VinaCapital Vietnam Opportunity Fund — A specialist investor in the frontier market

Vietnam remains one of the best long-term secular investment growth stories, driven by domestic consumption and infrastructure spending. However, the Vietnamese market was one of the world’s worst performing indexes last year, declining 33%, driven predominantly by the deterioration of the real estate sector, as well as domestic investors favouring attractive yields on deposits. This provides investors with a relatively attractive entry point to gain exposure to Vietnam’s secular growth story.

Vietnam is attracting increasing volumes of FDI as global companies such as Apple, Lego, Samsung and Intel seek to diversify their supply chains beyond China. For example, up to 60% of Samsung’s phones and 70% of Intel’s global output are now produced in Vietnam. According to the IMF, Vietnam currently attracts c US$16bn in FDI annually, compared to c US$1.5bn annually at the beginning of the 21st century. According to Vietnam’s Ministry of Planning and Investment, the realised foreign investments in H123 amounted to US$10.0bn (up 0.8% y-o-y). VinaCapital Investment Management (the investment manager, VinaCapital) sees Vietnam’s demographics as its key advantage, as the quality of its workforce is comparable to China while wages are roughly half that of coastal China. The redirection of part of the global FDI streams from China to Vietnam was recently accelerated by increasing trade tensions and China’s restrictive approach to COVID-19.

FDI is predominantly targeted at manufacturing, which now represents a bit more than 20% of Vietnam’s GDP, compared to c 30% at the peak of the so-called ‘Asian Tigers’ (Hong Kong, Singapore, South Korea, Taiwan), according to VinaCapital’s chief economist. VOF refrains from investing directly into large, global manufacturing companies that set up in Vietnam. It sees its opportunity predominantly in the companies that create the ecosystem around the growing manufacturing base – as Vietnam’s infrastructure remains underdeveloped and requires major investment in, among others, logistics, supply chain solutions, construction materials, and residential and industrial real estate.

Vietnam continues to urbanise, from a still relatively low 37% urbanisation rate. This creates further investment opportunities as cities expand and infrastructure improves, with public spending accelerating so far this year (up 20.5% y-o-y in H123). VOF capitalises on urbanisation via its investments in residential real estate, which currently makes up 25% of its portfolio. It is worth noting that the government still has capacity for new investments as the debt-to-GDP ratio stands at only 40% (vs c 60% on average for countries in the region) and it currently has over US$30bn unspent funds allocated to infrastructure projects. On top of that, the government is finalising a US$200bn national infrastructure master plan, which will include the expansion of the North-South Expressway, improved southern connectivity between industrial parks and logistics terminals, the completion of metro lines in Hanoi and Ho Chi Minh City and upgrades to major airports.

The newly emerging industrial economy also drives the expansion of Vietnam’s middle class. The disposable income of an average Vietnamese household is predicted to grow at an average of 9% a year to 2026 (Nhịp Sống Kinh Doanh forecast), well above the inflation rate (see below). Rising household income will support continued robust growth in domestic consumption and changing consumption patterns, as the increasing penetration of smart phones gives consumers online access to shopping, banking and investment services and property searches. Simultaneously, Vietnam’s overall demographic profile is still a positive driver of the country’s economy, with only 8.8% of the population aged over 65 (vs 12.3% in China and 16.8% in the United States). VOF has exposure to the increase in consumer spending through its investments in, among others, hospitals (eg Tam Tri Medical and Thu Cuc International General Hospital made up 6.8% of its NAV at end-June 2023) and commercial banking (Asia Commercial Bank, currently the largest portfolio position, made up 13.2% of NAV at end-June 2023).

Since 2000, Vietnam’s GDP has grown faster than that of any Asian country bar China, averaging 6.2% per year. The Vietnamese economy expanded by 8.0% in 2022, partly attributable to the post-COVID rebound in domestic and global demand. This is the highest growth in Vietnam since 1997 and well ahead of global growth of 4.1%, as well as the regional average of 5.6% (it was outpaced only by Malaysia with 8.7%). Despite the Q123 slowdown to 3.3%, predominantly on the back of lower demand for ‘made in Vietnam’ products in the United States, VOF still expects 4.75% growth in 2023 (although trimmed from 6% expected earlier this year and below the government’s target of 6.5%). This compares to the IMF’s forecast published in April 2023, which expects Vietnam GDP growth of 5.8% in 2023, accelerating to 6.9% in 2024. Vietnam’s economy is heavily influenced by demand from developed economies, as its exports represented 36% of the overall GDP in 2021.

