Vietnam Enterprise Investments — Mind the gap – it may close soon

VEIL’s managers believe Vietnam is on track to remain one of the best long-term secular investment growth stories, driven by domestic consumption and infrastructure spending (as discussed in our report on Vietnamese equities). They expect Vietnam’s per capita annual income to reach US$4,500 this year, which would lift Vietnam from a lower middle-income economy into the upper middle-income bracket, according to the World Bank’s criteria. Rising household incomes will support continued strong 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.

Infrastructure spending is the second pillar of Vietnam’s growth story. The country is becoming a new manufacturing hub, attracting increasing amounts of foreign investment as global companies such as Apple, Lego, Samsung and Intel seek to diversify their supply chains away from China. (For example, up to 60% of Samsung’s phones and 70% of Intel’s global output are now produced in Vietnam.) However, Vietnam’s infrastructure remains underdeveloped and requires major investment. The Vietnamese government is rising to this challenge and VEIL’s managers believe 2023 will be a ‘break-through’ year for public transport investment. The government is currently 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. Such significant expenditure will in turn attract more foreign investment and stimulate high rates of economic growth well into the future. The Vietnamese economy expanded by 8.0% in 2022 and VEIL expects it to grow by 6.0–6.5% this year, and at similar, if not higher, rates over coming years.

Such a positive growth story bodes very well for the long-term performance of Vietnam’s stock market, but events during 2022 conspired to disconnect the market from its very positive long-term prospects. The Vietnamese market was one of the world’s worst performing indexes last year, declining 33%, driven by a toxic combination of several unwelcome domestic developments and externally focused anxieties.

The domestic causes of the market decline included a deterioration in the property market and a sudden evaporation of liquidity in Q422, caused by regulatory reforms to the corporate bond market, which were, ironically, intended to improve market stability. Corporate bond yields reached 30%, making it very difficult for businesses to access credit. Bond market conditions were exacerbated by fears that the market will not be able to digest the heavy schedule of bond maturities and associated roll-overs due around mid-2023. There were also adverse external influences on market sentiment related to fears about how far the US Federal Reserve would go in its efforts to quash inflation pressures. Rapidly rising US rates were a particular concern for Vietnamese investors as they may compel the State Bank of Vietnam (SBV) to raise rates at the same pace, to maintain currency stability. The high-quality, high-growth names favoured by VEIL were particularly hard hit by the ensuing market sell-off.

However, the SBV has acted quickly, taking several steps to ensure financial system stability. It has undertaken open market operations (OMO) to improve liquidity, relaxed loan-to-deposit ratio (LDRs) calculations and issued Decree 8, which is intended to mitigate bond market pressures by easing the preconditions for bond issuance. The prime minister also formed a task force 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 is the first rate cut in two years, which the bank justified on the basis that inflation is ‘well-managed’ and the currency is stable. Later in the month, as developments related to US banks suggested the Fed would need to adopt a more cautious approach to further monetary tightening, the SBV cut the discount and OMO rates by a further 50 basis points. Vietnam’s central bank has also signalled the likelihood of further rate reductions over time to ‘give additional breathing room to the property and capital markets’.

These moves were welcomed by the equity market both as meaningful steps towards solving the market’s liquidity problem, thereby easing property market pressures, and because they provide greater clarity to the outlook for Vietnamese rates, suggesting that investors’ fears about aggressive domestic rates hikes were overdone. The prospect of further cuts to Vietnamese interest rates has since improved further thanks to an easing in domestic inflation pressures (inflation slowed to an annual rate of 3.4% in March 2023) and some appreciation in the Vietnamese dong against the US dollar.

The SBV’s initiatives in concert have seen the VN Index (VNI) lift off its 2022 lows, supported by a recent surge in buying by foreign investors, and VEIL’s managers are anticipating a material improvement in market conditions in 2023, especially in the second half of the year, once the corporate bond market has digested the mid-year re-issuance glut and investors have more clarity on the US rate outlook. This suggests the possibility that the current disconnect between Vietnam’s very favourable economic fundamentals and low equity valuations will begin to reverse over the course of the year.

