VinaCapital Vietnam Opportunity Fund — Vietnam carves its own post-COVID niche

Vietnam’s economy took a hit in 2021 as the COVID-19 Delta variant swept through the country, leading to harsh lockdown measures. Having emerged broadly unscathed (apart from the impact on international tourism) in the first wave of the pandemic, GDP growth had been forecast to reach 6.7% last year, but came in well below this at 2.6%, hampered by a large decline in consumer spending. However, the success of Vietnam’s COVID-19 vaccine roll-out (with more than 95% of the population over the age of 12 fully vaccinated as of early March 2022), coupled with the ready availability of antiviral medicines, means the country is well positioned to bounce back in the coming years. The International Monetary Fund (IMF) forecasts annual GDP growth of between 6.0% and 7.2% for Vietnam in the six years to 2027, and VinaCapital’s chief economist, Michael Kokalari, is cautiously optimistic, predicting 6.5–7.0% growth in 2022, in line with the 7.0% average of the five years pre-pandemic and consistent with the government target for this year. He says that while he is less confident on the manufacturing outlook – exports of ‘stay at home’ products such as computers and home office furniture were very strong in 2020 and 2021, but are likely to be constrained by an inflationary squeeze on disposable incomes in the West – the prospects for a recovery in domestic consumer spending are huge. Added to this, while Vietnam’s fiscal response to the pandemic has been relatively muted versus the averages in both developed and emerging economies, the government has recently approved a further c 4% of GDP to be spent largely on infrastructure projects, which should benefit both the public and the business sector. Even foreign tourism – which has been entirely absent for almost two years – is expected to stage a comeback in the second half of 2022, with the borders reopened as of March and visa requirements suspended for nationals of 13 countries, including the UK. While tourism makes up a relatively small part of Vietnam’s total economy – pre-pandemic it accounted directly for c 8% of GDP and c 10% of retail sales – its return will provide a further welcome boost.

Foreigners have been absent not just from Vietnam’s beaches and cultural attractions, but also from its stock market. Overseas investors were net sellers of Vietnamese equities in both 2020 and 2021, although domestic participants have enthusiastically taken up the slack, opening hundreds of thousands of new brokerage accounts during the pandemic. This has helped fuel the strong gains in the main VN Index – up 15.2% and 37.3% in 2020 and 2021, respectively, in US dollars, making it the best performer in the ASEAN region in both years. However, while foreign portfolio investment has been lacking, foreign direct investment (FDI) has remained robust – down only 2% year-on-year in 2020 and 1% in 2021, with $19.7bn disbursed during the calendar year, compared with double-digit declines globally. Vietnam’s stable government, high-quality workforce and low wage costs (c 60% below China’s, on average) continue to attract businesses keen to set up manufacturing bases there, including Lego’s first fully carbon-neutral factory, announced in December.

All this adds up to a very positive outlook for the economy and market, according to Kokalari and VinaCapital’s head of research, Ismael Pili (see next section).

While many commentators expect emerging and frontier markets to underperform in 2022 – given the headwind of rising US interest rates, which has historically signalled a stronger dollar – Kokalari and Pili, alongside lead fund manager Andy Ho, believe Vietnam can buck this trend. They point to the country’s robust foreign exchange reserves (c 10% above the minimum recommended by the IMF) and favourable trade position. Although the trade surplus shrank last year, this was largely as a result of imports of components outweighing exports of finished goods, so inventories are high and, even with low or no export growth, the stage is set for the surplus to bounce back. Furthermore, Kokalari questions the whole narrative of impending dollar strength, arguing that the US economy is much weaker than generally assumed, which could leave it vulnerable to over-tightening by the central bank. Vietnam, meanwhile, is one of the few countries in the world with positive real interest rates: the central bank base rate is c 4% while CPI inflation is c 2%.