That said, VOF sees the drop in exports as temporary (supported by the fact that inventories at US retailers have ceased to increase, according to Federal Reserve Economic Data) and expects that a surge in inbound tourism and buoyant retail consumption (it assumes +7.5% y-o-y in 2023) will support economic growth. International tourist arrivals stood at 69% of the pre-COVID level in Q123, mainly due to the lack of tourists from China (which accounted for 30% of Vietnamese tourism pre-COVID). While there has been some revival in tourism from China, VOF does not expect it to return to pre-COVID levels until at least next season, pointing out that many Chinese citizens are choosing to travel domestically to avoid the risk associated with any potential policy changes.

The Vietnamese market was one of the world’s worst performing indices last year, declining 33%. The domestic causes of the market decline included a deterioration in the property market and a sudden evaporation of liquidity in Q422 (see details below). As real estate companies make up a significant part of Vietnam’s stock market, the decline affected the broader market performance and valuations. The trading activity has fallen sharply and capital has been moved to currently attractive bank deposits. The main reason for the dour sentiment in Q422 among Vietnamese retail investors was the government’s regulatory scrutiny of illegal practices by certain companies. The crackdown targeted companies that issued corporate bonds, with some using the proceeds to speculate in the stock market. As a result, corporate bond yields reached 30% at peak, making it difficult for businesses to access credit. Bond market conditions were exacerbated by fears that the market would be unable to digest the heavy schedule of bond maturities and associated rollovers due around mid-2023. While VOF has confirmed it has not invested in companies targeted by the regulatory action, the liquidity crunch affected its portfolio (given that a quarter of VOF’s portfolio is allocated to real estate companies) and resulted in US$27m in write-downs (3% of current NAV; see the Portfolio section for details).

At the height of the selloff, Ho Chi Minh Stock Exchange (HOSE) stocks dipped to 8.0x forward earnings (compared to the 10-year average of 13.7x). Since then, corporate earnings expectations have been gradually lowered on the back of macroeconomic developments, whereas the VN Index is up 7% year to date (see Exhibit 2). Nevertheless, the P/E ratio is still 18% below long-term averages.

The trigger event for the liquidity crunch in the real estate sector came in late 2022, when the government issued a decree aimed at improving transparency, strengthening investor protections and improving disclosure requirements in corporate bonds issuance. Unfortunately, the decree was introduced in the wake of allegations of illegal activities (resulting in two high-profile arrests in the real estate sector). As the decree was introduced when the trust of issuers was low, corporate bond issuance basically came to a standstill and many companies, in particular several real estate developers, found that they were unable to issue new bonds or roll-over existing bonds that were maturing. The government has embarked on multiple initiatives this year to revive the market, but so far it is too early to tell how positive this will be for issuers. According to Bloomberg, 1,200 real estate projects worth US$34bn were on hold in May and a wave of insolvencies has already hit the market. 554 Vietnamese property companies have closed in the first five months of 2023, a 30% year-on-year surge (source: Vietnam’s General Statistics Office).

That said, VOF’s chief economist says that the real estate sector is structurally healthy with significant unmet residential demand, while the main issues are a result of limited access to capital for real estate developers because of limited liquidity in the banking sector and regulations around corporate bond issuance. Some comfort comes from a recently resumed projects of Novaland, which is the publicly listed real estate development arm of Nova Group, and one of Vietnam’s top real estate developers (VOF is invested in several Nova Group projects, including Novaland and Nova Consumer Group, which saw recent write downs). Also, Vietnam’s prime minister has directed the construction minister to work with the company’s chairman to remove obstacles faced by Novaland’s projects. A broader picture of some revival in the construction industry can also be seen in increasing demand for steel – Hoa Phat Group’s (11.8% of VOF’s NAV) sold steel volume increased 11.4% q-o-q in Q223.

