VinaCapital Vietnam Opportunity fund review

VinaCapital Vietnam Opportunity fund (VOF) is one of the longest-established and largest Vietnam-specialist investment companies listed in the UK.

 Vietnam

Launched in 2003 and listed on the LSE Main Market since March 2016, VOF joined the FTSE All-Share Index in June 2016 and the FTSE 250 Index in March 2018. The manager invests in public and private equity, primarily via privately sourced deals, seeking to take advantage of market inefficiencies.

VOF has a diversified portfolio, providing broad exposure to Vietnam’s economy, across three main asset class segments – listed equity, unlisted equity and private equity. Investments are focused on Vietnam’s domestic economy, in sectors the manager believes will see the strongest growth, notably consumption, construction, infrastructure, real estate, financials and healthcare. Exposure to overseas trade is limited, moderating the risks associated with macroeconomic uncertainties such as currency volatility and international trade policy.

VOF mainly sources investments at the private equity or pre-IPO stage via privately negotiated deals, including government privatisations, structuring them to include a degree of downside protection. VOF typically takes super-minority stakes in companies, aiming to secure up to three-year performance commitments, with financial penalties; ‘drag along’ rights to ensure shareholders participate on equal terms if a business is sold to a third party; and board representation to influence company management. VOF’s lead portfolio manager is VinaCapital’s chief investment officer Andy Ho. He is supported by three deputy portfolio managers, VinaCapital’s chief economist Michael Kokalari and a 10-member research team.

Performance

VOF’s sterling NAV and share price total returns have lagged the VN Index return over one year to end-November 2019. Although performance has been lacklustre over one year, VOF’s longer-term absolute returns have been strong, and its 10.9% compound annual NAV total return over 10 years is a shade ahead of the VN Index’s 10.5% pa return. Its share price total return for the same period is a creditable 15.2% pa.

During FY 2019 (ended 30 June), VOF’s private holdings generally performed well, while its listed investments were more volatile.

Two of its top 10 holdings, Hoa Phat Group (HPG) and Coteccons Construction (CTD), saw large share price declines over the period of -21.2% and -30.5% respectively, in US$ terms.

HPG has been a holding in VOF’s portfolio since 2008, during which time the company has increased in size from ca $400m to ca $3bn. It is a leading steelmaker in Vietnam, with circa 25% market share. The company suffered in 2019 after its main input cost (iron ore) rose significantly on the back of a supply shortage following the collapse of the Vale-owned Brumadinho dam in Brazil and it was unable to pass on the cost increase to customers because most of its competitors make steel from scrap iron, which was unaffected by the iron ore shortage. In addition, a government crackdown on private land transactions has slowed the pace of property development, meaning lower demand for HPG’s construction steel.

CTD – which Ho said is by far the largest construction company in Vietnam – has also been negatively affected by the land issue, as well as a continuing struggle between two major shareholders (one of whom is the chairman), which has led to a lot of retail investors selling their shares in the company.

As the land transactions problem is addressed and construction picks up again, both HPG and CTD should benefit.

VinaCapital Vietnam Opportunity fund

Price327.5p
Market cap£600.0m
Nav*380.0p
Discount to NAV13.8%
Yield2.6%
*Estimated daily NAV at 18.12.19

Investment Strategy – Privately negotiated deal sourcing

VOF’s portfolio is constructed using a bottom-up approach, with lead manager Andy Ho taking a three- to five-year view, selecting investments that he believes present the greatest value opportunities from a range of industry sectors and asset classes. Prospective investments are subject to detailed analysis to identify the best risk-adjusted returns and the manager prefers to invest where VOF can influence the strategic direction of a business.

The manager favours a concentrated portfolio and makes stock allocations without reference to index weightings; together with its private equity-like approach, this differentiates VOF from other, more index-oriented funds. VOF’s listed holdings are typically sizeable minority stakes, which the manager is often able to divest at a premium to the market price in cases where a strategic investor is seeking to acquire a controlling stake. Ho noted that given the low cost of capital amid a backdrop of continued monetary easing, foreign investors may prefer to buy a majority stake in an existing Vietnamese company rather than build their own operations in the country.

Thorough due diligence is performed on all new investments, with potential exit routes identified and evaluated before VOF commits to an investment. The manager typically seeks to invest at a discount to equivalent listed company valuation multiples, aiming to achieve an internal rate of return of 20% or more. Prospective new investments are also reviewed by a risk committee, prior to submission to a six-member investment committee for final approval.

Environmental, social and governance (ESG) considerations are increasingly embedded in the investment process, focusing on issues pertinent to Vietnam such as air and water pollution, the use of child labour and the validity of land transactions. Ho said ESG analysis forms an important part of the due diligence process and that VOF will engage with a potential investee company to ensure it tackles any ESG deficiencies, or may walk away if there is no commitment to improve.

The Managers’ View – Grounds for optimism

Commenting on the macroeconomic outlook, lead portfolio manager Andy Ho noted that although he is somewhat concerned about the potential effect on Vietnam of China’s economic slowdown, recent data have been positive. He pointed out that Vietnam’s manufacturing Purchasing Managers’ Index (PMI) increased from 52 in May 2019 to a near-record high of 52.5 in June, driven by a six-month high rate of growth in new orders. Vietnam’s PMI is one of the few in the world currently not below 50 (albeit only at 50.5 at end-September, falling to 50.0 at end-October), which indicates the manufacturing sector is not contracting.

The country runs a significant trade surplus with the US, but although the Trump administration recently made negative comments regarding the trade relationship, Ho does not expect Vietnam will be targeted with draconian tariffs. He also noted that Vietnam and the EU have signed a long-awaited free trade agreement (EVFTA), which will effectively abolish tariffs on almost all goods exported to the EU over the next few years, creating a major competitive advantage for Vietnam relative to China and other ASEAN countries. However, Vietnam is feeling some ill effects from the slowing Chinese economy, such as slower growth in tourist arrivals from China which is up 4% in the first nine months of 2019, versus 23% in the same period of 2018.

Chief economist Michael Kokalari described the Vietnamese economy as being in a ‘Goldilocks’ situation, with GDP growth at ca 7% being strong enough to propel earnings but without putting pressure on inflation, which remains very benign at ca 2%. Although trade tensions between the US and China have affected exports in the region – Thailand, Malaysia and South Korea have all seen c. 10% falls in exports, with Japan and Taiwan declining c. 5% – Vietnamese export growth remains healthy at ca 10% for Q3 2019, illustrating the effect of companies relocating production from China to Vietnam to circumvent US tariffs. Furthermore, consumer sentiment in Vietnam is among the most positive in the world and the currency has remained stable as the central bank has boosted its foreign exchange reserves to circa $73bn, the equivalent of four months’ exports. The economist added that the Vietnamese dong has decoupled from the Chinese renminbi (RMB) and barely reacted to the renminbi declining to the psychologically significant level of RMB7/$ in September. Looking ahead, Kokalari said the current outbreak of African swine fever across the region could put some short-term pressure on inflation, with Vietnam’s pork supply down 18% and expected to fall further – China’s is down c. 50% – causing significant price rises. However, although inflation could rise to ca 3–3.5% in the near term, it should return to ca 2.5% as the epidemic subsides, and with GDP growth forecast at a slightly lower but still robust ca 6.8% for next year, the outlook remains favourable.

Commenting on the composition of the portfolio – the core of which remains in companies where the entry point has been through a private equity deal, pre-IPO private placement or equitisation – Ho said that buoyant stock market valuations in recent years have increased the pace of companies seeking a main stock market listing via IPO. For example, VietJet was a pre-IPO investment by VOF in 2016 and listed on the Hanoi Stock Exchange in 2017. VOF fully exited the position in summer 2019, having seen a c. 100% return on its initial $10m investment in less than three years. Investment team member Duong Vuong added that the team has been trimming or exiting certain listed positions where valuations look more attractive in private equity, or where holdings are small and valuations have moved to the point where it is more difficult to build a strategic stake.

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