Asia Frontier Capital (AFC) – September 2017 Newsletter

“Patience is bitter, but its fruit is sweet.”
– Aristotle

AFC Funds Performance Summary

Frontier markets performed well last month as the MSCI Frontier Markets Net Total Return USD Index gained +2.0% and the MSCI Frontier Markets Asia Net Total Return USD added +3.8%. At the same time, the MSCI World Index Net Total Return USD Index rose by +2.2%.

The AFC Asia Frontier Fund gained +0.7% while the AFC Vietnam Fund rose +1.1% in September. The AFC Iraq Fund lost −1.8%.

AFC Asia Frontier Fund winner in the HFM Hedge Fund Performance Awards 2017

CEO & Fund Manager Thomas Hugger receives the award

(Source: HFMweek)

This prestigious award, in the category “Long/short equity Asia ex-Japan”, was presented to AFC CEO and Fund Manager Thomas Hugger on the 28th of September in Singapore. Besides winning in this category, the AFC Asia Frontier Fund was also nominated in three other categories. The full list of winners can be seen here. Similarly, last year, our AFC Vietnam Fund won an award at the 2016 HFM awards. Winning these types of accolades is testimony to the consistent performance of our funds since their inception. This is a result of our dedication to and focus on a structured risk management process and a robust stock selection process.

AFC Asia Frontier “Parallel Fund” in Luxembourg to launch on 1st November 2017

In order to provide better and easier access for our European investors, Asia Frontier Capital will launch a “Parallel Fund” of the AFC Asia Frontier Fund in Luxembourg. The launch of the AFC Asia Frontier Fund (Lux) is planned for the 1st November 2017. The subscription period at EUR 1,000 is from 1st October 2017 until 31st October 2017.

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.

The impending launch, which was announced in a press release Uli: this is a link], was made possible after we received authorisation from the “Commission de Surveillance du Secteur Financier (CSSF)” in Luxembourg on 20th September 2017 to launch the “AFC Asia Frontier Fund (LUX)” under the existing Umbrella Fund “LS Opportunities Fund Sicav-FIS” which is managed by “Limestone Platform AS”, Tallinn, Estonia.

On the occasion, Marc Faber, editor & publisher of The Gloom, Boom and Doom Report ( and shareholder of Asia Frontier Capital, commented: “In general, international investors have far too little exposure to emerging markets and in particular to Asian frontier economies. I believe that European investors should further diversify their investments into fast growing emerging economies and in particular add holdings in Asian frontier economies, which I expect to have sustainable long-term growth going into the next decade”.

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 and he explained the significance of the event in an interview with the organizer that can be found here. For further information about this event see .

If you have any questions about our funds or would like any additional information, please be in touch with our team at

Upcoming AFC Travel

If you have an interest in meeting with our team during their travels, please contact Peter de Vries at

AFC Asia Frontier Fund – Manager Comment – September 2017

AFC Asia Frontier Fund (AAFF) USD A-shares gained +0.7% in September 2017. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+3.8%), the MSCI Frontier Markets Net Total Return USD Index (+2.0%), and the MSCI World Net Total Return USD Index, which gained +2.2%. The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +72.6% versus the MSCI Frontier Markets Asia Net Total Return USD Index, which is up +55.7%, and the MSCI Frontier Markets Net Total Return USD Index (+52.2%) during the same time period. The fund’s annualized performance since inception is +10.4% p.a., while its YTD performance stands at +1.3%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 8.91%, a Sharpe ratio of 1.15, 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.

The fund got back into positive territory this month as the Pakistani market stabilized after the volatility it had faced over the past few months. The KSE100 Index gained 2.9% this month and most of the fund’s holdings in Pakistan closed in the green, led by a consumer finance company which gained +19%. During the month, an election was held for the National Assembly seat which was vacated by former Prime Minister Nawaz Sharif which resulted in his wife competing for the seat in this constituency. Though the ruling PML (N) led by the Sharif family regained this constituency, the win was not as comprehensive as the one in 2013, so it would be too early to judge in whose favour next year’s national elections will swing, although the PML (N) still has a very strong voter base in Punjab which accounts for the majority of the seats in the National Assembly.