While still relatively high, declining rates available on cash deposits are among the factors driving domestic investors towards listed equities. Pili adds that private equity investment is not readily accessible to the domestic retail market. The high level of domestic inflows has boosted market liquidity in Vietnam, which now stands at almost $1bn daily, higher than any of the regional peers except Thailand, with domestic investors accounting for 94% of trading activity in 2021 (89% retail and 5% institutional). Domestic investors opened c 1.5m new brokerage accounts during 2021, meaning there are now more than 4m trading accounts among a total population of c 100m people. While he is a little more cautious on the outlook for the year ahead, Pili points out that consensus expectations for further solid gains in the VN index are well supported by earnings growth expectations of 26% for the market as a whole and more than 35% for VOF’s listed portfolio companies. In addition, as shown in Exhibit 1, the average forward P/E multiple of 12.6x is the lowest in any of the ASEAN markets, and is 8pp below the 10-year average despite two years of double-digit stock market gains. ‘We expect greater volatility, but Vietnam remains a fundamentally attractive market, with a favourable macro backdrop, strong earnings growth and attractive valuations’, he concludes.

The Russian invasion of Ukraine in late February – in addition to having a heavy human cost – could further dampen investor sentiment, particularly towards countries that are net importers of energy. Vietnam is largely self-sufficient in oil, natural gas and coal, but does spend c 1% of GDP on energy imports. VOF’s managers point out that while Russia and Vietnam – which share a communist philosophy – have a legacy of strong relations, there is little direct economic linkage between the two countries, with imports from and exports to Russia each making up less than 1% of total trade, while Russian tourists accounted for less than 4% of pre-COVID-19 arrivals. None of VOF’s investee companies is reliant on economic links or trade with Russia.

Furthermore, Vietnam remains relatively insulated from volatility in the Chinese economy and markets, and in fact is benefiting from an increased pace of manufacturing being ‘reshored’ from China to Vietnam, given Vietnam’s more pragmatic approach to dealing with COVID-19.

VOF’s portfolio is concentrated, with the top 10 public equity holdings (Exhibit 2) effectively accounting for the whole of the 65.6% listed equity allocation (Exhibit 4). Public equity holdings often start in the private portfolio; two relatively recent market debutantes among the top 10 holdings are An Cuong Wood Working (currently on the UPCoM segment and therefore technically classified as ‘unlisted equity’, as are Airports Corporation of Vietnam and Quang Ngai Sugar) and Orient Commercial Bank, which listed on the Ho Chi Minh City stock exchange in January 2021. While steelmaker Hoa Phat Group (HPG) remains the largest holding (12.9% at end-March 2022) compared with a year ago, and contributed c 10% of VOF’s 2021 returns, its weighting has been cut by 6pp as the managers seek to focus their efforts elsewhere, in areas such as financials, real estate and consumer stocks.

As well as reducing HPG, the team has made a complete exit from Vinamilk (a former top holding) in consumer staples. ‘It is still a very good company, but it has reached a level of maturity in terms of earnings growth at which it is probably better in other people’s portfolios’, portfolio manager Khanh Vu explains. ‘Over 14 years of investing in Vinamilk we have made a 5x multiple on invested capital, so it has been a very good investment, but it is about being disciplined in the face of lower growth expectations.’ The team has instead been seeking opportunities in the consumer discretionary space as Vietnam moves towards a strategy of ‘living with COVID’.

Ho says the key sector calls for the year ahead are banks (the majority of VOF’s financials exposure) and real estate, where VinaCapital forecasts year-on-year net profits growth at 30% and 25% respectively. Among banks (the VOF team prefers commercial banks to state-owned names), the key drivers of performance are expected to be higher margins, higher fees and lower credit costs. Asset quality is the foremost risk, given households and businesses have been affected by COVID lockdowns. Also, given that banks have a beta (sensitivity to market movements) of 1.2, the managers caution that share prices could suffer in a period of market correction, even though fundamentals remain sound. The call on real estate covers both commercial and residential property, with commercial landlords such as mall operators expected to reap the rewards of a return to in-person spending, while housebuilders are set to benefit from continued strong demand and an increase in domestic rents. Unlike banks, real estate has a beta of less than 1 (0.89) and could therefore be relatively insulated from near-term market volatility, according to the VOF team.