One positive aspect of the past year’s sharp equity market sell-off is that Vietnamese stocks are presently mispriced, and very cheap, both in terms of their price to earnings (P/E) ratios (8.6x for 2023, which is a 10-year low) and relative to their East Asian peers, which have an average P/E ratio of 15x. The Vietnamese market is also cheap in terms of its price to book (P/B) ratio. Its five-year 12-month P/B ratio is below the low reached at the onset of the pandemic. In short, in the words of VEIL’s managers, ‘the worst is behind us’ and current market conditions represent a ‘sweet spot of mispriced long-term fundamentals and growth prospects’.

With valuations at historic lows and the equity market set to improve as the year progresses, now seems an ideal time for investors to grasp the many attractive opportunities provided by the market at current levels – opportunities that VEIL’s managers believe will allow them to continue delivering alpha over the medium term.

VEIL’s investment strategy is guided by the same secular themes of growth in middle class consumption, infrastructure and urbanisation that underpin Vietnam’s medium-term growth prospects, and the portfolio is overweight to sectors related to these themes, notably retail, technology, banking, steel and industrial parks (Exhibit 1). The trust is also usually overweight residential real estate, but it trimmed this exposure in late 2022 and early 2023 and is now slightly underweight, due to ongoing uncertainties about the sector’s near-term outlook. However, the sector remains very important to the managers and is VEIL’s second largest sectoral position.

In recent months VEIL’s managers have maintained their focus on high-growth, high-quality names, but they adopted a slightly more defensive stance to reduce portfolio risk during Q422’s volatile market conditions. In addition to the reduction in exposure to residential real estate mentioned above (via trims to positions in Vinhomes and Dat Xanh Group), the managers have also reduced holdings in retail, where consumption has fallen due to the knock-on effects of property market weakness. Partial sales of retail positions included trims to Mobile World, Vietnam’s largest retailer, which sells mobile phones, consumer electronics and groceries, and Phu Nhuan Jewelry (PNJ), the country’s leading jewellery retailer. Mobile World is one of VEIL’s largest holdings and its long-term outlook remains very bright, thanks to its strong management team and successful execution. However, Q422 earnings dropped sharply as the company cut prices to boost demand, and its latest guidance has been negative.

Conversely, PNJ has been performing strongly, with the share price rising 14.0% in Q422, thanks in part to growing demand for gold and diamonds for investment purposes, as other investment options such as stocks, property and cryptocurrencies all weakened in 2022. The company’s growth prospects remain ‘excellent’ according to the VEIL team, but they opted to take some profits.

The proceeds of these sales were used in part to modestly increase exposure to banks and steel and material companies. The managers consider state-owned corporate banks as attractive short-term investments, due to their low bond market exposure and high-quality assets, which have appealed to the market during the downturn. They have added to existing holdings in Vietcombank (VCB) and VietinBank (CTG). However, over the longer term, the managers prefer privately owned banks, as these institutions are pioneering the digitalisation of banking services, and this should help them gain market share over time. VEIL’s two key private bank holdings, which are also its two largest positions, are Asia Commercial Bank (ACB) and Vietnam Prosperity Bank (VPB).

Steel company stocks were oversold last year due to rising coal prices, which forced some companies to temporarily close plants, so valuations in this sector are attractive at present, according to the managers. In addition, steelmakers will benefit from increased demand from rising infrastructure investment, and also from China’s reopening. The managers topped up holdings in steelmakers Hoa Phat Group (HPG) and Hoa Sen Group (HSG), although overall exposure to materials and resources has declined over the past year.

However, the managers have held on to much of the cash raised by recent portfolio sales in order to raise the trust’s cash position, with the intention of maximising their capacity to take advantage of investment opportunities when they feel the time is right. The cash position at end February 2023 was 6%, compared to a usual level of around 1%.

The managers’ high-conviction investment approach is reflected in the concentration of VEIL’s portfolio. In total, its top 10 holdings represented 66.8% of the portfolio at end February 2023, and Exhibit 2 shows significant overweights to several companies, although the portfolio is less concentrated than in February last year.

VEIL’s long-term focus on high-quality, high-growth names resulted in a negative return in the year to end March 2023, as these stocks were hit hard by last year’s market rout. VEIL declined by 28.1% in NAV terms in the 12-month period, although this was a slightly better outcome than the benchmark decline of 28.7%. The trust outperformed more decisively in share price terms, declining by 23.7% over the period. This reflects some narrowing of the trust’s discount over the year.