The State Bank of Vietnam (SBV) has acted quickly, taking several steps to ensure financial system stability. It has undertaken open market operations (OMOs) to improve liquidity, relaxed loan-to-deposit ratio (LDR) calculations and issued Decree 8, which is intended to mitigate bond market pressures by easing the preconditions for bond issuance. The prime minister has also formed a taskforce to assist banks as they restructure their non-performing loans.

In mid-March, the SBV surprised markets by reducing its discount rate from 4.5% to 3.5% and cutting the OMO rate from 6.0% to 5.5%. This was the first rate cut in two years, which the state bank justified on the basis that the currency is stable and that inflation is ‘well-managed’; the most recent reading of Vietnam’s inflation (June 2023) stood at 2.0%, compared to the SVB’s target of 4.5%. Vietnam’s central bank has signalled the likelihood of further rate reductions over time to ‘give additional breathing room to the property and capital markets’, especially given expectations of looser US Federal Reserve policy following developments in US regional banks, which resulted in a further 50bp OMO rate cut in May 2023, and 50bp discount rate cut in June 2023. On top of that, the SBV has recently announced higher credit growth limits for commercial banks, easing banks’ appetite for deposit growth. In turn, deposit rates at Vietnamese banks have seen a reduction of 200–300bp since the beginning of the year to the current 6.5–8.0% on 12-month deposits. The Vietnam Association of Realtors highlights that a large number of deposits mature in Q323, so with lower deposit rates, some of the money could enter the stock and the property markets.

The government has launched a US$5.1bn subsidised loan package to support the development of over 1m new affordable housing units. Additionally, it is encouraging consumer spending by cutting VAT to 8% (from 10%) and allowing companies and individuals three- to six-month delays in the payment of various taxes. The deadlock in corporate bond issuance was addressed by walking back some of the new regulations that were introduced in late 2022 to impose stricter conditions on issuance, as well as directing ministries to address various administrative bottlenecks that are impeding real estate development and infrastructure projects.

VOF invests predominantly on private terms (in private businesses or in listed companies), which we see as a great advantage given the fund’s focus on a frontier market such as Vietnam. VinaCapital has a strong position in the market, often being a partner of choice for private businesses, which gives it strong negotiating position in structuring the deals. As at end-June 2023, 80% of the positions in VOF’s portfolio were entered into on private terms, although a significant part was converted into regular public equity holdings over time, and as at end-June 2023 around 29% still had privately negotiated terms, with 14.6% of the portfolio in private equity and 14.5% in public equity with private terms (see Exhibit 4).

The privately negotiated terms include sophisticated agreements, often with a convertible component. The investment manager operates under the assumption that many investments in Vietnam, whether being public or private equity, are illiquid for large ticket sizes, which VOF takes into consideration when structuring a deal. The agreements often include ‘drag and tag along’ agreements with the sponsors/business owners, which means that despite holding a minority position (VOF usually acquires a 5–40% stake with a US$25–75m ticket size), VOF can arrange the sale of a majority stake to a strategic investor, therefore attracting a wider investor audience and requesting a premium for control.

This also allows the manager to structure investments in a way that provides downside protection from the risk of weak business results, or against some deficiencies in governance, best practice, or financial performance. Firstly, a great amount of time is spent on financial, legal, as well as ESG due diligence (the manager estimates that almost three quarters of employee time is spent on evaluating and subsequent monitoring of private investments). Secondly, VOF usually secures board representation in the investee companies so it can have a firsthand view of the developments within the company. Thirdly, investments are structured to provide a recovery of invested capital, including fixed capital return in the worst-case scenario.

VOF’s usual downside protections include, among others: put options back to the sponsor at a minimum IRR and convertible components. While the investment manager uses debt-like instruments to secure repayment (including a target internal rate of return, IRR, of 12–18% in VND terms), it sees principal repayment as the worst-case scenario and in some instances, views the debt-like instruments as equity structuring rather than provision of debt. At the same time, the manager highlights that since inception only a single-digit percentage of investments (by count) has triggered a principal repayment, which we attribute to VOF’s thorough due diligence practices. The downside protections provide investors with an additional layer of security.