As Vietnam’s economy develops, the team sees a wider range of areas from which to benefit: not just consumer spending, infrastructure investment and FDI-supported manufacturing growth, but increasingly ‘21st century’ themes such as digitisation and environmental initiatives. The managers point out that the harsh COVID-19 lockdowns in the third quarter of 2021 led to a much greater use of e-commerce, home delivery and mobile payments services, not just among the young but across the age spectrum. Although consumer discretionary stocks remain a small – if overweight – part of VOF’s portfolio for now (5.0% compared with c 3.4% of the VN Index), the VOF team argues that the sector has much to offer in terms of earnings growth in 2022 and 2023, further lockdowns notwithstanding.

VOF’s NAV total return beat the VN Index total return (in sterling) in each of the last two calendar years, both of which saw strong performance by the market. However, in 2021 and moving into 2022 (12-month figures to 31 March are shown in Exhibit 5), its share price has failed to match the index gain, with discounts to NAV widening across the peer group (see Exhibit 9). We would argue that having produced NAV and share price total returns of c 15% pa or more over three, five and 10 years (Exhibit 6, right-hand chart), the persistent double-digit discount to NAV remains unwarranted.

During calendar 2021, VOF’s top three sector positions (accounting for c 70% of the portfolio) were the key contributors to performance, with the real estate holdings up 42.4%, financials returning 63.1% and materials up 46.0% (all in US dollar terms). In H122, the picture was a little more mixed: while real estate continued to perform well, with a return of 15.7% in the six months to 31 December 2021, the financials and materials holdings returned just 4.0% and 0.3% respectively. The best performing sectors for the portfolio over the period were industrials (+24.5%) and consumer staples (+18.6%). The two largest public equity positions, steelmaker HPG and housebuilder Khang Dien House (KDH), were also the two biggest individual contributors to VOF’s returns in calendar 2021, although again there was a divergence in H122 (July to December), with HPG down by 7.4% as higher input prices weighed on margins, while KDH rose by 37.5%.

As shown in Exhibit 7, VOF has outperformed the benchmark VN Index over the long term (and significantly so in share price terms, given a very wide discount to NAV at the start of the 10-year period; see Exhibit 11). While the picture over shorter periods has been more mixed versus the benchmark, performance versus the broader Asia ex-Japan Index has been extremely strong, and even compared with the US-heavy MSCI World Index, VOF has outperformed over almost all the periods shown. In the last quarter of 2021, a surge in the VN Index hurt VOF’s relative returns (Exhibit 8), although the fund outperformed the benchmark in December as concerns over the Omicron variant of COVID-19 and the more hawkish tone of the US Federal Reserve weighed on listed equities. In 2022 to date, VOF’s NAV total return has outperformed the index, perhaps partly owing to the stabilising effect of private investment in more volatile equity market conditions.

Following a reorganisation of AIC sectors in 2021, which saw China and India-focused funds move to their own peer groups, VOF is one of five funds in the Country Specialist sector, which features the two other Vietnam-focused funds as well as specialists in Russia and Korea. Given the recent suspension of trading in many Russian stocks following the invasion of Ukraine and the consequent difficulty of assigning any value to them, we have temporarily excluded JPMorgan Russian Securities from the table in Exhibit 9. VOF is the second largest fund by market cap both in the sector as a whole and in the Vietnam subgroup. In performance terms, it is most instructive to look at VOF versus its direct peers – Vietnam Enterprise Investments (VEIL) and Vietnam Holding (VNH). Over the year to 31 March 2022, VOF’s 36.4% NAV total return was broadly in line with VEIL (+37.9%), but well behind VNH (+59.2%). In a second year of strong performance for listed companies in Vietnam, VOF’s private equity holdings (c 20% of the portfolio) may have held back its returns versus the other two funds, both of which are focused on public markets. VNH in particular performed strongly after rebalancing its portfolio away from banks and construction and towards smaller and mid-cap stocks in the second half of 2021. VOF also ranks third of the three funds for NAV total return performance over three, five and 10 years, but in all cases has produced strong absolute returns that are ahead of the non-Vietnam peers in the sector.

