Vietnam Enterprise Investments — Robust growth underpins long-term opportunities

A better than expected Q319 GDP growth rate of 7.3% suggests Vietnam’s economy has been relatively resilient thus far in the current environment of slowing global economic growth. Manufacturing was a bright spot, growing 12.7% year-on-year, but the construction, trade and retail sectors were also strong contributors to Q319 growth. Although Vietnam could stand to benefit over the longer run from multinationals diversifying their manufacturing facilities beyond China, it may not be immune to the short-term effects of the US-China trade dispute, which has contributed to a manufacturing contraction in many economies around the world. Vietnam’s October PMI at 50.0 indicates the sector is not contracting; however, this reading has fallen for the fourth consecutive month.

As shown in Exhibit 2 (LHS), the Vietnam equity market valuation became overstretched in 2017, trading at a P/E multiple premium approaching 60% relative to Asia ex-Japan equities. It has since come back to more reasonable levels and currently trades at a mid-teens multiple, which is comparable to other developing Asian markets (except China). Vietnam’s economic growth prospects, however, are among the strongest in the region. As shown in the chart on the front page, the IMF forecasts Vietnam’s GDP to grow at a compound rate of 6.5% pa between 2019 and 2024, an acceleration over the previous five-year period. This is significantly faster than the forecasts for Asia-Pacific and advanced economies, and should underpin solid prospects for Vietnam’s equity market.

VEIL is the largest and longest-established listed fund focused on Vietnamese equities. It was launched in August 1995 as a closed-ended fund, incorporated in the Cayman Islands, and was originally listed on the Irish Stock Exchange. In July 2016, it de-listed from the Irish Stock Exchange and was admitted to the Main Market of the London Stock Exchange; it has been included in the FTSE 250 Index since July 2017.

VEIL’s investment objective is to deliver long-term capital growth. It aims to outperform the VN Index on a rolling three-year basis by employing a rigorous fundamental investment approach that is unconstrained by benchmark considerations. The portfolio is relatively concentrated, with 35–40 holdings representing the manager’s highest-conviction investment ideas. Most of its companies are listed on one of Vietnam’s three exchanges: the Ho Chi Minh Stock Exchange (HSX), the Hanoi Stock Exchange (HNX) and the Unlisted Public Companies Market (UPCoM), an exchange for newly listed state-owned companies, which must transfer to either the HSX or HNX within one year. VEIL is permitted to invest in unlisted companies, although these tend to be those with visible plans for listing in the near term.

Vu Huu Dien believes Vietnam has many positive investment characteristics that make it a particularly attractive market for the long-term equity investor. These include social and political stability, and a well-managed economy that is fast-growing, yet with manageable inflation and a stable currency. In his view, its economic prospects are underpinned by a number of structural factors, such as a growing working-age population, urbanisation and rising consumption. Vietnam has a population of c 97 million and Dien notes the country adds around one million new entrants into the workforce each year, helped by a culture of gender equality, which results in high female participation. He believes Vietnam’s demographic profile, with a median age of 31 years, to be attractive: young enough to be economically active, yet at the point of generating disposable income. In the manager’s view, a highly educated workforce and its Confucian work ethic are among the factors that have made the country an attractive destination for foreign direct investment (FDI), which has helped develop its strong manufacturing capabilities. Dien expects Vietnam to continue to attract FDI, and he thinks the country is a beneficiary of multinationals looking to add or diversify capacity in Asia.

Dien argues that the risks to Vietnam’s outlook are likely to be externally driven, including the US-China trade dispute and protests in Hong Kong, which may further aggravate the relationship between these two economic giants. These international issues have a global impact, but Vietnam has been a relatively safe haven so far. Dien thinks it unlikely that the US will target Vietnam on trade issues despite its rising trade surplus. He believes the size of Vietnam’s trade with the US, while growing, is insufficiently significant for it to be targeted, and that the country represents a geopolitical counterbalance to China’s ambitions in the region. Dien also expects that, should the US take issue with Vietnam on trade, its government is likely to prefer a path of co-operation rather than retaliation, which should militate against an economically damaging outcome. He notes that the Vietnam stock market largely reflects the domestic economy, and relatively few export-oriented companies are listed. The manager believes Vietnamese equities to be attractively valued, and is finding plenty of long-term opportunities. Dragon Capital’s research team monitors its own universe of 60 stocks (covering c 75% of the market), which is currently trading on a forward 2020 P/E multiple of c 11x, based on the team’s expectations for 18% EPS growth.

VEIL follows a disciplined bottom-up investment process to find well-managed companies with sustainable growth that trade on reasonable valuations. It has a well-resourced investment team of three portfolio managers (led by Vu Huu Dien) who are supported by 10 sector specialist analysts. Around 1,600 stocks are screened by quality, size and liquidity criteria, which results in a universe of around 135 stocks that are subject to in-depth analysis. Key components of the process include getting to know the managements of companies, evaluating financials and determining the intrinsic value of the business. Assessment of a company’s environmental, social and governance (ESG) standards is integrated into the investment process, and Dragon Capital’s reputation and size help facilitate effective engagement with managements. Dragon Capital is a signatory of the Principles for Responsible Investment (PRI), which has awarded the group high A+ and A ratings.

The manager is not constrained by index considerations and the portfolio typically holds 35–40 stocks, representing his highest-conviction, long-term investment ideas. The portfolio is materially different from the benchmark VN Index, which means its performance can diverge meaningfully.

