Vietnam's Market Emerging Again With Vietnam Opportunity Fund's Andy Ho

Vietnam’s stock market has been among the world’s leaders year-to-date. Historically, the VinaCapital Vietnam Opportunity Fund is always among the best performing funds over any intermediate length of time. VinaCapital’s Chief Investment Officer provides the firm’s market insights in this interview. Prior to working at VinaCapital, Andy Ho held positions as Director of Investment at Prudential Vietnam, with the investment arm of Dell Computers, and at Ernst and Young. Mr. Ho is also engaged in private equity transactions in Vietnam. He has completed deals in excess of $700 million in Vietnam when he is not managing VinaCapital’s public equity portfolio.

Jon Springer: The Vietnam Stock Exchange Index (VNI) is up over 10% year to date. What are the factors currently driving the market?

Andy Ho: In January the VNI increased by 10.3%. Year to date [as of Feb 20, 2014] the VNI increased 13.1% [to 571] and trades at a trailing PE of 14.2 times. The extraordinary level of foreign net inflow has been the key driver, with ETF’s being the main channel. Year to date foreign net inflow has been US $108m.

Those are the direct factors. Indirectly, we can look at a number of factors that make Vietnam an attractive destination at the moment. A lot of it has to do with an economic environment that is quite stable measured in terms of inflation, currency in terms of the U.S. dollar and political stability.

This stability has been going on for 24 to 36 months now. I think it has reared its head as a major point because there is a lot of instability in various countries around the world. When QE3 tapering was just a rumor in late 2013, we saw a lot of emerging economies' currency devalue significantly against the U.S. dollar which created a perception of instability around emerging markets but at the same time Vietnam showed a very stable currency that didn't lose any value. Thus, over the last six months people began to realize there is a lot of uncertainty and volatility in emerging markets around the world yet they have to put some money to work in emerging markets. Vietnam has basically shined above other emerging markets in terms of economic and political stability which has attracted a lot of investors to look at Vietnam.

Further to that, there has been a tremendous of sticky money - FDI, foreign direct investment - coming into Vietnam. The reason we call it sticky is because it doesn't leave on the whims of people discussing QE3 tapering or other news related volatility. This is money that is invested for the long term. This comes from folks like Samsung opening up their factories in Vietnam. Samsung is producing about 25% of their smartphones worldwide in Vietnam now and pushing toward 40% in the next 12 to 18 months. There are a lot of FDI investments like this coming into Vietnam now. The commitment was well above $20 billion in 2013. This has led to a lot of positive news for Vietnam.

What this has led to is FII, foreign indirect investment, coming on a net basis over $100 million year to date in 2014.

If you look further, about 2 or 3 months ago the price to earnings [PE] ratio was very inexpensive. The market was 15% lower 2 or 3 months ago. So PE valuation now is in line with regional markets at 14 to 14.5. Before the run-up we were trading around 12 times. Now the argument is we're in line, can we do better? I think we can do better if we show good earnings growth and Vietnam continues to have good political and economic stability.

At this level of PE ratio, we are at a similar level to Thailand which is going through a lot of turmoil. In theory we should be trading at a premium valuation to Thailand based on their current issues. The market will dictate this over the next 3 to 6 months.

Springer: You don't feel the new laws that allow more foreign ownership of companies is impacting the stock exchange valuations?

Ho: I think it is more a perception. The move from a 49% cap to a 60% cap is not going to effect a lot of companies to be honest. The key companies that are trading at the limit already such as VinaMilk are mainly owned by state owned enterprises [SOEs] that have come out and said they are not interested in selling. If they are not selling, how can the foreigners buy more? I think it is good news for the stock market in the medium to longer run that the foreign ownership limit is expanded from 49% to 60%. But, in the immediate future, it is unclear how investors like ourselves will benefit.

Springer: With markets from China to the United States facing some headwinds, are Vietnam's markets impacted by those headwinds?

Ho: Sure. Domestic and international investors should be sensitive to these headwinds, especially as the market of the VNI has increased over 13%. I think there will be a lot of people taking profit at this level. Vietnam is an international player and any such headwind like those faced by China will certainly impact Vietnam. We encourage domestic and international investors to be sensitive to that.

If interest rates go up in the United States, more people will keep money in the U.S. and buy U.S. Treasuries or put it in U.S. deposits and be less likely to take risk. That certainly takes more money away from emerging markets such as Vietnam. China slowing down could potentially mean there will be less exports from Vietnam to China. China is a huge trade partner and if China slows down that means less demand for Vietnamese goods.

On the other hand, I think there are a lot of international investors looking for emerging market risk and finding that they have few choices; and thus Vietnam becomes even more interesting. At the moment, one can see that there is political turmoil in all parts of the world from South America (Venezuela) to Eastern Europe (Ukraine and Turkey) to Southeast Asia (Thailand). And in addition, there has been a lot of currency volatility in the emerging economies. Vietnam, with a stable Vietnamese Dong against the U.S. dollar and no political unrest coupled with a steady and growing GDP and a large population becomes awfully interesting at this time.

