VietNam Holding — Restructured company offers opportunity

Vietnam’s very positive long-term economic outlook is underpinned by many favourable attributes, including a young population, a strong export sector and its ability to attract significant foreign direct investment (FDI). The median age of 30.5 years is the youngest in ASEAN, while urbanisation is increasing rapidly. Vietnam’s economy is very open, with trade accounting for 200% of its GDP, partly a reflection of its strong manufacturing capabilities. This has underpinned FDI and the country continues to attract multinationals as they look to diversify their global manufacturing bases in response to the implications of the ongoing US-China trade dispute. Exports from Vietnam to the US increased by over 27% year-on-year for the first half of 2019. Vietnam already hosts many multinational companies and is an established manufacturing hub for numerous industries including electronics, textiles, footwear and fishery products. It is moving rapidly up the value chain and recent high-profile foreign investors include Google and, reportedly, Apple.

As shown in Exhibit 2, Vietnamese equities’ valuations had become overstretched in 2017 and early 2018. A sharp correction in the VN Index last year has brought the forward P/E multiple back in line with Asia ex-Japan; however, growth prospects for Vietnam are superior. Its GDP grew by 7.1% in 2018, among the highest in the world. According to the IMF, this should continue to be the case. As shown in the chart on the front page, it forecasts the country’s GDP to grow at an annual compound rate of 6.5% between 2019 and 2024, whereas growth in Asia ex-Japan is expected to continue to decelerate gradually (led by a slowdown in China).

VNH was launched in April 2006 as a closed-ended fund, incorporated in the Cayman Islands and listed on AIM. In February 2019, the company changed its legal domicile to Guernsey and its shares were de-listed from AIM and admitted to the Main Market of the London Stock Exchange in March 2019.

VNH’s objective is to achieve long-term capital appreciation through investing in a diversified portfolio of companies based in Vietnam that have high growth potential at an attractive valuation. The investment approach is bottom up and unconstrained by index considerations. The company has adopted the guidelines of the Principles of Responsible Investment (PRI), which exclude certain investments, such as companies significantly involved with alcohol and tobacco and those that do not commit to reducing, in a measurable way, pollution and environmental problems arising from business activities.

The fund has a bias towards mid- to small-cap companies with market capitalisations below $1bn and is permitted to invest up to 20% in unlisted equities, which in practice is in firms that have visible near-term plans for an IPO.

VNH does not follow a benchmark, although for certain purposed it references the performance of the portfolio against the VNAS. The fund is a member of the AIC Country specialists – Asia Pacific peer group.

The fund has undergone several significant governance and investment management changes since September 2017. These arose from existing shareholders’ concerns regarding historic failings by the previous fund manager, VNH Asset Management (VNHAM), and the former board. The issues included:

Following dialogue with several of the larger shareholders, the former board agreed to step down at the 2017 AGM and was replaced by four new independent directors (see page 11). The new board conducted a full ‘root and branch’ review of the investment management and corporate governance arrangements, which resulted in several actions and significant changes in 2017 and 2018. These included:

The directors believe these changes signal the board’s commitment to protect and promote the interests of shareholders and to broaden the appeal of the company to help reduce its discount to NAV. In its view the Cayman domicile and AIM listing were an impediment to some investors. Furthermore, a Main Market listing should benefit shareholders due to the more rigorous corporate governance, regulatory and reporting requirements and may attract more institutional investors, which should help improve the liquidity and valuation of the shares.

Dynam Capital was appointed the fund manager of VNH on 16 July 2018, replacing the previous manager VNHAM, which had been in place since the fund’s inception in 2006. Dynam Capital is a newly established firm, registered in Guernsey and formed by Vu Quang Thinh and Craig Martin.

Vu is the chief investment officer (CIO) and managing director of Dynam Capital. He was previously also CIO of VNHAM, where he managed VNH since July 2011. Before that, Vu was the founder of MCG Management Consulting and head of the management consulting practice for KPMG in Vietnam. He holds an MBA from Washington State University and a BA of mathematical science from Hanoi National Economic University.