The investment opportunity pool in Vietnam is skewed towards real estate (18% of VN Index weight as at end-May 2023), and VOF also has significant exposure to the industry with 23% of the portfolio in real estate as at end-June 2023 (see Exhibit 5). The largest exposures within the industry are Khang Dien House (10.1% of NAV, second-largest position in the portfolio), Vinhomes (4.8%), as well as investments related to Nova Group (Novaland, Project Norfolk: 2.1% at end-December 2022). Together, they represent 17% of VOF’s NAV and 74% of its real estate exposure.

VOF has invested in the residential developer Khang Dien House (up 41% ytd, down 5% since its peak in August 2022) for 14 years, since before its IPO in 2010. Despite unfavourable market conditions and fear-driven sell-offs in 2022, the company continues its development, as highlighted by the recent announcement of an agreement with Keppel Land Group (KLG). KLG is one of Asia’s leading property developers from Singapore, present in Vietnam since 1990. The companies will develop residential and sustainable urban area projects in Ho Chi Minh City. It is also worth noting that KDH’s market cap increased 14x since its IPO to date.

Vinhomes is Vietnam’s largest real estate developer with a US$10.5bn capitalisation. The company was affected by the broad equity market sell-off in H222 to a lesser extent than other property developers and has seen a 31% year to date recovery in its share price, back to its August 2022 levels.

VOF also has exposure to real estate through Novaland, which is the publicly listed real estate arm of Nova Group. VOF is invested in Novaland through a private transaction, directly in its Project Norfolk II and III, both as lender and shareholder. The instrument reached its maturity at the end of the year and the company was unable to meet its repayment obligation, which resulted in a US$18.8m write-down suggested by VOF’s external valuer (we calculate that this was roughly a third of Novaland’s fair value in VOF’s portfolio). The terms negotiated at the time of investment allowed VOF not to write-off the investment in full despite the default, as the investment has 1.5x collateral coverage through Novaland shares. The manager is also in direct talks to recover its invested capital through additional collateral along with the target IRR. As highlighted above, Novaland has resumed three of its flagship projects and the chair of Novaland has been assigned to a governmental taskforce that aims to lower regulatory burdens seen in the market.

Another US$7.9m was written down on Nova Consumer Group (an agricultural subsidiary of Nova Group) as the company failed to meet its agreed milestone, which was completing an IPO before end-2022. This was also one of VOF’s private investments, and VOF chose to exercise its rights within the investment terms, which included a put option, among others. VOF is still in negotiations to improve its collateral and recoverability.

In February 2023, VOF invested US$30m (c 3% of NAV) in a private equity round of US$38m in Chicilon Media for an undisclosed stake. Chicilon Media operates LCD screens located in the lifts and lobbies of residential and commercial buildings across Vietnam. The company has consistently delivered double-digit revenue growth on average and has remained profitable, even during the COVID-19 pandemic. Chicilon Media is a market leader in a highly concentrated market (there are only two players) and is four times the size of its closest competitor in terms of market share. Importantly, when the company launched in 2006, there were nine companies in the market.

VOF’s NAV decreased by 8.8% in sterling TR terms over the 12 months ending June 2023, compared to a 11.6% decrease in the VN Index. We note, however, that the private part of VOF’s portfolio is valued periodically and may reflect valuation changes with an inherent lag. Nevertheless, VOF consistently delivers returns above the broader Vietnam equity market over the long term, with a 10-year average annual NAV return of 12.5% versus 9.6% delivered by the VN Index. It is important to note that VOF managed to outperform the market despite a 2.1pp NAV loss (Edison calculations) coming from write-downs, which the manager expects to recover (as described above).

