VinaCapital Vietnam Opportunity Fund — Strong deal flow underlines private markets focus

As illustrated in Exhibit 2 (left-hand chart), Vietnamese equities have significantly outperformed Asia ex-Japan and world stock markets over five years, although volatility has been more marked recently. However, in contrast to many other market indices, which have reached new multi-year highs, the VN Index remains c 13% below its 2018 high in sterling terms. While Vietnam’s current 13.9x forward P/E multiple is c 6% higher than its 10-year average, it is below the five-year average multiple of 14.8x, and it is at c 4-15% discounts to the market valuation multiples of its regional peers, the Philippines, Indonesia, Malaysia and Thailand.

Earnings growth prospects benefit from Vietnam’s robust economic outlook, with the IMF projecting steady c 6.5% per year GDP growth to 2024. This compares to five-year forecast declines in GDP growth rates for China and G7 major advanced economies, from 6.1% to 5.5% and from 1.6% to 1.4%, respectively. Investors may also see Vietnam’s potential to benefit from the ongoing US-China trade dispute and the prospect of continuing market reforms as reasons to consider adding exposure to the country.

VOF is one of the longest-established and largest Vietnam-specialist investment companies listed in the UK. 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.

Commenting on the macroeconomic outlook, lead portfolio manager Andy Ho notes that although he is somewhat concerned about the potential effect on Vietnam of China’s economic slowdown, recent data have been positive. He points 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 notes 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 (up 4% in the first nine months of 2019, versus 23% in the same period of 2018).

Kokalari describes the Vietnamese economy as being in a ‘goldilocks’ situation, with GDP growth at c 7% being strong enough to propel earnings but without putting pressure on inflation, which remains very benign at c 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 c 10% for Q319, as a clear effect of companies relocating production from China to Vietnam to circumvent the 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 c $73bn, the equivalent of four months’ exports. The economist adds that the Vietnamese dong (VND) has decoupled from the Chinese renminbi (RMB) and barely reacted to the RMB declining to the psychologically significant level of RMB7/US$ in September. Looking ahead, Kokalari says 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 c 3–3.5% in the near term, it should return to c 2.5% as the epidemic subsides, and with GDP growth forecast at a slightly lower but still robust c 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 says 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 adds 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.

Although the pace of new private investments has been slower in recent years – only two new private investments were made during FY19, in a regional hospital operator and a real estate developer – VOF has a healthy deal pipeline, having recently announced a $17m investment into leading plastic packaging group Ngoc Nghia (see Current positioning), and with three more deals totalling c $70m close to completion. Ho explains the strong performance of listed companies in recent years has encouraged private deal sponsors to put higher valuations on their companies, which means VOF must be satisfied it can still achieve its target returns at a higher entry price. VOF seeks companies with strong market positions in industries that are not fragmented. The first of the deals that are expected to complete in the coming months is a $30m investment (for c 30% of the company) in a leading steel structure fabricator, supplying structures for use in factories (where the pace of building is expected to increase as more manufacturers move their production from China to Vietnam), as well as sports stadiums and subway systems. A planned $26.5m (c 30% of the company) is targeted at another regional healthcare operator that, in addition to its two existing investments in the sector, would give VOF a platform covering northern, central and southern Vietnam. The third deal is a planned $20m (c 15% of the company) in a leading convention centre operator. Ho says all the deals are very much focused on providing growth capital to allow these companies to expand and cement their strong competitive positions.

In recognition of Vietnam’s favourable economic prospects, Ho notes that Fitch Ratings upgraded Vietnam’s rating outlook from ‘stable’ to ‘positive’ in May 2019, with an accompanying statement that Vietnam has demonstrated an improving track record of economic management, strengthening its buffers against external issues through persistent current account surpluses, falling government debt levels, high economic growth rates and stable inflation.

VOF’s portfolio is constructed using a bottom-up approach, with the manager 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 notes 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.