Though macro concerns continue to remain given the wide current account deficit and worries over possible currency depreciation, economic indicators are positive, with auto sales and private sector credit continuing to show double digit growth. Further, industrial production grew at 13% YoY in July 2017, with the growth being broad-based across industries, which is also a positive sign. Though the Pakistani rupee depreciation can hurt consumer discretionary companies in the auto and consumer appliance industries in the short run, the longer-term demand drivers continue to be in place, i.e. improved power supply, improved security, urbanisation, and rising disposable incomes. Further, valuations for such companies in the consumer discretionary sector continue to be attractive.

Vietnam contributed positively to fund performance as well with most of the fund’s Vietnamese holdings ending positive this month. A consumer conglomerate has done well for us over the past few months as it was undervalued after posting disappointing first half numbers and it also announced a share buyback during the month, which led to positive sentiments for this stock. Economic data out of Vietnam remains robust with 3Q17 GDP growth at 7.5% led mainly by the manufacturing and services sectors, which have grown by 12.8% and 7.3% respectively to date. Foreign Direct Investments (FDI) have also grown by 13% YoY this year to USD 12.5 billion, while FDI commitments have grown by 34% YoY to USD 25.5 billion, which continues to reflect the rise of Vietnam as a low-cost manufacturing destination.

Mongolia was once again the highest contributor to performance this month as the economy continues to recover from a bottom on the back of rising coal and copper exports. On the political front, on 7th September the Mongolian People’s Party, with its super majority in Parliament, voted to oust the current government due to the MPP’s Presidential candidate having lost the July election. On 25th September U. Khurelsukh was elected in a landslide win, with 64% of the votes, against two other candidates for the position of Prime Minister and was approved for the position on 4th October. After the new government is created we would hope to see it advance discussions on several mega projects, including the consortium of Shenhua, Sumitomo and Mongolian Mining Corporation to operate and develop the government owned Tavan Togloi coking and thermal coal deposit, in addition to construction of a railroad and mine-mouth power plant.

The Sri Lankan government introduced a new tax bill and some of the major positives are the incentives given to new investments in the form of tax concessions and an increase in the tax exempt threshold for employment income, which could be positive for disposable incomes going forward.

The largest negative contributor to performance was the fund’s biggest holding, a Bangladeshi pharmaceutical company, whose GDR the fund holds and which is trading at a discount of 48% to the local listing. Fundamentally this company has shown better than industry growth this year with the outlook also being positive. Therefore, we believe the fundamentals will eventually be reflected in the price.

The best performing indexes in the AAFF universe in September were Mongolia (+18.4%), Pakistan (+2.9%), and Vietnam (+2.8%). The poorest performing markets were Iraq (-1.9%) and Laos (-1.8%). The top-performing portfolio stocks this month were (like the previous two months) all from Mongolia: a construction materials company (+45.1%), a cashmere producer (+44.2%), a brewery (+39.4%), a commercial property company (+37.5%), and an apparel company (+31.8%).

In September, we added to existing positions in Laos, Mongolia, Pakistan, Papua New Guinea, Sri Lanka and Vietnam and we exited a Bangladeshi pharmaceutical company. Additionally, we partially sold six companies in Mongolia.

As of 30th September 2017, the portfolio was invested in 117 companies, 1 fund, and held 3.7% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (7.6%) and a pump manufacturer from Vietnam (3.0%). The countries with the largest asset allocation include Vietnam (28.3%), Pakistan (21.2%), and Bangladesh (16.1%). The sectors with the largest allocations of assets are consumer goods (30.5%) and industrials (14.7%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 15.92x, the estimated weighted average P/B ratio was 2.74x, and the estimated portfolio dividend yield was 3.97%.