Springer: In my research of investment fund options in Vietnam, your flagship VinaCapital Vietnam Opportunity Fund [VOF] with almost $800 million in assets is always among the top 3 performing Vietnam funds over any time period greater than 9 months. Currently in the near term, the Opportunity Fund is lagging the VNI and Van Eck’s Vietnam ETF. What do you think is causing the Opportunity Fund to lag the index?

Ho: VOF is a unique fund that offers a diversified set of asset classes in Vietnam. No other fund offers a risk and return profile of this size for Vietnam. VOF is diversified and has other asset classes such as real estate and hotels. Therefore, when the capital market does well, a little over 50% of VOF’s portfolio will do well, not 100%, as it is only 52% in public equities.

The size of VOF means that it has scale and, among our peers, the highest level of market liquidity for its shares in London allowing investors to enter and exit easily. According to Rothschild, 80% of trades in Vietnam funds are attributed to VOF.

Also, our size provides access to meaningful sized deals in Vietnam and both better investment terms and minority protections.

However, as a diversified fund, when one asset class does well, another asset class may underperform. This is the nature of having a large diversified portfolio. Together, VOF can deliver a less volatile portfolio.

For other funds that only invest in the Vietnam stock exchanges, when investment picks up they may go up quickly but when selling pressure develops, they may go down quickly. Both our fund's size and our diversification from public equities gives our fund greater stability.

Springer: With the assets not publicly traded on the stock exchange such as real estate and private equity, how do you value them and how do they help your fund's performance be among the top performing Vietnam investment funds?

Ho: Over the years we have delivered on private equity investments and we have delivered on real estate investments in terms of positive returns. That is why the volatility of our entity is significantly less than our other competitors because the others are subject solely to the returns from the stock market. We measure ourselves in terms of risk-adjusted return. We believe our risk adjusted returns are more attractive than our competitors over 1, 3 and 5 years.

Our private equity holdings are not marked to market unless we have a transaction. The only reason we would not keep the company on the books at cost is if we need to impair the value of the company due to underperformance. In the past we have been able to exit these companies at 3 to 5 times cost. We have had a number of good exits: Prime which is the largest construction materials company in Vietnam that we exited at better than 3 times return, we sold our vodka business to Diageo at over 5 times return, we sold the largest private hospital system to Fortress Healthcare at almost 3 times return. The upside potential for our private equity positions is quite significant. We have proven over time that we can enter and the add value and exit these investments at an average return of 2.5 to 3 times original cost.

With hospitality and hotels, these are operating assets that generate profit and income. We are a 50% shareholder of what we think is the best hotel in Vietnam, the Sofitel Metropole in Hanoi. It's a 5-star hotel with 365 rooms where most of the diplomats stay. It has the highest occupancy and average room rate in Vietnam.

For our real estate holdings, we mark to market our real estate holdings once every six months.

Springer: Do you think the mixed nature of your fund's holdings plays a role in the discount the VinaCapital Vietnam Opportunity Fund trades at? (25% as of January 31, 2014, updated monthly.)

Ho: At the end of the day, all the Vietnam funds trade at a discount. From a macro perspective, the only thing you can conclude from that is that the supply outstrips the demand for Vietnam investment funds. And then, if you see that some funds trade at a great or lesser discount, then you may attribute it to the illiquid nature of the portfolio or other attributes particular to the funds. If you look at VOF, in theory if illiquid assets were penalized, we should trade at a much larger discount. But we're not. We are trading in comparable range with the other funds. So, are we being penalized with a bigger discount for our illiquid holdings? Maybe. Maybe not. Maybe in the sense that if we did not have the illiquid holdings we would trade at less of a discount, maybe 10%, because we are a large fund that has a good track record. I don't know the answer but I think what we can say is the supply outstrips the demand for Vietnam investments. When the demand surpasses the supply, we will see the funds again trade at a premium to the NAV.

What we are committed to doing, and a lot of the Vietnam funds do, is take the profit that we make from investments and use that for share buybacks. This effectively reduces the supply. We are doing our job to reduce the supply and we hope the market sees that Vietnam is attractive enough to increase the demand.

Springer: Some people may consider that if they invest in a fund trading at a 25% discount, and they can capture both capital markets and a diminishing discount, that would be an enhancement to their gains.

Ho: Sure. If you look at an investment trading at a 20% discount and the discount goes to zero, that's a 25% gain if the NAV stayed the same. Vietnam is creating a situation where the capital market is going up significantly, driving the value of NAV. If the fund managers are operating correctly, they should be taking profit and using that cash to buy outstanding shares thus reducing the supply and helping reduce the discount even faster.

Springer: While the average PE ratio of companies on Vietnam’s Stock Exchange is reasonable, some of the big names might be getting long in the tooth. A market commentator noted in mid-February that food conglomerate Masan Group had attained a PE ratio of 150 (based on 2013 EPS of 602 Dong). Where do your investment funds look for value and is your fund trimming any positions that seem overpriced?

