VinaCapital Vietnam Opportunity Fund — Continues to outperform its benchmark

Vietnam’s government is actively incentivising investments and customer spending to boost the economy, after a slower start to the year (the International Monetary Fund (IMF) forecasts GDP growth for Vietnam of 4.7% in 2023, from 8.0% in 2022). The actions of the local government and monetary authorities included:

The actions seems to have started bearing fruit, which is especially seen in investors’ return to the stock market at the expense of bank deposits. Liquidity on the Ho Chi Minh Stock Exchange (HOSE) is surging, with an average trading value in September of US$1.1bn, 53% above the year-to-date average. Credit growth has also improved, with 6.9% year-to-date growth as of September, and at the same time lower interest rates have eased banks’ nonperforming loans level, which should translate into higher net interest margins in H223. The banks are likely to benefit from the revival of economic activity on every angle: an increase in investments, spending and mortgage lending.

VOF has increased its exposure to financials to 23% of its portfolio (up 3pp y-o-y), including its recent equity investment (with privately negotiated terms) in Vietnam Prosperity Bank (VPB, 5.7% of NAV at end-October). The investment manager is confident in VPB’s robust profit growth, given its 24% credit growth quota received from the SBV on the back of the acquisition of GPBank; a capital increase from Sumitomo-Mitsui Banking Corporation, which will alleviate funding costs; as well as good progress on the restructuring plan within its consumer lending business.

Vietnam’s economic growth has slowed recently, to 4.2% in the first nine months of 2023 (9M23), compared to 8.8% in 9M22 and 5.8% pa on average over the last five years. The slowdown was primarily driven by lower demand for ‘made in Vietnam’ products in developed countries, as rising interest rates and elevated inflation have dampened customer confidence around the world and prompted retailers to reduce their inventory levels. Vietnam’s manufacturing output grew by 2% yoy in 9M23 (compared to 10.7% in 9M22), which shaved 2pp from Vietnam’s GDP growth, according to VinaCapital’s estimates.

That said, September was the second month in a row with increasing export orders, which may be an indication that the destocking process in the US has essentially run its course. Optimism is slowly returning to Vietnam’s manufacturers, as the manufacturing PMI readings returned to close to 50 (from May’s low of 45). At the same time, the tightening partnership with the US, as highlighted by US-Vietnam Comprehensive Strategic Partnership announced in September 2023 after the visit of US President Biden to Vietnam, should stimulate FDI. The partnership is targeted predominantly at semiconductor production and supply chains, but it also covers a range of initiatives in various areas such as education, energy, finance and agriculture. After the visit, several close cooperations have been announced. The recovery of the manufacturing industry is expected to translate into higher GDP growth in 2024. The IMF in its recent forecasts expects Vietnamese GDP growth at 4.7% in 2023, and a return to the long-term average of 5.8% in 2024.

VOF does not invest directly in foreign manufacturers, but should benefit from the revival of the economy and increased employment through its investments in the materials, financials and consumer sectors. Steel producer Hoa Phat Group (8.8% of VOF’s NAV) reported a rapid 17% mom growth in steel sales in August, which was predominantly driven by exports as the company expands its reach to other Association of Southeast Asian Nations (ASEAN) countries, and growing investment in the manufacturing sector should further improve its results. At the same time, increasing employment should create demand for customer discretionary products (10.0% of VOF’s NAV), for example jewellery (Phu Nhuan Jewelry makes up 3.4% of VOF’s NAV).

As described in our previous note, Vietnam’s real estate sector suffered a liquidity crunch in late 2022, which continues to linger. However, the government initiatives aimed at revitalising the property market are starting to bear fruit, as highlighted by an impressive 85% q-o-q growth in condominium sales in Ho Chi Minh City and Hanoi in Q323. It is important to note the continued structural undersupply of the local housing market, with the Ministry of Construction estimating that Vietnam needs to spend US$9.6bn on building a further 300k social housing units for low-income earners in urban areas to meet the demand. We believe this underpins the good long-term prospects for Vietnam’s real estate sector, once the current liquidity issues are sorted out. We note that housing development has seen some revival in recent months, with major projects being resumed. While the liquidity crunch is not over yet, with VND65.9tn bonds maturing in H223 and VND124tn in 2024, the government is introducing incentives to provide much-needed breathing space for issuers. These include allowing companies to use other assets to make bond payments if approved by debtholders, as well as extension of debt maturities.

As at end-October 2023, 23% of VOF’s portfolio was allocated to the real estate sector. The good quality developers (eg Khang Dien House and Vinhomes – a combined 12.7% of VOF’s NAV) continue to benefit from the government's policy measures as highlighted by Vinhomes’ 80% take-up rate at the Ocean Park 3 project. Meanwhile, VOF’s real estate investments in projects led by NovaGroup had US$23.4m of write-offs reversed (out of a total of US$26.8m in reversals made) as at end-June 2023 (despite their earlier default) due to an ongoing negotiation and settlement process, as described later in the note.

VOF offers investors exposure to the rapidly growing Vietnamese economy, while simultaneously offering some degree of downside protection from the risk of weak business results, or against some deficiencies in financial performance through its privately negotiated terms of investments. While almost 80% of VOF’s portfolio is allocated to listed stocks, we need to highlight that most of the investments were entered into pre-IPO, or through private equity, or as investments on private terms. VOF’s usual downside protections include, among others: put options back to the sponsor at a minimum internal rate of return and convertible components.