AFC Iraq Fund – Manager Comment – September 2017

AFC Iraq Fund Class D shares returned −1.8% in September as a holiday shortened month was further compressed with average daily turnover down to 3-year lows. Most of the losses took place in the last 2-3 days as buyers disappeared and prices were marked down. The fund ended the month in-line with the with the RSISUSD index which lost −1.9%. The fund is now down −11.3% YTD, which is an outperformance compared with the RSISUSD index which lost −16.7% in the same time period.

In spite of intense international focus, the Kurdish referendum was almost a non-event for the market during the month. The referendum’s implications will follow the market section.

The month was compressed to just over two weeks of trading due to the Eid and Islamic New Year holidays. While the last 10 days were marked by the start of the month of Muharram, one of the four sacred months of the year. In Iraq, it has an oversized role as the 10th day of the month known as Ashura, occurring on the 1st October, marks the start of the 40-day annual Arba’een pilgrimage. It is estimated that over 20 million Shia pilgrims will visit Karbala to commemorate the martyrdom of Iman Hussein, which was a bifurcation point in the Shia-Sunni divide.

Turnover Index (green) on the ISX vs its 10-day moving average (red)

(Source: Iraq Stock Exchange (ISX), AFC)

The pick-up in oil revenues due to the rise in oil prices, as supply-demand shifts into balance, should have positive implications for the equity market. The market’s correlation with oil revenues, especially since 2014 (below), supports the thesis that the market’s correction since February has run its course and the current phase is likely to be followed by an upward move.

Oil Revenues (green) vs the RSISUSD Index (red)

(Source: Iraq Stock Exchange (ISX), Rabee Securities, Iraq’s Ministry of Oil, AFC)

Thoughts on the Kurdish referendum and its implications

The Kurdish Region of Iraq (KRI) would need Brent prices consistently above USD 60 for its budget to break-even under its official borders, but above USD 80 for its budget to break-even within its aspirational borders (AFC analysis based on data from World Bank reports, Pareto Securities, and newswire reports). Given that this is an austerity budget composed mostly of current spending and oil related payments with hardly any capital spending, it follows that, the KRI would need Brent prices near USD 70 for many years to build the financial wherewithal to contemplate independence within its official borders let alone its aspirational borders. The Kurdish Regional Government (KRG), aware of its financial position, is thought to have planned the referendum to strengthen its position in a post-ISIS Iraq in the 2018 parliamentary elections, in the same way that the referendum of 2005 did for its fortunes in post-Saddam Iraq.

The Iraqi constitution has no provision for a secession and is silent on referendums on important issues. The referendum would not have caused controversy, especially internationally, had it been used to obtain a mandate to seek a negotiated secession as it has been billed. However, the issue that ignited the regional and international opposition was the forceful inclusion of what is termed the “disputed territories” or about 40% more land than the official KRI area. The constitution refers to “Kirkuk and other disputed territories” but does not specify them. They are areas with Kurdish majorities.

However, this is not as simple as it seems given the complex web of minorities living in the disputed territories: the area used to be part of a major ancient trade route, in which the Iraqi part begins with the Syrian and ends with the Iranian borders, and over the centuries was settled by diverse populations. The last to settle were Turkic peoples during the Ottoman Empire who eventually became the Turkmen of Iraq. Kirkuk, in particular, is problematic as it’s claimed by Arabs, Kurds, and Turkmen with the latter being the most likely to have a legitimate claim. The discovery of oil in Kirkuk in 1927, and the following boom, diluted the Turkmen population with migration of Kurds from the north and Arabs from the south. The census of 1957, accepted by all, showed at the governate level that the ethnic makeup was 48.2% Kurds, 28.2% Arabs and 21.4% Turkmens but that the city of Kirkuk was 37.6% Turkmens, 33.3% Kurds and 22.5% Arabs. These percentages changed significantly under the prior regime which enforced Arabisation at the expense of Kurds and other minorities, but saw a process of reversal after 2003 with the return of some Kurds but not so much the Turkmen.

