The Best Market in the World?

By Carl T. Delfeld
Vice Chairman, ASEAN Investment Council.

This article has been kindly made available to EmergingMarkets.me by Thomas Hugger, CEO and Fund Manager of Asia Frontier Capital

Wouldn’t it be great if you could create an ideal market to invest in out of thin air? 

Right off the bat you would want growth – lots of growth potential.  Perhaps economic numbers like inflation and interest rates on a declining trend.  Political stability, low valuations coupled with low costs and increasing flows of capital would also be nice.

Of course, we will never find the perfect market.  There is always risk with any investment and flaws to even the best story.  But looking over the world right now, the best market I can find is Vietnam.

Let’s put the major negative to the Vietnam story out on the table.  Like China, it has an authoritarian communist government and all the negatives that come with it.  Fortunately, investors have the flexibility to sidestep the country’s state-owned enterprises and focus on smaller private companies that are on a high-growth trajectory.

The list of Vietnam’s positives is really quite impressive.  Here are just a few for starters: a low level of capital stock so every dollar of investment yields big jumps in productivity, attractive demographics to fuel consumption, a talented, well-educated, ambitious people with a great faith in their future, low real wages for a decisive competitive advantage, tremendous opportunities for market reforms to unlock blocked potential, and low valuations and rising, robust foreign investment to drive its industry and stock market forward.

Let’s take a closer look at some of these and more.

Significant catch up potential with neighboring countries

Vietnam has a long way to go before it catches up with neighbors such as Thailand in terms of urbanization, per capita incomes, and size of its stock market and manufacturing base.  About 70% of Vietnamese still live in rural areas and are involved in agriculture so, just like during China’s rise, urbanization will supercharge growth and incomes.

Improving macro fundamentals & infrastructure

The country’s macro picture is considerable better than five years ago.  Foreign reserves have tripled to $34 billion.  Interest rates have come down from 20% to 8%. Inflation has fallen from 18.7% to just 0.6%. Meanwhile annual economic growth has been pretty stable in the 6%-7% range.  Vietnam’s infrastructure is improving with 267,000 km of roads and 1.49 cell phones per person.  The economy is well diversified and the country is rich in resources and has become an energy exporter.

Market reforms in banking and finance

A significant issue for Vietnam is bank debt and non-performing loans. It is making incremental progress but much more needs to be done to open and modernize its financial system. It also needs to move forward on plans to privatize 289 state-owned companies.  In addition, Vietnam has to reign in government spending.

Low stock valuations relative to competitors

For some reason, many of Vietnam’s large state-owned companies are expensive but medium and small sized companies are a terrific value.  The trailing price to earnings ratio for this group is just 7.8 compared to 26.9 in Indonesia and 21.3 in the Philippines.  The Vietnam market index trades at just 1.1 times book value with a dividend yield of 6.3% while Indonesia is a 2.4 times book value and the Philippines is at 2.6 times book value.

Excellent demographics signal long-term growth of incomes and wealth

In contrast to China’s premature greying society, Vietnam’s population of 98 million is at a demographic sweet spot with and average age of just 27 years old with 70% under the age of 35.  Wealth has risen at an annual compounded rate of 13.5% over the last decade meaning Vietnam’s consumer and investor class is expanding every year. The literacy rate is 94% with primary education improving every year.

Geographic and strategic importance at the heart of ASEAN

If the Trans-Pacific Partnership (TPP) passes muster, Vietnam will likely be the greatest beneficiary.  As the recently founded ASEAN Economic Community (AEC) moves forward, intra-ASEAN trade, already growing fast, will gain even more momentum. Vietnam’s long coastline and position facing the South China Sea and shipping lanes that account for 40% of global trade underlines its strategic importance.  Vietnam’s cooperation with America is deepening as it seeks a hedge on China’s growing weight in the region.

Low cost base for manufacturing and services

A wave of capital is washing over Vietnam driven by many factors including wage rates significantly lower than in China.  South Korean, Japanese, Chinese, American, and European companies and their governments are falling over each other to establish manufacturing hubs and seek better relations with Vietnam.

One example is the Japanese Government’s recently announced $1.7 billion aid package to Vietnam.  During the last three years, there has been more foreign direct investment flows into Southeast Asia than into China.  $60 billion of direct investment has flowed to Vietnam over the last five years with $14.5 billion in 2015.

Below are just some of the foreign investment projects announced just during March of 2016:

Samsung R&D Center – $300 million
Zincox Resources steel plant – $115 million
Nestle’s 6th factory – $70 million ($520 million total)
LG Display doubling manufacturing base – $1.5 billion.

Here are just some of the blue chip companies increasing production in Vietnam.

Add Vietnam to Lower Portfolio Risk & Volatility

Putting some Vietnam into your global portfolio offers another surprising benefit – it will likely lower portfolio risk and volatility.  This is because it beats to its own drummer and moves in the same direction as world markets only about 40% of the time while emerging markets move in tandem 87% of the time.

The Best Way to Invest in Vietnam

Unfortunately, most advisors and gurus send investors interested in Vietnam to the Vietnam ETF (VNM)?   This is a an epic blunder since this ETF includes sizable exposure to some of Vietnam’s largest, inefficient state-owned companies that also happen to trade at pretty high multiples.  This is reflected in VNM’s dismal performance – down 5% so far this year and down 26.8% over the last two years.

You definitely need to avoid this outcome.

A much better strategy is a diversified portfolio of small and medium-sized private companies that are growing fast and trade at very attractive valuations.  This is the strategy of Asia Frontier Capital’s Vietnam fund. This fund is up 53% over the last 30 months for an annual gain of 19.2% since inception.

http://www.asiafrontiercapital.com/afc-vietnam-fund.html

Here are a couple of companies in this fund right now.

Vinasun is a dominant taxi company with annual revenue just short of $200 million.  The entrance of Uber into the country has created a more competitive environment but there is plenty of room for both to grow and the stock is trading at just 6.9 times expected 2016 earnings.  A major asset is that the Government of Singapore is one of Vinasun’s largest shareholders.

Dien Quang is a leading lighting company in Vietnam.  A couple of years ago, it entered the LED lighting industry offering lower cost and more efficient lighting for residential and commercial users.  The company’s sales are growing at double-digit rates, plans to double production by the end of 2017, and its stock is trading at just 9.8 times 2016 earning.

The lesson here is to look beyond conventional wisdom.  Look beyond China and country ETFs that don’t capture the growth and vitality of countries like Vietnam.

Carl Delfeld is Vice Chairman of the ASEAN Investment Council, a Forbes Asia columnist, founder of Chartwell Partners and a specialist on emerging and frontier markets. He represented the United States on the board of directors of the Asian Development Bank in Manila after serving as a consultant on emerging capital markets with the U.S. Treasury and the U.S. Senate Finance Committee. Mr Delfeld has written four books and is the author of numerous commentaries that have appeared in publications including Investor’s Business Daily, Forbes, Fortune, Barron’s, The Economist, Businessweek and the Asian Wall Street Journal, and on television channels such as Fox and CNBC.

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