Vietnam Enterprise Investments — Well-established record of Vietnam expertise

Stronger than expected Vietnamese GDP growth of 7.4% in Q118, led by export growth of 22%, has resulted in upgrades to consensus forecasts for 2018. Dragon Capital’s own expectation for 2018 GDP growth has been raised from 6.9% to 7.2%. As shown in Exhibit 2, the IMF expects Vietnam’s real GDP growth to accelerate over the next five years to a compound annual rate of 6.5%, compared with 6.0% achieved in the previous five years.

The VN Index has performed strongly over the past two years and, in March 2018, surpassed the previous peak of March 2007. This triggered profit-taking, but the sell-off has been amplified by factors including investors becoming more risk-averse, and escalating trade tensions between China and the US (which would have negative implications for Vietnam). As shown in Exhibit 3, the VN Index has corrected around 20% from its recent peak. Consensus earnings forecasts for Vietnam are less comprehensive than for more widely researched markets. Dragon Capital’s own research team believes its universe of 60 stocks (which covers c 75% of the market) trades on a 12-month forward P/E of 15x, with forecast EPS growth for 2018 of c 30%, among the highest in the region. The P/E multiple is higher than that of the MSCI AC Asia-ex Japan Index; however, this index is two-thirds weighted in markets that traditionally trade on lower multiples: China, and relatively developed, slower growing countries, South Korea and Taiwan.

VEIL is the largest and longest established fund focused on Vietnam equities listed on the London Stock Exchange (LSE). Previously listed on the Irish Stock Exchange, its shares were admitted to the Main Market of the LSE in July 2016, and included in the FTSE250 Index on 18 July 2017.

The investment objective is to deliver medium- to long-term capital growth, outperforming the VN Index (a capitalisation-weighted index of all the companies listed on the Ho Chi Minh stock exchange) on a rolling three-year basis. VEIL seeks to achieve this through bottom-up stock selection to build a concentrated portfolio of c 35 high conviction investments, unconstrained by index considerations. Most of the holdings are listed one of Vietnam’s main exchanges: the Ho Chi Minh Stock Exchange (HSX), Hanoi Stock Exchange (HNX) and the Unlisted Public Companies Market (UPCoM)1. VEIL is also permitted to invest in unlisted companies, and as at end-December 2017, these comprised 4.8% of the portfolio. Most of these investments are expected to list on an exchange within the next six months, after which, the unlisted portion of the portfolio should fall below one percent.

The manager is upbeat on the prospects for Vietnam and VEIL. He sees a favourable economic environment and expects sustainable GDP growth of around 6-7% pa for the next few years with low inflationary pressures (even factoring in higher oil prices, the manager expects moderate inflation of c 4% this year). Strong foreign direct investment (FDI) over the past decade has helped develop a robust and diverse manufacturing sector, underpinning future export prospects. Vietnam has posted current account surpluses each year since 2011 and foreign exchange reserves are at a record high. Longer term, Vu highlights many structural advantages to support sustained economic growth, including political stability and a favourable demographic profile with a young median age of 31 years.

Accelerating privatisations and government divestments over the next few years could provide exciting investment opportunities for VEIL. The manager observes an equity offering pipeline of up to $12-13bn from the private and state sectors through to the end of 2019, which contain very attractive assets and franchises. Given VEIL’s fundamental research capabilities and long-standing reputation as an investor in Vietnam, he believes it is very well-placed to take advantage of upcoming opportunities.

Vietnam’s potential inclusion in MSCI Emerging Markets index could provide a meaningful boost to its stock market over the next few years. Dragon Capital estimates the inclusion process could stimulate foreign inflows of $7-9bn into Vietnam equities. The manager notes Vietnam is already well qualified for inclusion in terms of market capitalisation and liquidity. However, foreign ownership limits (FOLs) and the lack of a trading system, such as a foreign board, to improve transparency is an impediment for inclusion. The manager believes the government may amend laws to raise FOLs, which would strengthen Vietnam’s case for qualification, and he is looking for the government to increase the FOL for commercial companies to 63% from the current 49%, and for financial companies to 49% from the current 30%.

Vu believes the Vietnam equities market offers attractive investment opportunities given lower valuations following its recent correction, and stronger than expected Q118 earnings, which has led the team to raise expectations for 2018 EPS growth to c30% (24% as at end-March 2018).

VEIL maintains a relatively concentrated portfolio of c 35 stocks, differing significantly from the VN Index, which reflects the manager’s bottom-up focus. Based in Vietnam, a well-resourced team of three portfolio managers (led by Vu Huu Dien) supported by 10 sector specialist research analysts (each covering around 70-80 companies), facilitates a hands-on approach of meeting company managements and in-depth analysis, with particular focus on valuation and good corporate governance. The team is also experienced in the evaluation of unlisted or recently listed companies, applying the same investment process. New listings and government divestments are expected to continue to be an important source of investment opportunities in Vietnam over the next few years, and VEIL appears well placed to take advantage of these given the team’s depth of expertise. All new investment decisions are reviewed by an investment advisory committee, comprising Dragon Capital’s senior managers CEO Le Minh Anh, Deputy CEO Alex Pasikowski, CIO Bill Stoops and CRO Gavin Patterson. The committee meets monthly with the manager and reviews the portfolio to ensure VEIL is on track to meet its investment objectives.