The complexity can only be glimpsed at by noting that while at a governate or district level a simple majority might be Kurdish, many villages and towns that dot the area are almost entirely made up of different minorities. The area was almost in limbo after 2003, being administratively part of federal Iraq with some of the areas close to the KRI border policed by the KRG. After the fall of Mosul to ISIS in 2014 and the collapse of the Iraqi army, the area fell under the control of Kurdish military forces, in the process increasing the official KRI by 40% in both land and population. An uneasy state of affairs prevailed while the country battled ISIS, in which the areas were policed by the KRG but administratively and financially managed by the federal government.

Therefore, the inclusion of the disputed areas, and not the rights of the Kurdish people for self-determination, caused the Iraqi, regional and international opposition. The forced inclusion of these areas to be accepted, even as a basis for dialogue with federal Iraq, would legitimize similar future actions in the region, and hence the coordinated regional response. Away from the heated war of words, actions on the ground are different and aim to re-set the relationship between Federal Iraq and the KRG to a more even keel. An example of re-establishing federal authority is setting shadow border posts on Turkish and Iranian sides of border, outside the KRI, on important trade routes to Iraq via the KRI (about 27% of all Iraq inbound land trade), collecting custom fees but allowing trade flow. It’s logical to conclude that action on oil exports would be along similar lines and should accelerate restabilising dialogue. None of the measures would work without regional support or without the tacit agreement of international players. Economic realities will ultimately prevail, with the KRG re-establishing dialogue and forming alliances with the moderate forces in Iraqi politics. Crucially, the crisis has strengthened the position of these moderates under the current prime minister, already bolstered by the success of the ISIS campaign.

The almost unanimous international support for a unified Iraq should lead to financial support for its reconstruction and reinforces the argument made here in the past: 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 created such fertile grounds for the rise of extremism. After the military resolution, these would be long-term solutions which will involve significant investments in infrastructure to bring much-needed developments and create prosperity.

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 that “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 30th September 2017, the AFC Iraq Fund was invested in 14 names and held 3.8% 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 (96.6%), Norway (2.8%), and the UK (0.6%). The sectors with the largest allocation of assets were financials (52.5%) and consumer staples (22.7%). The estimated trailing median portfolio P/E ratio was 9.42x, the estimated trailing weighted average P/B ratio was 0.94x, and the estimated portfolio dividend yield was 4.32%.

AFC Vietnam Fund – Manager Comment – September 2017

The AFC Vietnam Fund returned +1.1% in September with a NAV of USD 1,840.73, bringing the net return since inception to +84.1%. This represents an annualised return of +17.6% p.a. The September performance of the Ho Chi Minh City VN Index in USD was +2.8% while the Hanoi VH Index gained +3.6% (in USD terms). Since inception, the AFC Vietnam Fund has outperformed the VN and VH Indices by +37.2% and +37.7% respectively (in USD terms). The broad diversification of the fund’s portfolio resulted in a low annualized volatility of 9.10%, a high Sharpe ratio of 1.90, and a low correlation of the fund versus the MSCI World Index USD of 0.30, all based on monthly observations since inception.

The market went sideways in the last two weeks of the month, although the picture was very mixed. Surprisingly strong economic data will hopefully also support earnings when third quarter results will be published in October. The index in HCMC went up +2.8% while Hanoi added another +3.6% thanks to the index heavyweight, Asia Commercial Bank, which increased by +7% last month.

Market developments

With index heavyweights surging again, we would like to take some time to highlight the main drivers of the Vietnamese stock market.

Macroeconomic data remains impressive without any signs of a slowdown in economic activity. The biggest concerns in recent years have always been inflation, the trade deficit, and currency devaluation. Both inflation and trade numbers are under control and compare very favourably with other strong and growing economies. Most experts have been expecting a devaluation of the Vietnamese Dong for quite some time now, but the reality shows that this concern was overblown, since the Vietnamese currency is one of the most stable versus the USD in the whole region and beyond.