Martin is the firm’s executive chairman and a member of the investment committee. He has over 25 years’ experience investing in emerging markets. Between 2010 and early 2018, he was co-CEO of CapAsia and served on the boards of numerous companies in South East Asia. Prior to that, Martin was head of private equity at Prudential Vietnam. He holds an MBA from INSEAD and a master’s in engineering from the University of York. Martin is a member of the Singapore Institute of Directors and divides his time between Singapore and Vietnam.

The key on-the-ground staff of VNHAM moved to Dynam Capital, which now has 11 employees based in Vietnam, nine of whom are investment professionals. VNH is its sole client and all its resources are directed towards managing this fund.

The manager believes Vietnam offers outstanding investment opportunities over the long term, and follows three key investment themes of rising consumption, urbanisation and industrialisation. These trends are contributing to a rapid increase in the middle class, which the team thinks will grow by 35m people and account for half the population by 2035. In their view, this can underpin high growth in domestic consumption for many years. The manager also expects Vietnam to continue to attract strong FDI, as the country is increasingly recognised as an attractive manufacturing hub and labour costs are around half the level in China.

Meanwhile, Dynam Capital argues that Vietnam’s equity market should continue to deepen and attract foreign funds. The government is supportive of the development of the country’s capital markets; it has eased restrictions on foreign ownership limits and recently introduced new financial instruments, index futures and covered warrants. Its commitment to the privatisation of public companies should also help increase the size and liquidity of the equity market. The manager believes that Vietnam is likely to be included in the MSCI Emerging Markets (EM) index over the next few years, graduating from its current frontier market status, which would draw in significant foreign inflows. It notes that Vietnam’s market capitalisation is already larger, with better liquidity than several emerging market countries. The manager believes the government is motivated to promote Vietnam’s EM index inclusion, as increased foreign inflows would help the economy reduce its dependency on the banking system for funding and may expedite reform at state-owned enterprises.

VNH follows a fundamental investment approach to construct a relatively concentrated portfolio of c 20–25 stocks. The manager is not constrained by a benchmark and the fund’s holdings represent the team’s highest-conviction investment ideas with a long-term investment horizon.

The process starts with initial screening of the investment universe, which includes an ESG checklist to eliminate companies the manager would not wish to consider. Firms that pass the screen are then subject to due diligence including site visits, meetings with management and detailed financial analysis. The team is looking for companies that are well-managed industry leaders with a strong competitive position, have healthy balance sheets and cash flows, yet are attractively valued. The assessment of a company’s ESG credentials is of particular importance, reflecting the manager’s belief that firms that score highly, or are improving on these issues, tend to outperform in the long term. A written investment proposal is produced for all candidate stocks and reviewed by the senior members of the Dynam team. They also review the portfolio as a whole on a weekly basis, focusing on performance, portfolio composition and active ownership of the investments. Dynam Capital’s investment approach shares similarities with that of private equity. The team engages closely with portfolio companies, involving frequent monitoring against key performance indicators and ongoing mentoring. The manager typically finds small- and mid-cap companies attractive as these tend to be less well researched and their management more open to engagement. VNH’s relatively small size allows it the flexibility to invest in these companies and around half the portfolio is invested in stocks with a market cap of less than $1bn. This is significantly higher weight than the 18% mid- and small-cap component of the VNAS index.

The position size of investments largely reflects the levels of conviction in each company. Top-down analysis influences asset allocation to sectors and themes. Diversification considerations are also important and the fund is not permitted to invest more than 30% of its NAV, at the time of investment, in any one sector. VNH is also not permitted to invest directly in property but may invest in companies that have a large real estate exposure. As a signatory of the PRI, the fund follows its guidelines, which exclude certain investments including companies with businesses in the alcohol, tobacco armaments, and gaming industries. VNH will also not invest in companies that fail to commit to reducing pollution and environmental problems caused by their business activities.

