Vietnam Enterprise Investments — Long-established track record and local expertise

The VN Index has performed strongly year to date, gaining 43% in US$ terms to end-November 2017. Foreign net inflows at US$612m for the nine months to end-September 2017 were a record high, while domestic investors have also been active. Although the hoped-for inclusion of Vietnam in the MSCI Emerging Markets index did not transpire this June, foreign investor interest continued to be attracted by IPOs and further divestments of state-owned companies (SOEs). Foreign buyers taking strategic stakes in Vietnam companies has helped to lift the profile and valuation of the Vietnam equities market. The Jardine Group acquired around 10% of Vietnam’s largest listed company, Vinamilk (VNM), buying in the government auction, as well as the open market at a significant foreign premium to the underlying share price. Sabeco, Vietnam’s largest brewer, is also expected to attract significant foreign strategic interest in its next divestment tranche, scheduled for the end of this year. As shown in Exhibit 3, the VN Index valuation now appears expensive relative to its own history and relative to MSCI Asia ex-Japan. Consensus 2017 earnings expectations for Vietnam, however, are higher at c 20% EPS growth versus c 15% for Asia Ex-Japan, while ROE is forecast at over 15% compared to 12% in Asia.

Vietnam’s economic environment is favourable, with GDP growth accelerating from 5.7% pa in H117 to 7.5% pa in Q317. Manufacturing was a key driver, in particular strong output by foreign companies such as Samsung and Formosa. An improvement in September headline manufacturing PMI to 53.3 augurs well for continued economic expansion towards meeting the government’s target for 6.6% 2017 GDP growth. As shown in Exhibit 2, IMF expectations for Vietnam’s GDP growth rate over the next five years are comparable with that of the Asia region, having lagged the previous five years, and are significantly higher than forecast for the world.

VEIL was launched in 1995 as a closed-ended fund, incorporated in the Cayman Islands. Its shares were admitted to the Main Market of the London Stock Exchange (LSE) in July 2016, de-listing from the Irish Stock Exchange, and included in the FTSE 250 Index on 18 July 2017.

VEIL is the largest and longest established fund focused on Vietnam equities, with an investment objective of outperforming the VN Index (a capitalisation-weighted index of all companies listed on the HSX) on a rolling three-year basis, although not constrained by index weightings. It seeks to achieve its objective through a bottom-up, fundamental approach to stock selection, placing considerable weight on disciplined valuation and good corporate governance. The portfolio is relatively concentrated, comprising around 35-40 stocks, well diversified across a broad range of sectors. Most of the holdings are listed on the Ho Chi Minh Stock Exchange (HSX), Hanoi Stock Exchange (HNX) and the Unlisted Public Companies Market (UPCoM), a purpose of which is to receive newly-listed state-owned companies, which then must transfer to the HSX or HNX within one year. As at end-October 2017, unlisted companies comprised 5.7% of the portfolio.

The manager views the economic environment as favourable for Vietnam equities. The government’s official GDP growth target of 6.6% in 2017, places Vietnam amongst the fastest growing economies in the Asia. Furthermore, Vu believes the quality of Vietnam’s growth is improving, with rising productivity, a recovery in credit quality in the banking system and little inflationary pressure. Valuations for the VNI appear expensive relative to its own history. However, the manager focuses on Dragon Capital’s universe of top 50 ‘investible’ companies across the HSX and the HNX, which exclude companies that do not meet its basic investment criteria. Based on Dragon Capital’s research, this universe is more reasonably valued at 17x 2017 and 14x 2018 P/Es, with EPS growth forecast for 19% and 20% respectively.

The manager believes further SOE privatisations and divestments, as well as private sector listings, could provide catalysts for continued positive performance of Vietnam equities over the next few years. He observes that the pipeline of companies earmarked by the government for privatisation and divestment includes many important Vietnam franchises, offering “once in a lifetime” investment opportunities. With a persistent fiscal deficit of 6% of GDP, the manager believes the government is motivated to accelerate asset sales, which have been slower than expected over the past couple of years. The current privatisation programme, which started in 2014, has raised around US$2.2bn thus far, and the future pipeline indicates that up to US$18bn in IPOs and secondary divestments is expected to take place through to the end of 2019, which will be in addition to a further US$2bn in private sector listings. Furthermore, the manager believes the government will likely take measures to encourage listed companies that are legally permitted to lift foreign ownership limits (FOLs). This would help attract foreign inflows as well as help address the ‘market access’ impediment to Vietnam’s inclusion in the MSCI Asia ex-Japan Index, as around one-third of the Vietnam equities market, by market capitalisation, has reached the FOL.

VEIL is well-prepared to participate in upcoming listings, with a strong local reputation as a long-term institutional investor, a track record of investing in IPOs and the resources to carry out its own in-depth research into these companies. The pipeline suggests banks and property companies will dominate the upcoming listings and divestments. The manager views this positively, as these sectors fit well with VEIL’s investment themes of a growing middle class, deeper financial penetration and urbanisation in an economy where 65% of the population is still rural.

VEIL’s investment process is bottom-up and fundamental, selectively looking for companies with long-term investment potential for its relatively concentrated portfolio of c 35-40 holdings. Meeting managements is a key part of the process, which seeks to identify companies with strong, well-positioned business models, operational discipline and good corporate governance, at reasonable valuations. The ability to assess companies that are yet to list, or have relatively recently listed, is important to VEIL’s investment strategy. The investment team is well-resourced with 10 research analysts, covering 70-80 companies to support the fund’s three PMs, led by Vu Huu Dien. All new investment decisions are reviewed by an investment advisory committee (IAC), comprising Dragon Capital senior managers CEO Le Minh Anh, Deputy CEO Alex Pasikowski, CIO Bill Stoops and CRO Gavin Patterson. The committee meets monthly to discuss matters raised by the portfolio managers as well as to conduct its own portfolio review to ensure VEIL is on track to meet its investment objectives.