One of the main arguments for a weaker Dong by currency experts was the bearish view of the Chinese Yuan on concerns about growing risks in the Chinese financial sector and the sustainability of the economic growth model, something we have heard and read about for almost 20 years now. Every fresh burst of Yuan weakness, as seen in 2015 and early 2016, was accompanied by a strong correction in the Vietnamese stock market. Now, those experts calling for a weaker Yuan are back in their caves with the Yuan and other major currencies substantially up versus the USD in 2017. This development has helped the Vietnamese currency immensely and brought foreign investment capital into Vietnam and other frontier and emerging markets around the world.

Chinese Yuan (5 years)

(Source: Bloomberg)

Those kinds of foreign investment inflows are usually channelled into a narrow range of highly liquid and large cap stocks, as we have seen since the start of the year. IPO’s were very popular with foreign investors as they offered easy exposure to a market where many stocks have either low liquidity or full foreign ownership limits.

In the IPO market we have seen a mixed picture so far in 2017, similar to the market in general. Some of the bigger companies which were also added to the indices experienced price jumps after their listing, but the correlation between market cap and performance has been very low. Interesting, and almost worrisome, is the rather strong correlation between valuation and performance after listing. It seems that investors completely ignored cheap stocks in 2017 and jumped into expensive momentum stocks which offered M&A fantasies – the more expensive, the better?

New listings in 2017 with reasonable market turnover

(Source: AFC)

New listings of big caps in 2016/17 (market cap; USD billion)

(Source: Viet Capital Securities)

As companies with brand names well known to foreign investors went public, their listing valuations were already mostly higher than those of comparable companies. When we take the very successful Saigon Beer listing as an example, it is understandable that foreign brewery giants like Heineken or Carlsberg are interested in expanding into Vietnam via strategic acquisitions. Though the money they pay for those acquisitions is of less importance for them than having a foothold in this market with a population of more than 90 mln. With these kinds of transactions, usually done off-market, minority shareholders don’t have much to gain and should look at basic fundamentals in order to achieve long-term potential returns, such as dividend yield and earnings growth. Saigon Beer’s dividend yield of 1.4% is just half of the average yield of the market and compares very poorly to the average dividend yield of around 6% of our portfolio. While the profit margin improved from very low levels a couple of years ago, Saigon Beer’s top line growth was only 3% p.a. over the past three years. In a beer market such as Vietnam, where consumption is already the highest in SE Asia and with increasingly cutthroat competition, one has to wonder where future growth should come from to justify valuations of 35-40x earnings.

Saigon Beer (12 months)

(Source: Bloomberg)

Also, important to see in that example is that public investors were only able to buy at prices from around VND 200,000 or higher, when volume started to set in after it was listed at a price of 110,000 Dong!

Other examples of well-known names with initial stock price jumps before public investors were able to buy include Vietjet Air, with notable turnover at prices of 40% higher than their listing price, and Viet Capital Securities at 25% higher prices.

We know from experience to be patient with our portfolio, as those market cycles between favoring value stocks versus momentum stocks can go on for some time but never last forever as many market participants either think or wish.


The Vietnamese economy continued to deliver strong numbers, with a Q3 GDP growth of 7.46% compared to 6.4% in Q3 2016. This is the highest Q3 GDP growth number in 10 years. The ytd GDP growth reached now 6.41% compared to 5.93% in the same period last year and it looks more and more likely that we are able to achieve the government target of 6.7% this year.

Vietnam GDP Growth

(Source: Viet Capital Securities, GSO)

Also, FDI (Foreign Direct Investments) showed impressive numbers, with ytd FDI registration reaching a record high of USD 25.48 billion, +34.3% compared to same period last year and FDI disbursement increased to USD 12.5 billion, +13.4%.

The petroleum price increase in September had an impact on CPI, which grew from 2.54% in August to 3.4% in September but still well under control and not to worry.

(Source: VCSC, GSO, AFC research)

At the end of September 2017, the fund’s largest positions were: Agriculture Bank Insurance JSC (3.4%) – an insurance company, Sam Cuong Material Electrical and Telecom Corp (2.7%) – a manufacturer of electrical and telecom equipment, Global Electrical Technology Corporation (2.1%) – a electrical equipment company, Sonadezi Long Thangh Shareholding Company (2.1%) – a residential real estate developer, and Cantho Pesticides JSC (2.0%) – a manufacturer of agricultural chemicals.

