loose monetary policy and credit stimulation policy has significantly encouraged consumption. Total retail sales for the first eight months of 2017 grew 10.3% compared to 9.3% YoY.
At the end of August 2017, the fund’s largest positions were: Agriculture Bank Insurance JSC (3.4%) – an insurance company, Sam Cuong Material Electrical and Telecom Corp (2.5%) – a manufacturer of electrical and telecom equipment, Pharmedic Pharmaceutical Medical JSC (2.2%) – a pharmaceutical company, Cantho Pesticides JSC (2.0%) – a manufacturer of agricultural chemicals, and National Seed JSC (1.9%) – an exporter of seeds.
The portfolio was invested in 76 names and held 5.0% in cash. The sectors with the largest allocation of assets were consumer goods (34.1%) and industrials (26.5%). The fund’s estimated weighted average trailing P/E ratio was 9.67x, the estimated weighted average P/B ratio was 1.70x and the estimated portfolio dividend yield was 7.06%.
In line with our process of being on the ground in the countries we invest in, Senior Investment Analyst Ruchir Desai travelled to Bangladesh in July to meet with companies on the ground. All photos are by Asia Frontier Capital.
While Bangladesh is a market mostly overlooked by investors, to frontier investors it is not a market to be ignored. A population of approximately 160 million (the eighth most populous in the world) with a median age of 26 and per capita incomes rising from a low base, Bangladesh is an extremely attractive opportunity in the longer run, especially in the consumer space. We have been positive on the consumer story in the country since the inception of the fund and continue to be optimistic.
Bangladesh has favourable demographics
(Source: IMF, United Nations Population Division)
This was my third visit to Bangladesh in the past 18 months and there were more foreigners on the flight to Dhaka compared to my previous two visits which is a positive sign given the recent worries about the security situation in Bangladesh post the July 2016 incident. There is a more visible presence of security at the hotels over the past year and overall the authorities seem to be cracking down. International cricket teams have also not called off any tours (as had been the case in the past) which suggests that the security situation has improved over the past year. However, in Dhaka, the lack of quality hotel room supply means room rates are amongst the highest in the region (similar to Pakistan). With more international hotel chains such as the Intercontinental and Marriott expected to come up soon, this situation could possibly change.
During my previous visits all the company meetings were held at the Westin for reasons that would become abundantly clear this time around. In this trip, the company meetings took place at the companies’ offices and this meant navigating the Dhaka traffic. With traffic in Dhaka, seeing or experiencing is believing. It is a big deal to get five meetings done in one day on the road in the city. The growth in the number of vehicles and lack of adequate infrastructure means traffic moves extremely slowly and to make matters worse it was the rainy season. Moving a couple of kilometres can easily take 45-60 minutes if luck is not on your side.
Going through the chaotic traffic it is easy to recognise that the public transport infrastructure is very stretched and needs to be replaced. The buses are old and packed and commuters are also using other means such as mini trucks in which commuters are squeezed in, with some even hanging out of the back, while for shorter trips the cycle rickshaw seems to be the transport of choice.
One of the modes of public transport – but not without risks
Cycle rickshaw is a preferred and cheap mode of transport
This also means there is potential in terms of developing infrastructure not only in Dhaka but across the country and this is taking shape currently. Some major projects such as the Dhaka Elevated Expressway and Padma Multipurpose Bridge (Padma Bridge) projects are ongoing. The Padma Bridge project is quite important to the economy as it will significantly improve the connectivity between the south west and northern and eastern regions of the country.
Over two days of meetings I got the chance to meet with companies across the cement, consumer, financial services and pharmaceutical sectors and the AFC Asia Frontier Fund is an investor in some of these companies. Broadly speaking, for the reasons mentioned above we are positive on companies and sectors which give us exposure to the consumer sector and as a result our investments in Bangladesh have so far focussed on consumer staples, consumer discretionary, financial services and telecom companies.
There is immense potential across sectors in the consumer space in Bangladesh. For example, air conditioner and refrigerator penetration rates in Bangladesh are only at 3% and 20% compared to global averages of 60% and 85% respectively. Smartphone penetration is at 28% and consumer finance products such as credit cards, auto loans and mortgage loans, all have a penetration rate of less than 10%. With increasing urbanisation and higher disposable incomes, companies focusing on these segments are expected to see strong growth in the coming few years and the fund is well positioned to capture these opportunities.
Political stability over the past few years has helped improve economic growth rates and GDP growth this year should be between 6.5%-7% which is amongst the highest in the region as well as globally. However, with general elections expected at the end of 2018, a surge in political noise and blockades similar to 2014 should not come as a surprise. The opposition though seems to be in a weaker position so it is a bit early to judge whether we will have the same issues as experienced in end of 2014 and the beginning of 2015.
In the near term, there could be some pressure on macro stability as lower remittances along with slower exports has led to a current account deficit and has resulted in some currency weakness. However, the foreign reserve position is still strong with approximately 9 months of import cover, one of the highest in the region. The recent floods in the past month which have had a negative impact on rural areas could also impact consumer spending while inflation could also move up due to agricultural produce being impacted by the recent floods. However, we are more focused on the long-term opportunity in Bangladesh and continue to invest in companies that are promising in the medium and long term.
Inside a showroom of a consumer electronics retailer
I visited the store of one of the most well-established consumer electronics manufacturers and retailers in Bangladesh that the fund is invested in to check out its products and in between meetings, I also had a chance to visit some of the modern retail stores in Dhaka of which Shwapno (which means “Dream” in Bengali) is one of the leading retail chains. I checked out products of publicly listed consumer companies there which gives us a chance to also look at competing products as well as pricing of various brands. However, most of the retail sales in Bangladesh are still occurring through the traditional retail channel and modern retail is still very under penetrated.
Traditional retail in Bangladesh
Modern retail in Bangladesh
Being out on the road in Dhaka gave me a better perspective on the opportunities that Bangladesh offers both in terms of consumer demand as well as significant potential to improve various types of infrastructure. Until then we will have to make do with the traffic.