Exhibit 3 shows the portfolio’s sector exposure as at end-August 2019. Relative to the VNAS index, VNH is most notably overweight retail (17.4pp) and industrials (12.5pp), consistent with the manager’s key investment themes. One of the largest retail sector positions in the portfolio is long-held jeweller Phu Nhuan Jewelry (PNJ), which commands a 28% market share with a nationwide network of over 320 stores, six times greater than its next-largest competitor. The company also has strong manufacturing capabilities. The manager believes PNJ can become one of the industry’s top players in Asia and expects the company to generate organic growth of 20–30% pa over the next three years.

VNH also added to its position in Mobile World (MWG). Vietnam’s largest retailer with over 2,200 stores nationwide. MWG was established in 2004 as a mobile phone retailer and in 2010 launched a consumer electronics retail business; both are clear market leaders in their respective subsectors. More recently, the company diversified into modern food retailing with a ‘modern wet market’ format, to offer fresh produce of high quality and traceable origin in a store setting. Investors have been sceptical of MWG’s venture into food retailing; however, Dynam Capital believes MWG’s management can execute the new strategy successfully and took advantage of share price weakness to purchase the stock.

Investments in the industrials sector include the portfolio’s third-largest holding, Saigon Cargo Services. The company is a duopoly operator of the air cargo terminal in Tan Son Nhat Airport, which serves the capital Ho Chi Minh City and southern Vietnam. Its competitor operates at full capacity and there is no land available for expansion. This strong competitive position allows the company to benefit from high profit margins and generate returns on equity of over 40%. VNH was an early investor in this company, prior to it becoming listed on the VN Index and the manager continues to believe it is an attractive business.

VNH purchased a position earlier in the year in ABA Cooltrans (ABA), a nationwide cold-chain logistics provider. It is the only private company in the portfolio accounting for 4.1% at end-August 2019. The company serves large modern retailers including Vin Mart and BigC, as well as suppliers of fresh produce, such as Masan Nutri-Science and Bel Vietnam. The manager believes ABA has excellent growth prospects, directly linked to the growth in demand for fresh and safe food by Vietnamese consumers. VNH invested in ABA via a convertible bond, which the manager thinks is an attractive way to participate, giving the fund an option to take a significant equity stake in the business, while earning a decent coupon payment.

At the end of August 2019, the portfolio held two companies on the Unlisted Public Companies Market (UPCoM), an exchange for newly listed state-owned companies that must transfer to either the Ho Chi Minh Stock Exchange (HSX) or Hanoi Stock Exchange within one year. Since then, one of these companies, Gia Lai Electric (GEG), has listed on the HSX. GEG is the leading renewable energy supplier in Vietnam, operating the country’s first five solar plants, all of which meet the global environmental standards required by its strategic investors, the International Finance Corporation and Armstrong Asset Management, a Singapore-based clean energy investment specialist. The manager believes GEG’s growth potential is underpinned by an underlying 10% pa growth in Vietnam’s electricity demand, as well as the government’s intention to promote renewable energy consumption.

The remaining UpCoM holding is Viettel Post (VTP), the country’s second-largest postal company, which the manager thinks is well positioned to capture the proliferation of e-commerce in Vietnam, given its nationwide network of c 1,300 post offices and around 6,000 drop-off points. The manager notes that online sales accounted for only around 3% of Vietnamese retail sales in 2018, which is where China was 10 years ago. Dynam says this under-penetration offers attractive secular growth prospects for VTP, given Vietnam’s young and tech-savvy population, rising incomes and an increasing demand for convenience.

The portfolio is most underweight the banks and food & beverage sectors. These sectors are dominated by very large-cap stocks and the manager typically finds better opportunities in small- and mid-cap companies. VNH holds only one bank, Military Bank, which the manager believes is one of the best managed in the sector. Vinamilk and Sabeco are behemoths within the food and beverage sector. Both companies are among the largest listed companies in Vietnam and are well researched and widely owned, which the manager believes is reflected in their respective valuations.