The portfolio was invested in 76 names and held 3.0% in cash. The sectors with the largest allocation of assets were consumer goods (34.6%) and industrials (27.9%). The fund’s estimated weighted average trailing P/E ratio was 9.93x, the estimated weighted average P/B ratio was 1.76x and the estimated portfolio dividend yield was 6.81%.

AFC Travel Report: Mongolia – September 2017

In line with our process of being on the ground in the countries we invest in, CEO and Fund Manager Thomas Hugger travelled to Mongolia in August to meet with companies on the ground. All photos are by Asia Frontier Capital.

In my view, the best time to travel to Mongolia is from May to September when temperatures are moderate and usually don’t fall below zero! Bear in mind that Ulaanbaatar is the “coldest capital in the world” with an average temperature from December to February regularly below -20 degrees Celsius.

My flight to Ulaanbaatar from Hong Kong was just one week after typhoon Hato, one of the strongest in decades to hit Hong Kong and especially the former Portuguese enclave of Macau. Unfortunately, on the morning of my flight, typhoon Mawar passed by Hong Kong. It was quite a challenge getting to Hong Kong International Airport since upon leaving my home in the New Territories the typhoon signal number 8 was still hoisted, meaning more or less all public transport was shut down, including taxis. It took me considerably longer to reach the airport and thanks only to the Airport Express train being operational was I able to arrive at the boarding gate for my Mongolian Airlines flight on time.

I was surprised at how empty the normally busy Hong Kong airport was, likely a result of the shutdown of public transportation. As expected, my flight (which was also empty) took off two hours late. After a bumpy start, the Mongolian pilots guided the Boeing 737 safely through the turbulent weather with both engines on full power during the first twenty minutes of the flight.

Even in the late Mongolian summer the temperature difference between Hong Kong and UB can be enormous which means careful planning of what to pack (done by my wife, thankfully) is needed. When I left Hong Kong the ground temperature was about 32 degrees Celsius, though upon arriving at Chinggis Khaan Airport in Ulaanbaatar (“UB”) the temperature was a nippy 6 degrees. Walking through the central Sukhbaatar Square after dinner that night the temperature had then fallen to +1 degrees!

The first few company visits on this trip were to be held in Darkhan, the second most populous city with a population of 180,000 compared to Ulaanbaatar’s 1.4 million. In Mongolian, Darkhan means “blacksmith” since the city was built with the assistance of the Soviet Union in 1961 and still today remains a largely industrial town composed of cement, steel, tannery and other factories.

The picturesque trip from UB, 230km northbound to Darkhan was mostly inhabited by vast expanses of the green steppe where sheep, goats and wild horses grazed freely. On our drive, we passed several small villages and from time-to-time saw white “gers” (Mongolian yurts) which seemingly sprouted from the countryside in an otherwise desolate green environment where the nomads living in them were out herding their animals either on horse or motorcycle. It was a refreshing change to soak up the picturesque landscape void of any permanent manmade structures.

Vast openness on the Mongolian steppe

A small settlement in the steppe between Ulaanbaatar and Darkhan
(look at the holes in the road)

“Modern” nomads

“Traditional” nomads

I last visited Mongolia exactly one year earlier and ended the Mongolia travel report for October, 2016 with two positive notes: the restart of the gigantic copper mine “Oyu Tolgoi” in the Gobi desert and the increase of coal prices “which can lead to higher share prices”. However, I was three months too early with my positive call which is not too far off, no? The MSE Index reached a low in December 2016 (the average daily turnover in October 2016 was USD 5,800) and finally came out of the doldrums in July 2017 right after the surprise election where opposition member and former world wrestling champion K. Battulga was elected as the new President of Mongolia.

