By Steve Mantle, Saigon Asset Management
The Vietnamese government announced in June that restrictions on foreign ownership limits (FOL) for public companies will finally be removed later this year.
For almost a decade, listed equity has been capped at 49% available to overseas investors, with the exception of banks which offer a maximum 30% and are expected to still do so in the initial period after FOL relaxations come in to effect, along with a small number of currently unannounced ‘sensitive’ industries.
This has severely reduced the scalability of investment for overseas investors hoping to benefit from the portfolio diversification this frontier market offers. The country is desired for its relatively low correlation to world indices, as well as the strong potential the economy is filled with through favorable demographic trends, the Vietnam Index has risen more than 18% annually in 7 of the last 11 years.
GDP growth was 6% in 2014 and 6.3% in 1H2015, while the Trans-Pacific Partnership agreement alone is anticipated to add over 14% to baseline GDP. Other free-trade agreements with some of Vietnam’s biggest trading partners (including ASEAN, the EU and Korea) have also been or are being finalized.
The market capitalization of Vietnam’s $60bn stock exchanges relative to GDP is just 30%. The latest reforms in Vietnam’s capital market will ensure it benefits from this economic growth, ideally outpacing GDP to become more in line with Vietnam’s peers. In Indonesia this figure is 49%, in the Philippines 95%, and Thailand 116%.
Although the limits have arguably been a big hindrance to overall market growth, this hasn’t been entirely detrimental to Saigon Asset Management’s NAV growth. As an active fund manager, our flagship Vietnam Equity Holding (VEH) fund has benefitted for two main reasons:
- Once a stock reaches its foreign ownership limit, overseas investors trade itoff-market at a premium. VEH has made premiums of up to 20% (plus share price appreciation) from our investment team’s ability to identify good quality, investable companies ahead of many peers, before strategically divesting once at their foreign limit.
- ETFs are growing in popularity for investors wanting to simply replicate indices. However, foreign ownership limits have meant Vietnam’s two foreign ETFs cannot replicate the index. Instead, one has 86% of its net assets in 10 stocks and the other has 22% of net assets on exchanges outside Vietnam. While these overseas-listed ETFs offer lower management fees, they also offer far lower returns, not just against actively managed funds, but also the main Vietnam indices.
The lifting of foreign limits are naturally very welcome, given the rewards offered by a solid research and investment process in a better functioning, more active and open market. Extra liquidity and increased overseas participation in particular will provide great opportunities for our locally based investment team to achieve further market outperformance.
Some of the short- to medium-term potential upsides are as follow:
Vietnam has an allocation of less than 4% within the MSCI Frontier Markets index. The benefits to the Ho Chi Minh City Stock Exchange (HOSE) were minimal when the UAE and Qatar (who made up over 35% of the index) received upgrades to Emerging Market status. Liquidity and foreign room in Vietnam have both constrained its representation; in May three stocks were moved from the MSCI FM Index in to the MSCI FM Small Cap Index.
In the iShares MSCI Frontier 100 ETF, which has net assets of $582m, Vietnam has 4 constituents (out of 100). On July 23rd these made up 3.6% of the weighting, the ninth highest of any country. Vietnam has no allocation in the MSCI South East Asia Index, meaning most ASEAN funds have no exposure here and the ones that do have very little.
As of June 30th, Vietnam now has the third highest weighting in the FTSE Frontier Index Series (8.5%), up 1% from May following Argentina’s (13.9%) removal. If Qatar (37.5%) is promoted from this index – as it has been by MSCI – the combined effect of this and the FOL relaxation will surely give Vietnam a far higher weighting.
Even small gains in the weighting for frontier and ASEAN indices can have a significant effect on net foreign buying, in turn further helping market cap and liquidity.
The longer term benefit is accession to the MSCI Emerging Markets Index. MSCI announced in June they are adding Pakistan (9.2% Frontier weighting) to the review list for Emerging Market classification. The Karachi Stock Exchange (market cap $75bn) satisfies 14 of the 17 items in MCSI’s criteria. The HOSE meets just 7, although these latest reforms will help towards fulfilling 3 of the foreign ownership requirements. Additionally 2 more items, ‘clearing and settlement timescales’ and ‘investor registration and account set up’, are also being addressed in an attempt to make Vietnam more competitive.
This lack of index exposure is beneficial to local investment funds. Investors looking for access to Vietnam have limited options through frontier funds; many of these hold stocks that simply are either at foreign ownership limit or have large market cap.
The best route is via a locally based investment fund like SAM, which is ultimately a long-term value investor and has enjoyed some of its greatest success in the small and midcap segments- where over-representation of local retail investors leads to under-analysis and mis-valuations, giving plenty of hidden value. 18 of VEH’s 25 positions are outside the top 50 companies by market cap and these stocks often help drive NAV growth on the portfolio.
The number of Vietnam listed companies has grown just 5% in the last four years. The government has ambitious targets for future privatizations of state owned enterprises, which when combined with the growing desire from Vietnamese private enterprises to use public markets as a source of long term capital, will provide many opportunities to investors.
The expected increase in valuations and liquidity will help companies IPO, in turn creating a greater investable universe. The potential gains from confidently identifying hidden value in market entrants with no previous trading history are huge.
Furthermore, investors with the capabilities of an active owner are arguably best positioned to unlock significant additional intrinsic value potential by enhancing governance, strategy and operations, which SAM promotes heavily on the board seats it holds. As international investors start to play a larger role in Vietnamese companies, one would naturally expect better governance (a primary risk in frontier investing) and further distinction between local and internationally competitive companies.
Favorable demographics (50% of the ~90million Vietnamese population are under 30 years old, with high urbanization rates), macroeconomic growth, stability and now capital market reforms make the idiosyncrasies of Vietnam suitable for short, medium and long term investors.