VEIL’s managers argue that short-term volatility of this magnitude is not uncommon in emerging and frontier markets, and that investors should look through such turbulence, and focus instead on the longer term. To this end, the trust’s return objectives are to achieve capital growth and outperform the benchmark on a rolling three-year basis. VEIL has realised these objectives in the three years to end March 2023, and over the longer term, consistently delivering significant outright gains and outperforming the index. VEIL’s average annualised NAV growth over the three-year period was 23.0%, compared to a benchmark return of 17.1% (Exhibit 3), while the average annual return over the 10 years to end March 2023 was 13.6% in NAV terms, compared to a benchmark return of 8.0%. The trust has also consistently outperformed emerging market peers over one, three and five years (Exhibit 4).

Recent detractors from returns have included Mobile World, which has seen demand for consumer goods contract, resulting in a deterioration in its near-term prospects, as discussed above. VEIL’s real estate holdings have been adversely affected by investor concerns about corporate bond market illiquidity and its adverse impact on the domestic property market. Its top 10 holdings in Vinhomes (VHM) and Khang Dien Housing (KDH) were both caught up in last year’s sector-wide underperformance. VHM was also hurt by speculation about delays in property handovers, which were forecast to have a significant impact on Q422 and full-year earnings.

PetroVietNam Gas (GAS) came under pressure at the end of 2022 as global oil prices fell, sparking concerns that lower prices would damage 2023 earnings, while FPT Corporation, a technology, telecoms and education conglomerate, also detracted. FPT has a high return on equity and strong growth prospects, as the company is well-positioned to benefit from the digitalisation trend and migration to the cloud, according to VEIL’s managers. And the company’s various segments have been performing well overall. However, performance during Q422 was hurt by financial write-downs and weakening in pre-tax profits, due to higher labour costs and FPT’s exposure to the depreciation in the Japanese yen, as Japan accounts for 40% of the company’s global IT revenue.

VEIL is a member of the Association of Investment Companies’ (AIC’s) Country Specialists sector of funds. As can be seen in Exhibit 7, which includes a subset of Chinese and other Asian trusts with market caps above £60m and track records of three years or more, this is a diverse collection of funds, spread across different countries at various levels of economic development, so direct comparisons beyond VEIL’s immediate peers, VinaCapital Vietnam Opportunity Fund (VOF) and VietNam Holding (VNH), provide limited insight.

The key features of VEIL are shown in Exhibit 6, alongside those of its two London-listed Vietnam-focused peers, VOF and VNH.

VEIL is the second largest fund in its broader peer group. Its performance over the past year places it at the bottom of its peer group, and has distorted returns over three years, but the trust has outperformed all its peers over both five and 10 years and significantly outpaced its two Vietnamese peers over these periods. VEIL’s discount to NAV is somewhat above the average for its broader peer group, while the charges of VEIL and its two Vietnamese peers are among the highest. This is because the Vietnamese market is a relatively expensive market in which to trade, as it has only a few asset managers and thus lacks scope to outsource various administrative function that would, in other more developed markets such as the UK, usually be undertaken at a lower cost by third-party providers. Unlike many members of the broader peer group, VEIL only uses its cash management facility for short periods and is not using it at all at present. Like the majority of its broader peer group, VEIL does not pay dividends.

Like many other investment companies, VEIL’s share price declined relative to its NAV in early 2022, at the onset of Russia’s war with Ukraine, and continued to trade around 20% until late 2022, when it began to narrow, and it has since settled around 15%, broadly consistent with its long-term average (Exhibit 8).

VEIL’s board actively manages the discount to avoid large fluctuations and to ensure that it remains consistent with the discounts of other regional single-country funds invested in Asia, ex-Japan. To this end, in the financial year ended 31 December 2022, the company repurchased a total of 6.8m shares. This compares with purchases of 3.4m shares in the previous financial year ended 31 December 2021. So far in the current financial year, the company has repurchased a further 0.8m shares.

VEIL’s strong track record of outperformance suggests that its discount has scope to narrow closer to parity once near-term market instability abates and performance returns to form.