As shown in Exhibit 4, VEIL is well diversified across 13 sectors. Over the year to 27 April 2018, the most significant sector change is an 8pp increase to banks, which became the largest exposure in the portfolio at 23.1%. Banks have led the rally in the VN Index and this was the strongest performing sector in 2017, rising 61.6%. The sector has continued to do well in early 2018, buoyed by strong 2017 results. VEIL’s largest bank holdings, Asia Commercial Bank and Military Bank reported 2017 profits before tax increases of 59.3% and 26.4% respectively, which lifted their share prices, providing the manager opportunities to take profits. Still positive on the banking sector, VEIL invested in Techcombank, a smaller private commercial bank, with growing fee income and expansion plans into retail banking, due to list in June 2018. Having been overweight banks in 2017, VEIL is now slightly underweight this sector.

The largest exposure decline over the year is to food & beverage (reduced by 5.6pp). This largely reflects a 7.7pp reduction in VEIL’s long-held investment in Vinamilk (VNM), including the sale of a strategic stake to the Jardine Group at the end of 2017. Some of this was reinvested to increase VEIL’s holding in Saigon Beer Alcohol Beverage Company (Sabeco), from an opportunistic placement ahead of the state auction in December 2017 - Vietnam’s largest asset sale to date - which resulted in Thai Beverage purchasing a controlling stake. The manager views Sabeco as a relatively defensive investment given its strong franchise and cash flows, while new management may address the inefficiencies of the company and improve profitability over the medium term.

The manager views the portfolio as well positioned to benefit from Vietnam’s strong economic growth, and in particular a rising middle-class which should support multi-year secular growth for banks, real estate and domestic consumption.

As shown in Exhibits 5, 6 and 7, VEIL’s NAV total return has outperformed the VN Index over one, three, five and ten years. Its share price total return has also outperformed over these periods, with the exception of 10 years, which captures the global financial crisis in 2008. At that time, VEIL experienced exceptional share price volatility, rapidly moving from trading at a premium to NAV to a steep discount, as foreign investors became very risk-averse, and sold perceived risky assets, including Vietnam equities.

VEIL currently trades on a 14.8% discount to cum-income NAV, narrower than its three-year average of 16.5%, having ranged between 24.2% to 7.8% over this period, as shown in Exhibit 8. The board has an active discount management policy and can repurchase up to 14.99% of issued share capital if it believes it to be in the interests of the shareholders. In February 2017, the company conducted a share buyback programme, repurchasing 0.8m shares representing 0.4% of issued shares at a total cost of $3.2m.

VEIL has two classes of capital in issue: ordinary shares and non-redeemable management shares. Dragon Capital owns all of the 1,000 management shares in issue, which have the right to appoint two members to the board. Management shares carry one vote each but are not entitled to dividends. In a wind-up situation, paid-up nominal capital will be returned to ordinary shareholders ahead of owners of management shares. There are currently 220.1m ordinary shares in issue.

VEIL is permitted to borrow up to 20% of NAV for the purposes of capital flexibility, including for investment purposes. The company has a loan facility with Standard Chartered, which was increased from $40m to $80m during FY17, and the board has approved borrowing up to $100m. As at end-April 2018, VEIL had net gearing of 0.4%.

Management fees were revised with effect from 1 August 2017. Previously, the investment manager was paid 2% of net assets pa. Under the current fee structure, a 2% management fee is payable on net assets up to $1.25bn, reducing to 1.75% pa between $1.25bn and $1.5bn, and further reducing to 1.5% on net assets over $1.5bn. There is no performance fee.

VEIL’s investment objective focuses on medium- to long-term capital appreciation and no dividends have been paid since its inception.

Exhibit 9 shows selected members of the AIC Country Specialists – Asia Pacific sector. This peer group covers a diverse range of very different countries, and performance is heavily influenced by individual markets, not just manager performance. VEIL is one of the largest funds in the group and its NAV total return ranks first out of 10 over one and three years; second out of 10 over five years and fifth out of eight over ten years. Among the Vietnam subgroup peers, VEIL’s NAV total return ranks first out of three for all periods except 10 years, where it ranked third, though all three funds delivered strong absolute returns. It is the only Vietnam specialist that does not charge a performance fee.

The board has returned to five members following the appointment of Vi Le Peterson as an independent non-executive director on 24 April 2018. Peterson is an international business consultant and advises multinational corporations on trade and investment in Thailand and Vietnam. She has banking experience with Australia and New Zealand Banking Group from 1981 to 1996. Between 1996 and 1999, Peterson served as Minister-Counsellor and Senior Trade Commissioner for Vietnam, based at the Australian Embassy in Hanoi. Chairman Wolfgang Bertelsmeier was appointed director July 2009 and assumed his present role in November 2013. The other board members are senior independent director, Stanley Chou (appointed January 2016), Derek Loh (appointed March 2011), Gordon Lawson (appointed July 2014) and non-independent director Dominic Scriven (appointed May 1995), the founder of Dragon Capital.