Mongolia Stock Exchange Top 20 Index (12 months)

(Source: Bloomberg)

After arriving in Darkhan I was eager to understand the mood of the local businesspeople regarding the economic outlook. Expecting things to have started to turn, it was a rude awakening. Prior to our first meeting we drove through the industrial zone of Darkhan City and saw various idle factories, many of which dated back to the Soviet era. These were mainly heavy industrial factories and we had the chance to tour an idled former construction materials company, an idle factory for steel products, as well as an idled coal products company. Interestingly, all three companies are still listed on the MSE and do trade from time-to-time.

Our first factory visit was a company producing leather and leather products (mainly boots and coats). The factory was established with the assistance of the Bulgarian government in the 70’s and still today a sculpture at the entrance honours the lead Bulgarian communist party member who provided technical assistance to the company. In our meeting with the CEO we were provided a bleak outlook for both the leather industry and his company due to falling raw leather prices globally.

We also met with the CEO of a food company producing bread, Mongolian cookies and other baked goods. However, the company is better known regionally for its ice cream which we sampled and enjoyed, especially the locals from our brokerage company. At the moment, the company produces ice cream only for the regional market in Darkhan, though they have plans to import ice-cream machinery from China which will increase production capacity considerably. In general, the mood in Darkhan was not optimistic and my first impression was that the turnaround in the real economy is yet to happen.

Bread and confectionary factory in Darkhan

That evening we spent the night in a traditional Mongolian yurt in a beautiful tourist camp overlooking the entire plateau. Fortunately, our yurt was a bit more upscale than some of those we saw during the drive to Darkhan on either side of the highway! These traditional yurts are still a common sight not only in the countryside but also on the outskirts of Ulaanbaatar where over 700,000 people live in what are termed the so-called “ger districts.”

Traditional Mongolian family home: yurt or in Mongolian “ger”

The next morning, we awoke early to enjoy the stunning view from the camp site and the peaceful silence. After enjoying a traditional Mongolian breakfast, we began our drive back to UB and arrived just in time for our first meeting, having successfully navigated the traffic-clogged streets in the city center. Over the course of the next three days I had the opportunity to meet with 17 companies (mostly with the CEO’s) who informed me about each company’s latest performance and business outlook. I was also able to visit the factory of a meat producing company which is either currently or preparing to export meat to Iran, Russia, and China, a dairy factory, and not to mention the Mongolian Stock Exchange “MSE”.

Visiting a dairy factory

In general, the mood and business outlook in UB was considerably more optimistic compared with Darkhan. Obviously, some of the companies I met have gone through an extremely difficult period during the past three to four years, but now many are either expecting or already experiencing an uptick in business including a return to profitability. The rise in coal prices, and especially the increased demand for coal from Chinese companies (due to the tightening of sanctions against North Korea and China’s implementation of production curbs and environmental controls), combined with higher copper prices has resulted in a marked increase in revenues for the Mongolian mining sector leading to positive GDP growth in the first half of the year. Now, big foreign companies are again looking to invest into the sector. As a result of higher coal exports, the country’s balance of payments has turned positive and forex exchange reserves have begun growing again. The recovery though remains fragile, as during my trip there were reports of a 160-kilometer-long line of trucks full of coal on the Mongolian site of the border to China in the South Gobi Desert due to Chinese bureaucracy. Probably the longest traffic jam in the world!

At the visitor gallery of the Mongolian Stock Exchange “MSE”

Since my visit to Mongolia at the end of August, the Mongolian Stock Exchange Index has increased further and is now up +47.7% year-to-date as of 30th September, 2017. According to Bloomberg the MSE is the 5th best performing stock market this year globally!  However, the MSE index is not really a good benchmark since it is a capital weighted index and the top two companies in the index now have a combined index weighting of 54% and which are up year to date by 243% (a coal mine) and 59% (a brewery which recently merged with Heineken’s Mongolia beer business), respectively. Good stock picking is generally the name of the game in our frontier universe and since company research in countries like Mongolia is “basic”, we find on the ground meetings a highly effective method to generate good returns and more importantly to avoid serious investment mistakes.

I hope you have enjoyed reading this newsletter. If you would like any further information, please get in touch with me or my colleagues.

With kind regards,

Thomas Hugger
CEO & Fund Manager

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