Ho: The VNI is trading at around the average PE of regional peers. For PE to expand further, we need continued economic and political stability. What we would like to see is earnings growth to be strong for the first half of 2014 which would mean PE does not have to expand at the same time the stock market continues to grow.

We are not invested in Masan currently. We did invest many years ago as a private equity investment. We actually made a very healthy return. The valuation now seems a bit rich on a PE scale. I think it is an anomaly to be above 100. I think that's just considering a short period of time. That's not a realistic picture of what is going on at Masan. I figure they are trading in the mid to upper 20s in terms of PE which is still quite rich in terms of valuation.

We do see that there are a few shares listed on the stock market that seem a bit rich relative to the market average PE ratio. We tend to stay away from these investments or do take profits when the opportunity arises for investments in our portfolio that have risen significantly in value.

Springer: There has been talk that the small companies on the Vietnam Stock Exchange are quietly outperforming and offering better investment opportunities than the big names. Do you agree and are there some small cap companies you are investing in that you could discuss as examples?

Ho: There are a number of small to mid cap companies that we like and have done well recently. Unfortunately it is difficult for us to invest directly into these shares because the liquidity of these share are very low. In fact, one could argue that most stocks in the Vietnam markets have low liquidity. Because of such low liquidity, we tend to develop or acquire our position in listed companies before they list, typically as a private equity investment or participation in their equitization process.

Pretty much, about 75% of our holdings in listed equities we acquire before they list whether they are large or small. This is an emerging market. In order to take a meaningful stake we can't really buy directly on the stock market without impacting the prices.

This is why our fund has been successful. We know how to enter into these assets, we know how to enter into these companies and we tend to do it before they list. Typically the negotiation does entail minority protections such as a commitment to list, commitments to certain levels of performance and a commitment to have drag along rights in the case that they don't list that allows us to sell our position to a strategic buyer.

So there are a lot of rights we get in these companies in advance of being listed. If they list, that's great and that's what we want; and that's what we have experienced with a lot of our portfolio companies. But it also creates a situation where we don't have to go into the market and spend $15 or $20 or $30 million to buy shares in the stock market; otherwise we would drive the prices way up and when we completed our purchases the prices would come down.

Springer: Regarding the flip side of the same issue, what is your exit strategy from positions?

Ho: We have a combination of three exit strategies. One is trade sales. We have had more trade sales than anyone else in Vietnam. For examples of our range, we have sold international schools, the hospital businesses, and a construction business. Secondly, we exit large blocks of shares. We move what we call is a "veto block," roughly 25 to 35%. Investors appreciate this because they get some minority control over the business and normally are guaranteed a couple of board seats.

The third way is to sell shares slowly into the stock market. With that is the caveat that a lot of our investors buy VOF because they want exposure to Vietnam, its stock markets and the key assets of Vietnam. They want that exposure so we provide that through our holdings - the milk company, the construction material company, the oil and gas company - so we will sell down and take profit when the prices are high but will also pick up shares when the share price is low. We try to hold some of these positions steady so that our investors have the exposure they want in Vietnam.

Springer: Are you selling into this rally currently or holding steady?

Ho: We are taking a little bit of profit. We are mostly staying tight because valuations are only at the average level of the region. If we go up to an average PE of 18 or 19 times on average, and we are above the regional average, then we would be taking more profits.

Springer: The one concern people always bring up about Vietnam is concern about the banking situation and their non-performing loans (NPLs).

Ho: That's a good worry and on top of our worry list. The banks report NPLs to be about 4 to 5% while at the same time folks like Moody's think the NPLs could be as high as 15%. The worry from a number of perspectives is that: there hasn't been a substantial mechanism to alleviate these NPLs; the government has established an asset management company to buy the bad debt but unfortunately they are buying the bad debt with bonds instead of cash. The way it works for a $100 of bad debt the bank sells to the government, every year the banks have to take a $20 expense to it for 5 years. It is difficult because they take a hit every year on the P & L; and they don't have the cash to go create more loans and create velocity in the market with their cash.

The other issue is that when there is bad debt, the banks need to take more initiative to auction off the bad debt, take the write off and move on. They are not doing this from their perspective that they don't have that many NPLs, only 4 or 5%, but then there is Moody's suggesting 15%. So there is a discrepancy out there of what is really bad debt and what really isn't bad debt out there. If we cannot get our head around as to what is the bad debt out there, there is little motivation to clear it out.

Springer: There are a lot of different investment options in Vietnam. Why should investors choose VinaCapital?

Ho: I think investors ought to consider track record and scale when it comes to investing in Vietnam. As you mentioned, we have a strong track record and if one standardizes it against risk, we probably have the best risk-return profile.

Our strong track record has allowed us to grow to be the largest fund for Vietnam and being that we are large, we have scale. Again, this provides significant comfort to our investors because they can buy and sell our shares easily and we can access small to large size deals more easily with solid investment terms. Our executives are also Vietnamese. I am Vietnamese and our CEO is Vietnamese. This is a significant factor when it comes to sourcing, negotiating and exiting investments.