The manager continues to focus his efforts on unlisted and private equity investments. Historically, this is where VOF has generated superior returns, although many of VOF’s more recent private equity investments have quickly become listed equities, which has inflated this segment’s returns. Private equity comprises off-market investments in tightly held businesses, which VOF typically holds for around four years as a strategic partner. The manager expects VOF’s exposure to this category to rise to c 20% over the medium term. Unlisted equity investments are holdings in companies that are progressing towards listing on a main exchange – to meet the conditions for listing, a company must allot sufficient shares to have at least 100 shareholders, then list within six months on Vietnam’s Unlisted Public Company Market (UPCoM). Valuations often move to a substantial premium upon listing on UPCoM, as well as on a subsequent main exchange listing, but the manager stresses it is a company’s fundamental prospects that drive VOF’s investments, not potential IPO upside.

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 (IRR) 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 says 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.

VOF’s portfolio comprises three main asset classes – listed equity, unlisted equity and private equity (see Exhibit 3). The predominant focus is on privately negotiated, off-market investments, but the manager highlights that, more recently, due to favourable market conditions, companies have tended to list quite soon after VOF has invested, thus increasing the proportion of portfolio holdings in the listed equity segment. In line with its strategy to reduce direct real estate exposure, VOF sold its last major real estate project, Green Park Estate, in November 2018, although operating assets still fall into this category.

Over the year to end-November 2019, listed equity exposure declined markedly, but remains by far the largest asset class represented in the portfolio. Unlisted equity exposure also declined over the year to 16.0%, while private equity exposure increased to 13.5%, including the $17m investment into packaging firm Ngoc Nghia. Net cash increased from 1.5% to 10.3% of NAV over the year to end-November 2019, in anticipation of the closing of several private equity deals. Overall, the portfolio is well diversified by sector, with exposures reflecting the manager’s focus on domestic segments of the economy that are expected to benefit from Vietnam’s continuing urbanisation and economic development, notably consumption, construction, infrastructure, real estate, financials and healthcare.

The new investment in Ngoc Nghia ties in with the consumption theme. Ngoc Nghia is one of Vietnam’s largest makers of recyclable PET plastic packaging and supplies plastic bottles to companies including Coca-Cola, PepsiCo and Unilever. Ho comments that Ngoc Nghia has invested in advanced manufacturing equipment and has a strong commitment to research and development focused on minimising environmental impact. As part of the deal, VinaCapital now has two seats on Ngoc Nghia’s board, meaning it can help to shape both the company’s strategic direction and its progress on environmental issues.

As illustrated in Exhibit 5, VOF’s sterling NAV and share price total returns have lagged the VN Index return over one year to end-November 2019. VOF’s NAV declined by 0.7% during the first quarter of calendar year 2019, while the VN Index bounced by 7.6%, and this difference largely accounts for VOF’s weaker relative NAV performance over one year, as well as three and five years. The left-hand chart in Exhibit 5 serves to highlight the volatility of the VN Index compared to VOF’s more stable return profile – reflecting the fund’s orientation towards private investments, as well as the manager’s bottom-up approach to portfolio construction – which gives VOF clearly differentiated company and sector exposures from the benchmark. 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 FY19 (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 (-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 c $400m to c $3bn. It is a leading steelmaker in Vietnam, with c 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 says 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.

The board has taken a number of actions since 2016 to support a narrowing of VOF’s share price discount to NAV: publishing daily NAVs (from 5 November 2019), redomiciling the fund from the Cayman Islands to Guernsey; moving the listing from AIM to the LSE’s Main Market; transferring asset management to a regulated entity to make VOF’s shares eligible for UCITS fund investment; and reducing management and incentive fees. Additionally, VOF’s shares entered the FTSE All-Share Index in June 2016 and the FTSE 250 Index in March 2018, supporting improved liquidity. There is also an ongoing share buyback programme.

As illustrated in Exhibit 8, VOF’s share price discount to NAV has moved in a c 10% to 25% range over the last three years and has generally been less volatile since late 2016. After briefly widening to 25.6% in October 2018, the discount has narrowed to 13.8% at 18 December 2019, which is somewhat wider than its narrowest point in 12 months (10.9% in September 2019), but lower than its 15.2%, 17.9%, 19.9% and 24.9% averages over one, three, five and 10 years, respectively.

As at 18 December 2019, VOF had 183.2m ordinary shares in issue, with a further 16.2m shares held in treasury. Under its share buyback programme, VOF repurchased 6.6m shares in FY18 (3.3% of shares in issue) and 9.2m in FY19 (4.4% of shares in issue) at a cost of £30.6m (see Exhibit 1), with a further 1.5m shares bought back so far in FY20 at a cost of £4.2m. Gearing up to 10% of total assets is permitted but VOF has no corporate level borrowings, although some underlying investments use leverage.