VOF has the lowest ongoing charges in the peer group, although it is the only fund to have a performance fee structure, meaning total fees in FY21 were higher than those of its peers. It is also the only one of the three Vietnam funds to pay a dividend. There is very little gearing deployed in the sector as a whole (JPMorgan Russian Securities had some at 28 February but none by 31 March), and none at all among the Vietnam funds. Following a sell-off in many areas of global equity markets since the turn of the year, compounded by the war in Ukraine, discounts to NAV have increased for all three Vietnam specialists in 2022 to date, with VOF’s and VNH’s widening by c 4-6pp versus c 3pp for VEIL.

Since 2017, VOF has paid semi-annual dividends, reflecting the board’s view that such payouts are an efficient way (alongside share buybacks) of returning capital to shareholders while the shares continue to trade at a discount to NAV, as well as providing greater appeal to potential investors and ensuring the investment managers remain focused on high-return investment opportunities. The intention is for the dividends each to represent c 1% of VOF’s prevailing US$ NAV per share, although payouts had been held at 5.5c per share during FY19 and FY20 (both years that saw VOF’s NAV decline) to avoid a cut in absolute terms. As performance rebounded in FY21, dividends also increased, with 6.0c paid for H121 and 8.0c for H221 (an increase of 27% in the total dividend compared with FY20). Dividend income from portfolio holdings grew to $20.4m (c 12c per VOF share), a 21.4% increase on the $16.8m (c 9.5c per share) received in FY20. For H122, a first interim dividend of 8.0c has been declared, unchanged on H221, with underlying portfolio dividend income of $6.2m or c 3.7c per share. In the FY21 annual results, VOF’s outgoing chairman of the board, Steve Bates, commented: ‘As the Vietnamese market matures, so we expect the income account of the fund to become more predictable and to show growth which reflects the underlying earnings growth of the businesses in which we invest.’ However, the new chairman, Huw Evans, added in the H122 report: ‘Given the current global uncertainties, the Board has decided not to increase the dividend at this stage but will review the dividend again once the results for the full year are known.’

Dividends are paid in April/May and November. Investors can receive their dividends in sterling (Exhibit 10), at an exchange rate set around 10 days before the payment is made. Because of FX volatility, the sterling value of the dividends can fluctuate, with the 11c total dividends in FY18, FY19 and FY20 translating to 8.15p, 8.48p and 8.61p respectively. FY21’s total dividend in sterling amounted to 10.2p (4.3p in H121 and 5.9p in H221), while based on the FX rate at the time of declaration (24 March 2022), the H122 dividend of 8.0c is equivalent to 6.07p. Based on the current share price and the H221 and H122 sterling dividends, VOF has a dividend yield of 2.4%.

VOF’s current 18.2% discount to cum-income NAV (Exhibit 11) is somewhat wider than the short- and medium-term averages (17.9%, 16.8% and 17.4% respectively over one, three and five years), possibly reflecting less favourable sentiment towards emerging markets and increased market volatility in the wake of the Russian invasion of Ukraine. The board operates an active share buyback policy and during FY21 repurchased 7.7m shares (FY20: 8.7m) at a cost of £28.2m, adding 14c to the US$ NAV per share. In H122, 2.8m shares (c 1.5% of the share base) were repurchased, adding a further c 4.0c to NAV per share. So far in H222, an additional 1.4m shares (c 0.9% of the share base) have been bought back. The total cost of repurchases in FY22 to date is £20.0m (Exhibit 12).

VOF, launched in 2003, is one of the largest and longest-established specialist Vietnam-focused investment companies. Listed on the London Stock Exchange, it is included in both the main broad UK stock market index and the mid-cap index of the 250 next-largest companies outside the top 100, which aids visibility and liquidity of the shares given buying by index-tracking funds. Rather than replicating the Vietnamese stock market index (which investors could access cheaply by buying an exchange-traded fund or similar), VOF seeks to add value through an actively managed approach, investing in both public and private companies, primarily via privately sourced deals, with the aim of taking advantage of market inefficiencies. The fund’s diversified portfolio provides 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, real estate and financials.

VOF’s lead portfolio manager is VinaCapital’s chief investment officer Andy Ho, who has been managing the fund for 14 years. He is supported by two long-serving deputy managing directors: co-manager Khanh Vu, who has been with the fund for 10 years, and Dieu Phuong Nguyen, who has been with the fund for 15 years and leads the private equity investments. They are supported by a deep bench of almost a dozen private equity investment professionals, as well as VinaCapital’s chief economist Michael Kokalari, and a large research team led by Ismael Pili.

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. The fund 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. As the public equity market in Vietnam develops further, private companies may seek to list on an exchange earlier in their journey than may previously have been the case. Because of this, VOF’s managers are increasingly also seeking terms on private equity deals that offer a degree of downside protection when a company lists.

Thanks in part to the way it structures its private equity investments, but also reflecting a growing dividend culture among listed Vietnamese companies, VOF is the only one of its three-strong UK-listed peer group to pay a dividend and currently yields 2.4%.

VOF’s portfolio construction is based on a research-intensive, bottom-up investment process. Vietnam’s equity market is not well covered by sell-side research, so the vast majority of the analysis used in the selection of both public and private equity investments is the proprietary output of the in-house investment and research team, although external resources may be used for analysis of environmental, social and governance (ESG) factors. The portfolio is built on a three- to five-year view, with the manager selecting investments that he believes present the greatest value opportunities from a range of industry sectors and asset classes. Ho favours a concentrated portfolio and makes investments into companies and sectors without reference to index weightings; together with its private equity-like approach, this differentiates VOF from other, more index-oriented funds. Prospective investments are subject to detailed analysis to identify the best risk-adjusted returns, and the manager prefers to invest where the team can influence the strategic direction of a business. The fund’s listed holdings are typically sizeable minority stakes, which can often be divested at a premium to the market price in cases where a strategic investor is seeking to acquire a controlling stake.

Private deal sourcing lies at the heart of VOF’s investment approach, with unlisted and private equity investments having historically generated the portfolio’s best returns. Private equity (currently 19.1% of the portfolio including a private credit investment structured as a bond) comprises off-market investments in tightly held businesses, which VOF typically holds for around four years as a strategic partner. Unlisted equity investments (13.6% of the portfolio at end-February 2022) 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 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. ESG analysis thus forms an important part of the research process (see next section), and VOF will engage with a potential investee company to ensure it tackles any ESG deficiencies, or it may walk away if there is no commitment to improve.

Thorough due diligence is performed on all new public and private positions, with potential exit routes identified and evaluated before VOF commits to an investment. For private equity investments, 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 the investment committee for final approval.

The VOF team actively addresses ESG issues using a range of approaches, drawing on codes and standards such as the United Nations-backed Principles for Responsible Investment (PRI) and the Performance Standards on Environmental and Social Sustainability produced by the International Finance Corporation, a sister organisation of the World Bank that supports the development of financial markets in less economically developed countries.

In common with many investors, VOF’s managers see ESG risk as an investment risk, having observed ‘situations in which shareholder value declined significantly when businesses polluted the environment, ignored global standards, relocated families from land without paying adequate compensation, or did not adhere to international best practices with respect to corporate governance’. To mitigate such risks, it incorporates ESG assessment and engagement into both its private and public equity investment decisions.

