The AFC Asia Frontier Fund (AAFF) USD A-shares gained +0.7% in August 2018. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+0.9%), while it outperformed the MSCI Frontier Markets Net Total Return USD Index (−5.4%), the AFC Frontier Asia Adjusted Index (−1.3%) and underperformed the MSCI World Net Total Return USD Index (+1.2%). The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +49.8% versus the AFC Frontier Asia Adjusted Index, which is up +28.5% during the same time period. The fund’s annualized performance since inception is +6.5% p.a., while its YTD performance stands at −12.2%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 9.10%, a Sharpe ratio of 0.67 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.33, all based on monthly observations since inception.
Investor sentiment within frontier and emerging markets was subdued as macro concerns regarding Argentina and Turkey remained elevated, leading to a selloff in both of these countries’ equity markets and currencies. This led to a negative spillover amongst frontier and emerging markets in general. However, aside from sentiment, Asian frontier markets are not fundamentally linked to the economic or political outcomes in Argentina and Turkey and this was reflected in both fund and stock market performance this month with the fund showing a positive performance despite issues in other larger frontier and emerging countries. Economic growth prospects for Asian frontier markets remain strong along with sound company fundamentals while valuations across our universe have become extremely attractive and none of the countries in our universe face the issues on the scale that some of the larger frontier and emerging markets are facing.
Performance this month was led by Bangladesh, whose market saw a rebound especially in banking stocks which have been weak so far this year due to worries over margin pressures. Despite the issues, some of the well-established private banks declared stable quarterly results which led to a rally in the sector with the fund’s bank holding gaining 17.2% during the month. The fund’s largest holding, a pharmaceutical company with the third highest market share in Bangladesh, was a major positive contributor to performance. The GDR listed in London which the fund holds gained 14.5% during the month and it continues to trade at a significant discount of 32% to the local listing in Dhaka whilst growth prospects for the company remain sound due to the growing healthcare consumption in Bangladesh where per capita health expenditures are amongst the lowest globally.
The Vietnamese market also witnessed a recovery with the VN-Index gaining 3.5% but this was led by a few large cap state-owned banks (which remain under-capitalised) and PetroVietnam Gas. However, the fund’s Vietnamese holdings did well despite not having exposure to the above-mentioned companies. The recent investment in an automotive holding company at a very attractive valuation of a trailing twelve months P/E of 6.0x was reflected in this month’s performance. The stock rallied by 30.2% due to good quarterly results and growth was mainly led by its associate investment, Honda Vietnam, whose motorbike volumes grew by 10% YoY in 1H18 compared to industry growth of 4%, while its net profits grew by 38% during the same period. The fund’s other Vietnamese holdings which did well were a construction company (+12.4%) which trades at a trailing twelve-month P/E of 8.1x and has 36% of its market cap as net cash with zero debt, and a consumer conglomerate (+12.8%) whose feed business should see an improvement in profitability going forward due to a big recovery in pork prices while its consumer staples business continues to do well.
On a macro level, the State Bank of Vietnam (SBV) is looking to rein in credit growth for the rest of the year as inflation came in above the 4% target in June and July while softening slightly in August to 3.98%. Higher food and fuel prices have led to this increase in inflation which has resulted in the SBV planning to not allow banks to increase their loan growth quotas for the rest of the year which could lead to lower credit growth for banks in the second half of 2018 given that loan growth in the first half was very strong for most banks.
Investors in Pakistan await further plans and announcements from the new government with respect to tackling the current account deficit and low foreign exchange reserves but with no major announcements on this front, the market remained weak. Despite this, fund performance did not suffer thanks to both reduced exposure as well as good quarterly results from a car manufacturer and fuel retailer which the fund holds and whose stocks did well during the month. Both stocks trade at attractive valuations with trailing twelve-month P/E’s of 8.3x and 9.2x respectively and both companies have business models which generate free cash flows on a consistent basis with net cash as a percentage of market cap for each company at 45% and 11% respectively with zero debt. Further, the car manufacturer has also announced an expansion plan which will increase capacity by 17%. Though economic growth is expected to slow down next year, we are seeing greater value in Pakistan as trailing twelve-month P/E multiples across most companies and sectors are less than 10x, while on the company level fundamentals remain stable.
In Sri Lanka, the fund’s largest holding in the country, a telecom company, declared good quarterly results led mainly by strong growth in its mobile data and fixed broadband business which grew by 34% and 39% YoY respectively in 2Q18. However, despite the good results and attractive valuations, the stock weakened due to policy changes announced by the government. The government plans to follow through on its telecom tower tax announced in last year’s budget but on a more toned-down version which will lead to an estimated 3% impact on the company’s net profit which is not severe. The telecom regulator also announced removal of the floor price rules for voice calls which has led to a fear of price cuts leading to a decrease in voice revenues and this resulted in a 15.5% correction in the stock price this month. However, voice revenues for the company and the industry in general have been soft over the past few years with most of the growth being driven by data and broadband which is the company’s strength due to its network coverage across the country. Further, with the fund’s holding being only one of the two profitable telecom players in a five-player market, the sustainability of any price competition in the voice business is questionable and with industry consolidation expected to lead to an oligopolistic market, larger players such as the company which the fund holds should benefit in the long run. The stock continues to remain very attractively valued at a trailing twelve month P/E of 7.9x and EV/EBITDA of 3.9x, a significant discount to other regional players in a similar competitively advantageous position.
Mongolia made a positive contribution to performance this month due to very good results from the fund’s cashmere manufacturer and retailer which led to this company’s stock price increasing by 24% while a coal producer the fund holds began to see increased shipments to China as the border transportation issues have been resolved to some extent, leading to a 26.1% gain in this stock for the month.
The best performing indexes in the AAFF universe in August were Bangladesh (+5.6%), Vietnam (+3.5%) and Mongolia (+1.5%). The poorest performing markets were Iraq (−5.9%) and Kazakhstan (−5.8%). The top-performing portfolio stocks this month were: a Vietnamese automotive holding company (+30.3%), a Mongolian coal company (+26.1%), a Mongolia cashmere producer and retailer (+24.0%), a junior copper miner from Mongolia (+20.0%), and a junior oil & gas company from Papua New Guinea (+19.4%).
In August, we added to existing positions in Kyrgyzstan, Mongolia, and Vietnam. We started to invest in Uzbekistan for the first time in the fund’s history and added 10 names mainly from the financial, industrial, and materials sectors. Though 10 names sounds like a lot, given the lower liquidity in this market, we are looking to build a basket of positions and are one of the few institutional investors in the country after it has opened up again over the past eighteen months. We exited a taxi company in Vietnam, a tobacco and construction company in Sri Lanka, and a logistics company in Pakistan. We partially sold one company from Bangladesh, three companies in Mongolia, and one company in Pakistan.
As of 31st August 2018, the portfolio was invested in 113 companies, 1 fund and held 8.0% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (7.2%) and a pump manufacturer from Vietnam (4.0%). The countries with the largest asset allocation include Vietnam (25.0%), Bangladesh (18.7%), and Mongolia (17.5%). The sectors with the largest allocations of assets are consumer goods (28.4%) and industrials (17.6%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 13.24x, the estimated weighted average P/B ratio was 2.46x, and the estimated portfolio dividend yield was 3.80%.