Dynam Capital was appointed the manager of VNH in July 2018 and in addition to the standard performance periods, we also show the periods since the date of change (SC). As shown in Exhibits 5 and 6, the NAV total return of the company has been very strong over 10 years, outperforming the VNAS, VN30 and MSCI EM indices. Performance has lagged the VNAS index over one, three and five years. More recent performance has been positive and the company has outperformed over three and six months.

Performance for the first six months after taking over management of the fund suffered, as the 15% tender offer in December required a repositioning of the portfolio to facilitate adequate liquidity, which presented a distraction for the team. Furthermore, the new manager inherited positions that it did not wish to continue to hold. Two positions sold had had a notable negative impact on the portfolio: media conglomerate Yeah1 and investment bank and brokerage house VietCapital Securities. Free from transitional issues, performance has improved as the team was able to re-focus on the day-to-day management of VNH.

VNH trades at a 19.0% discount to its total return NAV, which is wider than its three-year average of 16.3%. Over that period, it has ranged between 6.3% and 27.2%. The fund’s discount to NAV is also the widest among its peers (see Exhibit 9). The governance issues associated with the previous board and manager, and the fund’s trailing performance, are likely to have contributed to the depth of the discount.

A new board was appointed in September 2017 and, following a comprehensive review of VNH’s investment management and corporate governance arrangements, a number of measures were implemented, aimed at improving the appeal of its shares. The measures (see page 4) included the appointment of a new manager, a reduction in the management fees, a change in the fund’s domicile and a re-listing on the Main Market of the London Stock Exchange. The board also increased its buy-back authority from 10.00% to 14.99% of shares outstanding (renewed annually). These changes signal the board’s commitment to promoting the interests of shareholders. In conjunction with increased marketing efforts, the improved performance of the fund should help VNH’s discount to narrow over time.

VNH is a closed-ended Guernsey-domiciled investment company with one class of share; there are 51.0m shares in issue and none held in treasury. In October 2018, shareholders approved a tender offer for up to 15% of issued shares, which was implemented in November and December 2018, resulting in the repurchase of 9.7m shares at $2.72 per share. Gearing is permitted up to 25% of the NAV; however, VNH has historically not used this capability and presently, there is no loan facility in place. At end-August 2019, the fund had a net cash position of 1.5% of NAV.

Dynam Capital receives an annual management fee (paid monthly) of 1.5% of NAV for assets up to US$300m, then 1.25% on assets between US$300m and US$600m, reducing to 1.0% on assets above US$600m. There is an incentive fee of 12% of the excess performance in each financial year over an 8% compound hurdle, starting with the high-water mark as of 30 June 2018, capped at 3% of NAV in any financial year. Half of the incentive fee is payable in cash and half in VNH shares issued at the higher of NAV or the closing price at the financial year-end. Half of the shares will be locked up for one year and the rest will be locked up for two years. Previously, the management fee was 2.0% of net assets and a performance fee of 15.0% was payable on excess performance above a 5% hurdle rate. At end-June 2019 VNH’s ongoing charges rate was 2.23%, lower than 2.69% a year ago.

VNH’s objective is to deliver capital growth for shareholders over the medium to long term, rather than income. No dividends have been paid since its inception.

Exhibit 9 shows 10 members of the AIC Country Specialists – Asia Pacific sector (funds with a market capitalisation above £75m). This is a diverse group of funds investing in countries across a wide economic development spectrum, therefore we also present the average for the Vietnam subgroup. VNH is one of the smallest funds in the group, ranking ninth. Its current manager was appointed in July 2018, therefore the most relevant time period to consider may be one year, over which the fund’s NAV total return ranks sixth overall, and second in the Vietnam subgroup. The fund’s ongoing charge ranks third; however, it is the lowest among the three Vietnam funds. VNH trades on the biggest discount to cum-fair NAV among the subgroup of funds, suggesting there is scope for this to narrow should the recent changes implemented by the board bear fruit.

Since September 2017, the company has undergone significant corporate governance changes including the appointment of a new board, in response to shareholder concerns over historic failings of the former board. The VNH board consists of five independent non-executive directors, four of whom were appointed in September 2017: