One of the key investment opportunities in frontier markets is the potential for acquiring a larger share of manufacturing, primarily from China. Three countries are uniquely positioned to benefit from this global shift: Bangladesh, Cambodia and Vietnam. This is a long-term structural trend, but has accelerated in the past year as the trade war between the U.S. and China has dominated the headlines. Many companies (especially Chinese ones) have been moving their factories to countries such as Vietnam to take advantage of lower operating costs, and also to hedge their production exposure, given rising trade barrier risks.
This trend is apparent in Chart 1, which highlights the growing foreign direct investment (FDI) by Chinese companies in Vietnam, which reached over US$1.3 billion in 2016.
Chart 1: FDI investments from China to Vietnam (US$ million)
Source: China National Bureau of Statistics.
This movement of factories is driving the data in Chart 2, which shows the rising trade surplus between Vietnam and the U.S. This trend is very positive for the sovereign backdrop for Vietnam, because it generates hard-currency revenue that strengthens the Vietnamese currency and allows consumers to move up the consumption curve as their purchasing power increases.
Chart 2: Vietnam’s trade balance with the U.S. (US$ million)
Source: U.S. Census.
I wanted to investigate this first-hand, so after attending the largest Asian investor conference, in Hong Kong, I visited companies in Hanoi, the capital of Vietnam, to check on the Fund’s existing investments and find new ideas.
I spent a few days visiting mostly banks and industrial companies. Most management teams were fairly happy: the country is reaping the benefits of the U.S.-China trade conflict, with the benefits for manufacturers of “hedging” by having operations in Vietnam becoming increasingly apparent. It was apparent during these meetings that the management teams felt this trend would likely accelerate, especially among the Chinese textile and footwear companies that led the trend about five years ago.
One area to watch, though, is the banking system and the need for capital, given the planned move to the global standard of IFRS 9 accounting policies. The Vietnamese banking sector is growing loans approximately 15% per year, with a focus on mortgages and retail loans. However, since the banks are below minimum requirements under IFRS 9 rules, equity issuances are likely over the medium term, which could dampen investor sentiment. As well, the government is keen to privatize more businesses, including its own bank ownership. This too, although it could cause a short-term market overhang, is positive in the longer term, because the economy would be increasingly driven by private businesses.
One positive offset is the improvement in valuations for most companies. During my visit to Ho Chi Minh City in March, most valuations were quite rich, and I reduced the Fund’s exposure. But over the past six months, we have seen a correction as the general emerging and frontier markets declined. So I would argue that Vietnamese equities are fair value now – not cheap, but not expensive given attractive growth. This last point is important, because Vietnam’s relative size as a percentage of the frontier investment universe is increasing. As seen in Chart 3, Vietnamese equities, given recent IPOs and privatizations, have risen to account for over 8% of the MSCI Frontier Emerging Markets Index. This gives investors a more meaningful exposure to what is likely the best growth market in Asia.
Chart 3: Vietnam’s market as a percentage of the MSCI Frontier Emerging Markets Index
Thanks for reading,
Adam Kutas, CFA
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