Detailed due diligence on private investment opportunities may uncover ESG weaknesses relative to local and international standards. VOF’s managers say a company’s willingness to engage with their recommendations to improve ESG practices is a key influence on whether to invest; a motivation to change and a ‘clear roadmap for improvement’ can create significant value in a business, resulting in a better investment outcome for VOF.

For listed equities, the research team has developed an ESG grading system which assesses each company based on more than 120 questions. This allows the team not only to gauge the current ESG ‘quality’ of the portfolio, but also to set a benchmark for where they would like to see it in one to two years’ time, which can then drive engagement with investee companies to encourage ESG improvements. Where such engagement is unsuccessful, VOF’s managers may exit positions that score poorly on ESG measures.

VOF’s full ESG policy is available on the VinaCapital website.

Gearing is permitted up to 10% of net assets. However, until recently, VOF had no corporate-level borrowing, having deemed the cost prohibitive given the borrowing rates on offer. As Vietnam’s equity market has matured, the potential cost of borrowing has come down, and VOF has recently entered into a $40m three-year secured revolving credit facility (renewable annually) with Standard Chartered Bank, representing potential gearing of c 3% of NAV. The gearing has been agreed on ‘attractive commercial terms’ and provides the managers with a source of short-term liquidity that can be used to help manage the timing of investments and divestments, particularly in the private equity space.

VOF’s management fee is paid at a tiered rate of 1.50% of net assets up to $500m, 1.25% from $500m to $1.0bn, 1.00% from $1.0bn to $1.5bn, 0.75% from $1.5bn to $2.0bn and 0.50% above $2.0bn. Prior to the start of FY19 it was charged at a flat rate of 1.50%. The incentive fee structure was also revamped at the same time, reducing to 12.5% from 15.0% of any increase in NAV above 8% per year, capped at 1.5% of average net assets. 25% of any incentive fee paid to the manager is used to purchase VOF shares in the market, thereby ensuring that there is alignment of interest between the manager and shareholders, and excess fees above the cap are carried forward but can be clawed back if the NAV declines in a subsequent year. The strong performance in FY21 led to the accrual of $74.8m in incentive fees, with $16.6m being paid out to the manager and $58.4m deferred for potential future payment (accounted at $48.8m to reflect the time value of money). A further $12.9m in incentive fees was accrued during H122. Ongoing charges for FY21 were 1.66%, broadly the same as in FY20, although payment of the incentive fee raises the total fees to 3.06% (given the 1.50% cap) in respect of FY21.

VOF is a Guernsey-domiciled, closed-end investment company with one class of share. At 21 April 2022, it had 164.2m ordinary shares in issue, with a further 16.2m held in treasury. There is a discontinuation vote every five years, with the next due in 2023. As shown in Exhibit 13, VOF’s major shareholders include discount-focused institutions (City of London, Lazard, Wells Fargo), mainstream asset managers (Janus Henderson, UBS) and retail investor platforms (Hargreaves Lansdown, Interactive Investor). Trading liquidity (Exhibit 14) is comparable with the two Vietnam-focused peers; on average 277,800 VOF shares (0.17% of the share base) changed hands daily in the 12 months to 21 April 2022, compared with an average of c 0.20% of the share base for the three funds in aggregate.

Steve Bates, VOF’s chairman since May 2013, retired from the board at the December 2021 AGM. At end-FY21 he held 25,000 shares in the company. Peter Hames was appointed to the board in June 2021. A former fund manager, he helped set up Aberdeen Asset Management Asia in 1992 and remained there (based in Singapore) until 2010. He is also a director of MMIP Investment Management, an independent member of the operating board of Genesis Investment Management and a director of the open-ended Genesis Emerging Markets Investment Company. Hames has experience as a non-executive director of closed-end funds, having previously served on the boards of Polar Capital Technology Trust and Syncona.