As shown in Exhibit 4, the largest exposures within VEIL are to the banks and real estate. This will likely continue, given that the pipeline of SOE privatisations and divestments is skewed towards companies in these sectors. The manager maintains a positive view on the banking sector in Vietnam, which is benefiting from recent restructurings that have reduced non-performing loans and repaired balance sheets. Over the year, the real estate sector exposure has increased from 13.0% to 17.6%, partially attributable to strong performance from its holdings, but also due to additions to the portfolio, including participations in recent IPOs, Becamex and IDICO.

Exposure to the retail sector has increased from 5.6% to 11.2%, mostly attributed to Mobile World Group (MWG), the largest holding in the portfolio at 10.1% as at end-October 2017, up from 5.6% the previous year, as a result of additional purchases and strong share price performance. The manager maintains his positive outlook for this company, as it builds out a “mini-market” business, targeted at lower-income neighbourhoods, which it views as highly scalable and aligned with VEIL’s investment theme of rapidly growing consumption.

The food and beverage sector has been a source of funding for purchases, its weight falling by 9.3 percentage points to 9.9% of the portfolio, largely from reductions in VNM, which VEIL has held since its inception. As at end-October 2017, VNM was 7.2% of the portfolio, down from 18.5% a year earlier. Although the manager believes the company’s prospects continue to be bright, its valuation is now expensive relative to opportunities elsewhere. In November 2017, VEIL further reduced its VNM stake, taking advantage of a share price premium offered by the Jardine Group.

As shown in Exhibits 5, 6 and 7, VEIL has a longstanding, positive track record of performance and NAV total return has outperformed the VN Index over one, three, five and 10 years. It has also outperformed the MSCI Emerging Markets Index (MXEF) over each of these periods except 10 years, reflecting a pronounced peak in the VN Index in 2007. As at end-October 2017, the VN Index was 28.5% below its 2007 peak, while MXEF was 16.3% below its 2007 peak.

VEIL currently trades on a discount to NAV of 15.5%, below the 16.8% three-year average and well within the range of 7.8% and 24.2% over the period. The company has the ability to manage an imbalance in the supply of and demand for its shares through repurchases. In February 2017, VEIL repurchased 0.8m shares, representing 0.4% of issued shares outstanding.

VEIL has two classes of capital in issue: ordinary shares and non-redeemable management shares. Dragon Capital owns all 1,000 management shares, which carry one vote each but are not entitled to dividends. In a wind-up situation, holders of management shares are entitled to a return of paid-up nominal capital only after the return of nominal paid-up capital to the ordinary shareholders. Management shares also have the right to appoint two members to the board. The company has authority (renewable annually) to repurchase up to 14.99% of its issued share capital.

VEIL is permitted to borrow up to 20% of NAV (at the time of borrowing) for the purposes of capital flexibility, including for investment purposes. The board has approved borrowing of up to US$100m and, as at end-August 2017, the company has debt of $38m. VEIL is putting in place credit facilities of up to US$90m to allow it the flexibility to participate in upcoming equity offerings. As at end-October 2017, the company’s gross gearing was 2.9%, and net cash was 3.2%

VEIL’s investment manager, Enterprise Investment Management, a subsidiary of Dragon Capital, is paid a management fee of 2.0% pa on assets up to US$1.25bn, reducing to 1.75% pa on net assets between US$1.25bn and US$1.5bn, and further reducing to 1.5% on net assets over US$1.5bn. No performance fees are payable and in FY16, the ongoing charge was 2.16%.

No dividends have been paid to date by VEIL, reflecting its investment objective to achieve medium- to long-term capital appreciation of its assets.

Exhibit 9 shows the members of the AIC Country Specialists – Asia Pacific sector excluding Kubera Cross-Border, which principally makes private equity investments. This peer group covers many different individual countries, thus making comparisons less meaningful as performance is heavily influenced by individual markets, not just manager performance. Among the subgroup of Vietnam funds, VEIL is the largest and has the strongest NAV total return performance for one, three and five years. Its 10-year NAV total return performance is weaker than the other two Vietnam funds, reflecting a very pronounced pre-crisis stock market peak in 2007, providing a very high base for comparison (the VN Index has yet to return to its peak). VietNam Holding launched in 2006 and was not fully invested during this time, while VinaCapital Opportunities Fund held private equity investments, which are generally less affected by market volatility.

Following the resignation of Marc Faber in October 2017, the board consists of four independent directors and one non-independent director, Dominic Scriven. Chairman Wolfgang Bertelsmeier (appointed director July 2009, chairman November 2013) was at the World Bank for over 30 years, including 17 years at the IFC (International Finance Corporation), serving as Resident Representative for Vietnam between 1997 and 2000. Senior independent director Stanley Chou (appointed January 2016) is also managing director of investment advisory companies Lufin Asia Pacific and SCA International. Derek Loh (appointed March 2011) is a director with TSMP Law Corporation Singapore. He also sits on the boards of various Singapore-listed companies including Vibrant Group, where he chairs the Remuneration and Nomination Committees. Gordon Lawson (appointed July 2014) is a director of Ukrainian Opportunities Fund, Turiya Funds and Blakeney. Dominic Scriven (appointed May 1995) is the founder of Dragon Capital and a director of several Vietnamese public companies. He has over 30 years’ investment experience, concentrated in Vietnam.