Arthur: Frontier Investing With VNM

February 21, 2014

On the dicey frontiers of the investment universe, Vietnam looms as an exception, Main Management's Kim Arthur says.

This is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Kim Arthur, chief executive officer and founding partner of San Francisco-based Main Management.

When one thinks of equity investing in frontier markets, it’s easy, maybe even prudent to think of all the reasons why you shouldn’t, including political risk; currency risk; liquidity risk; trading risk; and fraud risk.

All that is fair enough, and there are other reasons as well. In many frontier markets, after all, the cost to buy and sell equities can exceed 3 percent for just the local broker’s fee. Think of that, when you can trade U.S. equities for close to nothing.

The investment case needs to be very compelling in order to offset these risks, but there are a few exceptions.

Vietnam is one of them. It’s the No. 66 country by geographic size (slightly larger than New Mexico) and No. 15 in terms of population, with 93 million people.

The literacy rate is close to 94 percent, only 5 percentage points behind the U.S. Fifty percent of those people are under the age of 26, as such the population pyramid is perfectly shaped for economic growth.

Vietnam’s gross domestic product (GDP) is No. 39 in the world at almost $350 billion, but more importantly, it grew at 5.4 percent in 2013 and is estimated to grow at a high 5 percent-plus rate for the next two years. This GDP growth is being fueled by a number of factors:

  • Only one-third of the population is urbanized, compared to China at more than 50 percent and the U.S. at over 80 percent
  • Vietnam joined the World Trade Organization (WTO) in 2007, but is negotiating to join the Trans-Pacific Partnership (TPP). This group would include the U.S., Australia, Canada, Chile, Mexico, New Zealand, Brunei, Japan, Malaysia, Singapore, South Korea, and Vietnam.
  • Currently, 50 percent of Vietnam’s exports go to the TPP – 12 countries
  • Privately run businesses and non-state enterprises make up more than 50 percent of GDP growth. Those tend to be the most productive and are run to enhance shareholder value
  • State-owned enterprises (SOE) are 20 percent of GDP and are being sold of (think of what Margaret Thatcher did in the UK during the 1980s) to bolster Vietnam’s government balance sheet and to expand the private sector
  • Finally, more of the foreign direct investment (FDI) is targeted at manufacturing. In 2012, 70 percent went here, with more focused on higher-value technology. This is part of the out sourcing to lower labor cost frontier countries.

So, what else can go wrong besides the initial five risks mentioned, which are again: political risk; currency risk; liquidity risk; trading risk; and fraud risk?

For starters, inflation is running at almost 7 percent. Half of the weighting of consumer prices is transportation and food. If these get out of hand, civil unrest will ensue. The banking sector has high rates of non-performing loans (NPL) that create a barrier for increased foreign investor ownership.

The foreign strategic investor ownership is being revised from 15 percent to 20 percent later this month (Feb. 20, 2014). Additionally, the government is revising the cap on foreign ownership of listed companies from 40 percent to 60 percent.

How do we play the above themes if we believe that price and proof are rarely in sync?

VNM, the Market Vectors Vietnam ETF (VNM | C-42) is your liquid exposure to Vietnam. You get paid a 2.8 percent dividend versus 1 percent for U.S. small-cap stocks.

 

I bring U.S. small-cap stocks into focus because the average market cap of VNM is $3 billion. You pay 76 basis points, or $76 for each $10,000 invested for the embedded management fee, which is a bargain price for frontier exposure. Finally, total assets in this product are just under $500 million, providing depth of liquidity.

With VNM, you gain exposure to 27 holdings, 75 percent of which are listed in Vietnam, with the balance listed in Thailand, UK, Malaysia, and India. The fund derives at least 50 percent of its revenues from Vietnam.

Almost two-thirds of the sector exposure is financial and energy, which is very similar to frontier exposure at large. For total frontier exposure, look at the iShares MSCI Frontier 100 ETF (FM | D-93), but you’ll pay more than three times Price-to-Book versus just one for Vietnam.

From a fundamental standpoint, VNM trades at 1.25x price to book, below its three-plus-year average of 1.4x and a high of 2.2x.

On a Price-to-Sales basis, VNM trades at 0.84x, below its average of 1.21x and a high of 2.5x. From both of these valuation metrics, it’s clear that the current price has not discounted the growth opportunity yet.

 

VNM_Price_To_Book

VNM_Price_To_Sales

 

You need to be aware that VNM will trade at a persistent premiums and discounts to net asset value (NAV), but the valuation of the underlying equities is a much more important factor to the investment thesis. Also, MSCI will be reconstituting the members in frontier markets this May 2014 by eliminating Qatar and UAE. Vietnam is currently a member in the MSCI frontier markets.

Finally, political risk has two sides just like a dagger. We know the downside, but there is an upside potential too. Vietnam had its first Doi Moi (renovation), or economic reforms, initiated in 1986. Twenty-eight years later, Vietnam appears to be at the tipping point of another Doi Moi aimed at increasing the standard of living for the 93 million people and, with a clear echo in the world of ETFs, expanding the valuation of VNM.


A pioneer in managing all-ETF portfolios, Main Management, LLC is committed to delivering transparent, cost-efficient, and customized investment solutions. By combining asset allocation insights with smart implementation vehicles, Main Management offers a unique approach that translates into distinct advantages for our clients, including diversification, cost efficiency, tax awareness and transparency. www.mainmgt.com.

 

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