A money manager takes a good look at a ‘bad’ trade and talks about it openly.
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.
Almost three months ago, we recommended frontier investing with VNM, the Market Vectors Vietnam ETF (VNM | C-36). It hasn’t gone terribly well so far, but I’m sticking to my guns, and here’s why.
Less than a month after the recommendation, the risk-on investing environment turned decidedly risk-off, and we have seen the Russell 2000 Index and Nasdaq Composite move down while the broader cap-weighted market indexes have remained in the black. Through May 9, for example, the Russell 2000 fell 4.37 percent, vs. a 2.2 percent increase for the S&P 500 Index.
Importantly, this sentiment correction has not been supported by a collapse in the fundamentals or a looming recession. I’m alluding to data showing that since 1966, all bear markets have been in front of or during a recession, with the exception of 1987.
Instead, first-quarter earnings per share will be up more than 6 percent, despite almost no growth in gross domestic product (GDP) in the quarter. The second quarter of 2014 is slated to have 8 percent-plus EPS growth and a rebound of GDP to 2-3 percent after a weather-impacted first quarter. Full-year S&P 500 Index earnings estimates are $120, up from $118 at the beginning of the year, according to Adam Parker of Morgan Stanley.
To return to our Vietnam investment, VNM is down 12 percent since we wrote about it here on ETF.com on Feb. 21, 2014, while the iShares Micro-Cap ETF (IWC | B-78) down 7 percent. Micro-cap represents a good risk-on alternative.
We wanted to give you an update on some of the investment considerations to see if the secular story of VNM is still in place. The context of this re-examination is, as I noted above, an ETF.com piece I wrote in February on why we own VNM, titled “Arthur: Frontier Investing with VNM.”
For all of 2013, Vietnam’s GDP grew at 5.4 percent. For the first quarter 2014, GDP grew at 4.9 percent, driven by the service sector, which grew at 6 percent. Helping to fuel this growth is a continued explosion in exports, which are estimated to grow at 20 percent in 2014.
The U.S. is 14 percent of Vietnam’s exports, driven by strong handset demand, which grew by 67 percent in 2013. China is 9 percent of exports and continues to grow, but has recently been in the headlines of East Sea territorial claims that we will address later in this article.
The currency has been stable this year after devaluation in 2013, and looks to remain stable, with a current account surplus of $1 billion year-to-date and $40 billion of foreign reserves, which can be used if necessary.
Finally, inflation, which was in double digits, is now running at 4.4 percent, which is the lowest rate in the last five years. With recent reductions in the interest rate on bank deposits from 7 to 6 percent, depositors are being paid a real rate of 160 basis points. While this is good, equities do provide a higher potential, albeit with greater risk of capital.
Another continuing driver of the Vietnamese economy has been the privatization of the state-owned enterprises (SOE), which are still more than one-fourth of GDP and have not been as productive as the private companies.
Since inception, 4,000 of these companies have been privatized, with 180 occurring during the 2011-2013 period. For the next two years—2014-2015—more than 430 SOEs are scheduled to be sold off, with proceeds used for financing the budget and to increase efficiencies for the Vietnamese economy.
Additionally, noncore SOEs can be sold at less than market value to encourage investor participation. Previously, such transactions were penalized, and subsequently rarely done. The current list of companies that will be privatized between now and the end of next year includes:
- Three largest airports
- Vietnam Airlines
- Vinatex, Vietnam’s largest garment manufacturer
- Mobifone, Vietnam’s third-largest telecom operator
The elephant in the room for the last week has been China. Last week, the $52 billion equity Vietnam Index had its biggest weekly retreat since 2001 over tensions with China. China National Offshore Oil Corp moved an $800 million oil rig into the waters that international law claims are Vietnam’s.
In addition to the oil rig, China sent 80 ships into the area. China’s military dwarfs Vietnam’s, though the Vietnamese have recently bought six submarines (three are deployed) and fighter jets are configured for attacking ships.
The two countries do have a history of cooperation and analysts are hoping that a diplomatic solution can be worked out. This might include a joint venture on any oil extracted from the area, using China’s capital equipment. The last time there was a border dispute between these countries was 1979. It took more than a decade before all issues were worked out, so there is reason and precedent to be worried.
Since price and proof rarely happen at the same time, what about the valuation of VNM?
In terms of multiples, its price-to-book is 1.29; price-to-earnings is 10.6; and price-to-sales is 0.95, as the charts below show.
All these variables point to VNM trading below its fair value. With Vietnam’s fundamentals (GDP, inflation, exports, etc.) moving in the right direction, it appears that one is being paid to take the risk of investing in VNM.
Geopolitical events, like those unfolding in the East China Sea, are harder to handicap, but history usually shows that investing once the event has been triggered—if the price is right—can prove to be productive.
At the time this article was written, the author’s firm, Main Management, held a long position in VNM on behalf of clients.
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.