In July 2018, a new tiered management fee structure replaced the previous 1.50% annual fee rate. Annual management fees charged on net assets are: 1.50% up to $500m, 1.25% up to $1.0bn, 1.00% up to $1.5bn, 0.75% up to $2.0bn and 0.50% thereafter. At the same time, the incentive fee was reduced from 15.0% to 12.5% of any increase in NAV above 8% per year, capped at 1.5% of average net assets for each financial year. Excess fees are carried forward but can be clawed back if NAV declines after the year end. The investment manager is required to use 25% of any incentive fee paid to buy VOF shares via open market purchases, subject to a minimum holding period.

The board expects the new fee structure to reduce costs significantly while maintaining a strong incentive for the manager to deliver superior returns, with fees reflecting the resources employed to manage VOF’s mainly privately sourced investment portfolio. Ongoing charges were 1.7% in FY19, 1.8% in FY18 and 1.9% in FY17 (charges including performance fees were 2.2%, 3.9% and 4.6%, respectively).

Shareholders voted decisively against VOF’s discontinuation at the December 2018 AGM.

VOF started to pay dividends in 2017, with the board intending to declare semi-annual dividends, each equivalent to c 1% of VOF’s prevailing NAV per share. Two dividends of 4.8 cents per share were declared in relation to FY17, with the 9.6c total dividend equating to c 2% of VOF’s year-end (30 June 2017) NAV per share. In respect of FY18, two dividends of 5.5c were paid in April and November 2018; the 11.0c FY18 total dividend was 14.6% higher than the prior year, principally reflecting VOF’s strong NAV growth in the first half of the financial year. The 4.25p sterling value of the second FY18 dividend was c 9% higher than the 3.90p first dividend payment, due to a decline in sterling versus the US dollar (from c $1.41 to c $1.29). In April 2019, VOF paid a 5.5c per share first interim dividend for FY19, with a sterling value of 4.22p, and a further 5.5c dividend was paid on 27 November, with a sterling value of 4.26p. This makes a total of 8.48p for FY19, a 4% increase on the sterling value of FY18 dividends, although in US dollar terms the dividend was unchanged. The FY19 total dividend (in sterling) represents a 2.6% yield on the current share price.

Exhibit 9 shows a comparison of funds in the AIC Country Specialist: Asia Pacific – ex Japan sector with market caps over £60m. The peer group includes two other Vietnam specialist funds, which are considered to provide a more relevant subgroup for comparison, as variations across the wider group largely reflect the different performances of stock markets across the Asia Pacific region. VOF’s NAV total return is ahead of the peer group average over three, five and 10 years, and it is second of the three Vietnam funds over one, three, five and 10 years.

VOF’s share price discount to NAV is wider than the peer group average. Its 1.7% FY19 ongoing charge is marginally above the broader peer group average and it is among the minority of funds that charge a performance fee. However, its charges appear competitive within the Vietnam subgroup of funds, and a lower tiered management fee and reduced performance fee structure have been in effect since 1 July 2018. Similar to five of its peers, VOF has no corporate-level gearing. VOF is distinguished from its Vietnam-focused peers in paying a dividend, and its 2.6% yield ranks third highest of the five dividend-paying funds in the wider peer group.

VOF’s board was enlarged to five directors in July 2018, with the appointment of Julian Healy. This is considered an appropriate number for a company of VOF’s size. Fees paid to individual directors were not increased, but the additional director took VOF close to its aggregate board remuneration cap, requiring shareholders to approve an increase in the cap from $0.50m to $0.65m at the December 2018 AGM. Martin Adams retired from the board at the December 2018 AGM, after more than five years’ service, and Kathryn Matthews joined the board in May 2019. She has 36 years’ financial services experience, holding positions including CIO Asia Pacific ex-Japan at Fidelity International based in Hong Kong and head of portfolio strategies group and global equities team at Fidelity Investments in the UK, also spending 16 years at Baring Asset Management. The other directors are Steven Bates (appointed in February 2013), who has served as chairman since May 2013, Thuy Bich Dam (appointed in March 2014) and Huw Evans (appointed in May 2016).