VOF’s downside protections have recently proven useful in the case of NovaGroup’s real estate projects. VOF is invested in two projects alongside subsidiaries of NovaGroup – Project Norfolk, which is a credit structured investment into real estate with Novaland, and Nova Consumer Group (NCG) – both of which suffered trigger events in late 2022. NCG failed to list by 1 January 2023 amid unfavourable market conditions, and VOF decided to exercise its put option on NCG shares against NovaGroup, which the company failed to honour. With negotiations concluded by end-June 2023, VOF has managed to secure an asset swap of sorts: NovaGroup has spun off a portfolio of food and beverage outlets, restaurants and cafes, which was acquired by IN Holdings, VOF’s portfolio company.

The real estate projects defaulted in late 2022 and prompted significant write-downs, as described in our previous note. The investment manager has taken additional measures to protect the company’s position as both a creditor and shareholder including rescheduling the payments and improving the collateral security in the form of real assets. The recovery of the real estate sector in Vietnam, as well as progress in the negotiation process, allowed VOF to reverse part of the previous write-downs. While the carrying values of these investments are still below their original cost and expected returns, the investment manager is making good progress in securing their value and expected repayment schedule.

The private equity component of the portfolio (20.3% at end-October 2023) also gives investors exposure to attractive sectors that are underrepresented on HOSE, such as healthcare. 9.2% of VOF’s portfolio is in the healthcare sector, which comprises predominantly its investment in Tam Tri Medical (which recently merged with another VOF private equity investment, Thai Hoa International Hospital), a hospital’s chain comprising 970 in-patient beds across Vietnam, and Thu Cuc International General Hospital, one of the leading private healthcare providers in the nation’s capital. The increasing disposable income of Vietnam’s citizens is steadily driving the growth of the sector, which has been increasing in value by 10% annually on average since 2017.

In FY23 (ended June 2023), VOF invested US$64.8m in new entities and follow-on investments, while receiving US$114.1m from divestments, dividends and other payments. This compares to US$186.5m investments and US$196.8m proceeds from divestments and cash distributions in FY22. The investment team has spent a considerable amount of time in FY23 resolving the existing investments that have been affected by the downturn in the real estate market. Nevertheless, the investment manager highlights that the opportunity pipeline remains robust.

A new addition to the portfolio is Chicilon Media, a leading digital advertising infrastructure platform. VOF has invested US$31m in the entity (out of a US$38m consortium investment), obtaining a 15% stake in this private company, and securing a board seat; see our previous note for details. VOF also increased its investment in IN Holdings as part of the deal with NovaGroup, as described above, and supported the expansion of Tam Tri Medical, including a merger with Thai Hoa International Hospital and the continuous roll-out of its establishments.

From September 2023, VOF has simplified its reporting by asset type; see the comparison in Exhibits 2 and 3. Equities traded over the counter and on the Unlisted Public Companies Market, which were previously recognised as ‘unlisted equity’, were consolidated into ‘listed equity’. According to the investment manager, the improving liquidity in these markets and daily mark-to-market valuations have rendered the earlier distinction no longer necessary and confusing for investors. VOF has also narrowed its definition of ‘public equities with private terms’ to include only investments that have a committed receivable and redemption from the counterparty as part of a restructuring and renegotiation efforts, and currently includes only two investments: Project Norfolk (Novaland) and Nova Consumer Group, described above. Investments that have privately negotiated terms and some downside protections, but are equity-like investments in nature, are currently recognised in listed equity or private equity depending on the listing of the issuer.

VOF has reported a 6.8% NAV total return (TR) in sterling terms over the 12 months ending October 2023, ahead of the 4.5% decrease in the VN Index. The best performing assets within the public equities portfolio were financials and materials, and the investment manager expects that financials will be a leading contributor to growth in 2024. Moreover, as the outlook for the real estate sector improves, the manager believes that it will also contribute positively to NAV performance.

The private equity assets (including public equities with private terms, PEPT) added US$54.3m to the FY23 revaluation, translating into 5.1% of current NAV. The revaluation consisted of the US$26.8m aforementioned write-down reversal (2.5% of current NAV), as well as a US$27.5m (2.6%) uplift reflecting investments, and improved performance and outlook of private equity assets including Thu Cuc International Hospital, Tam Tri Medical, IN Holdings, Chicilon Media and Hung Vuong Plaza.

Given that VOF has 20% of its portfolio allocated to private equity investments, which have less volatile valuations by nature, we believe that comparing its longer-term performance to public markets is more appropriate. Over the last five and 10 years, VOF has delivered an 8.6% and 13.0% return per annum, respectively, compared to 2.3% and 8.9% by the VN Index in sterling terms, respectively. Since inception, VOF has realised investments with total proceeds of US$1.5bn, achieving a 21–23% internal rate of return and a 1.93x multiple on invested capital. VOF invests with a long-term view and its investments have an average holding period of five to six years.

Recently VOF renewed its revolving credit facility of US$40m for another year, and as at end-September 2023, the facility was fully undrawn. The investment manager draws funds under the facility from time to time to manage the company’s cash balances and liquidity.

Investors have access to the opportunities arising from the rapidly growing Vietnamese economy through three country specialist funds listed on the LSE (see Exhibit 6). VOF is the only fund among them investing in private equity assets, which gives investors some downside protections as well as access to sectors unavailable on the HOSE exchange. VOF is also the only fund that distributes regular dividends, with a current yield of 2.4%. Moreover, the fund has a clawback mechanism in place, which shields investors from excessive fees amid volatile valuations; in FY23, the mechanism has reduced VOF’s ongoing charge ratio by 0.11pp to 1.54% – the lowest among its direct peers.