Meanwhile, VOF was able to execute successful exits in unfavourable market conditions. It has reduced its holdings in listed Hoa Phat Group (HOSE: HPG, steel rod producer), selling down US$144m worth of shares (HPG remains in VOF’s top holdings, representing 11.8% of its NAV). VOF has recognised that HPG’s capacity is at its peak and commodity input prices are changing unfavourably for the company. VOF invested in HPG at its IPO in 2007 and its IRR (both realised and unrealised) stands at 20% pa. VOF also sold its holdings in Ngoc Nghia Industry (HOSE: NNG; a PET bottle producer) to Indorama Ventures. VOF invested in the company three years earlier, before its public listing, and sold its c 30% stake for US$26m, realising an 18% IRR and a 1.5x multiple on invested capital (MOIC).

VOF presents two main profit/loss positions on its income statement: dividend income and unrealised net gains/losses on revaluation. Due to its structure (special purpose vehicles, SPVs, for investments) and IFRS 10 implementation (equity consolidation method for investment subsidiaries), this may appear counterintuitive. The changes in valuation (both realised and unrealised) are recognised in the change in the value of the investment subsidiaries, meaning that even a successful exit is presented as unrealised until the SPV distributes its proceeds to VOF. This distribution is then accounted for as both dividend income for VOF and a decrease in the value of the SPV making a distribution. Having said that, the actual change in the value of VOF’s portfolio should be assessed based on the cumulative value of both positions, whereas none of them reflect VOF’s recurring income from coupons and dividends.

VOF discloses the amount of dividends received from public portfolio companies once a year. In FY22 (ending June 2022) it received US$15.9m (down 22% y-o-y and slightly below the five-year average of US$17.9m). Additional recurring income comes from its private investments in the form of contractual and coupon payments.

UK-based investors have access to three funds focused solely on opportunities in Vietnam listed on the London Stock Exchange, varying in size and investment approach: VOF, Vietnam Enterprise Investments (VEIL) and VietNam Holding (VNH). VOF is the only fund among them that focuses on making new investments on private terms and the only one that offers regular dividend payments. VNH has the lowest exposure to the uncertain Vietnam property market at 10% of the portfolio (down 6pp y-o-y).

We compare VOF’s performance against its direct peers (VEIL, VNH) as well as against a broader group of funds investing in specific Asian countries (see Exhibit 10). Over the last year, Indian equities clearly outperformed other Asian developing markets (MSCI India was up 19.2% in INR terms over the 12 months ending June 2023), while Vietnam was one of the worst performing equity markets recently, exacerbated by domestic issues as described above. Over the long term, however, Vietnam remains an attractive market, with Vietnam-focused funds clearly outperforming peers over a 10-year period.

Among its direct peers, VOF has the lowest ongoing charge and is the only fund to pay dividends, with the current share price implying a 2.6% dividend yield. While VOF is the only fund to charge performance fees, these resulted in a total expense ratio below 0% due to the activation of a claw-back mechanism (US$22.1m was clawed back in 6 months to end-December 2022 from the accrued investment fee payable, compared to the US$7.3m management fee paid in the period). We note that funds focused on more mature markets (such as China, Korea) tend to pay dividends, whereas frontier markets (Vietnam, India) do not. Over the short term, VOF has outperformed its direct peers, which we attribute to its focus on the downside protection of its investments (although part of the outperformance has likely come from the valuations of private assets being less volatile). Over the 10-year period, VOF has delivered returns broadly in line with its direct peers (ahead of VNH, below VEIL).

VOF’s management decided to change the fee structure from 1 July 2023, effectively lowering its total expense ratio (see Exhibit 11).

VOF’s portfolio construction results in the fund receiving recurring revenue, which we view as the main advantage of the fund and the reason behind its ability to distribute regular dividends. Over the last five years, the portfolio income has covered c 80% of dividend distribution on average. VOF started distributing dividends in 2017 and pays these semi-annually (at the release of interim and full year results) with a target payout ratio of 1% of its NAV at each distribution, with the last two payments implying an annual dividend yield of 2.6% on the current share price.

On top of dividends, VOF executes share buybacks (and the investment manager also conducts shares repurchases from the market, see above). Since 2011 VOF has bought back US$400m worth of shares; the average amount repurchased annually over the last five years is US$34.2m, compared to US$23.3m per year in dividends.