Exhibit 3 shows VEIL’s sector exposures as at end-October 2019. The manager is focused on key domestic themes of rising income, the growth of the middle class and urbanisation, and over two-thirds of the portfolio is invested in the real estate, banks and retail sectors. The most significant sector change over the past year is a 7pp increase to real estate, which accounts for 31.4% of VEIL’s portfolio. This largely reflects the additions to the position in Vinhomes after participating in its IPO in May 2018. As at end-October 2019, Vinhomes was the second largest holding in the portfolio, at 7.7% of NAV. The company is Vietnam’s leading property developer, focused on the mid- to high-end segment of the market. The manager believes Vinhomes is very well placed for growth over the next few years, with around 40% share of the premium residential sales market and a vast land bank, which at some 20 times the size of its next largest competitor, in Dien’s view, should be sufficient for around 15 years of development.

VEIL’s exposure to the retail sector increased by 4pp over the past year, reflecting an addition to Vincom Retail and strong performance from holdings including Mobile World, the portfolio’s largest stock (11.2% as at end-October 2019). Investors had been sceptical about Mobile World’s diversification into food stores, giving the manager the opportunity to accumulate shares at weaker levels. The company’s businesses, however, have continued to be strong, and it recently announced eight-month results, reporting a 37% increase in post-tax profits.

The manager also initiated a position in Vingroup, the parent company of Vinhomes and Vincom Retail. Vingroup is a large conglomerate with a broad range of businesses. In the past, Dien has been reluctant to invest in this company in view of a lack of transparency in its underlying operations. This has improved significantly with the listing of Vinhomes and Vincom Retail, and the manager believes there may be further listings in the pipeline, which would also help unlock value in the company. He thinks the group’s supermarkets and convenience store business, VinMart, may be a potential IPO candidate following a US$500m investment in the company by Singapore’s sovereign wealth fund, GIC. Dien notes that the transaction implied a valuation higher than that of Mobile World, Vietnam’s largest retailer.

Sales over the past 12 months to end-October 2019 included the long-held position in low-cost airline VietJet. The company has performed well since it launched its services in 2011. Operating in an oligopoly environment, it increased its share to c 45% of the passenger aviation market. Two new operators are set to enter the low-cost air travel market this year, and the manager believes intensifying competition will create a more challenging environment, potentially depressing profitability. He has also disposed of power generation company PV Power, which VEIL had held prior to its listing, benefiting from the stock’s re-rating when it transferred from UPCoM to the HSX in January 2019. The manager thinks the outlook for profitability has deteriorated, with pressure on tariffs from the government, as well as rising input prices. Over the past year to end-October 2019, VEIL also took profits from several positions that have outperformed, including in Vietnam Engine and Agricultural Machinery (VEAM) and Saigon Beer.

As shown in Exhibits 5 and 6, VEIL has a solid track record for medium- and long-term NAV total return and share price performance, outperforming the VN Index over three, five and 10 years. Over these periods, VEIL has also significantly outperformed the VN30 and MSCI Emerging Markets indices. Performance over one year has lagged. Most of this underperformance occurred during Q119 when the market experienced sizeable foreign inflows, which concentrated buying in the largest and most liquid index stocks. VEIL was underweight some of the large-cap outperformers, as its focus on quality companies trading on reasonable valuations often leads it to stocks outside of the well-researched larger firms.

VEIL is currently trading at a 9.9% discount to NAV, which is narrower than its three-year average of 14.1%. The board seeks to avoid large fluctuations in the discount relative to similar single country investment companies investing in Asia ex-Japan, taking market conditions into consideration. It has the ability to manage an imbalance in the supply and demand for the shares through buy backs.

VEIL has two classes of shares in issue: ordinary shares and non-redeemable management shares. There are 1,000 management shares in issue, all owned by Dragon Capital. These shares confer the right to appoint two members to the board and carry one vote each. Management shares are not entitled to dividends, and in a wind-up situation, ordinary shareholders have priority over management shareholders in the return of capital. The board has the authority (renewed annually) to repurchase up to 14.99% of shares in issue, and year-to-date, the company has repurchased 1.5m ordinary shares, representing 0.7% of outstanding shares, at a cost of £6.9m. There are currently 218.1m shares in issue and 2.9m shares held in treasury.

VEIL is permitted to borrow up to 20% of NAV for the purposes of investment flexibility. The company has a $60m borrowing facility with Standard Chartered, of which $20m was drawn, as at end-September 2019. The alternative investment fund manager (AIFM), Enterprise Investment Management, a subsidiary of Dragon Capital, is paid an annual management fee of 2.0% of NAV up to $1.25bn, and 1.75% of NAV between $1.25bn and $1.5bn, reducing further to 1.5% of NAV above $1.5bn. There is no performance fee.

VEIL’s objective is to deliver capital growth for shareholders over the medium to long term, rather than income, and no dividends have been paid since the fund’s launch.

Exhibit 9 shows the 10 members of the AIC Country Specialists – Asia Pacific sector with market capitalisations above £75m. This is a diverse group of funds, investing across a broad geographic region with a wide variation of economic development, making direct comparisons less relevant. We therefore focus on the Vietnam subgroup of three funds. VEIL is the largest of the Vietnam funds. Its NAV total return ranks first over one, three and five years, and second over 10 years. Its ongoing charge ranks joint-highest; however, unlike the other two Vietnam funds, VEIL does not have a performance fee. It ranks first in terms of discount to cum-fair NAV, with a considerably narrower discount than its two subgroup peers.

The board consists of six directors, five of whom are independent and non-executive. The sixth member, Dominic Scriven (appointed in May 1995) is the founder of Dragon Capital and is a non-independent director. Chairman Stanley Chou has served the board as the senior independent director since January 2016 and assumed his current role in June 2019. The other directors and their dates of appointment are Derek Loh (March 2011), Gordon Lawson (July 2014), Vi Le Peterson (April 2018) and Entela Benz-Saliasi (May 2019)