Asia Frontier Capital (AFC) - January 2014 Newsletter
"Twenty years from now you will be more disappointed by
The AFC Asia Frontier Fund (AAFF) and AFC Vietnam Fund (AVF) have had an excellent start to 2014 after outperforming benchmarks and returning +7.3% and +8.8% respectively over the month of January. Since inception the AFC Asia Frontier Fund has returned +20.2% and the recently launched AFC Vietnam Fund has returned +11.1% for investors after less than two months of trading. With strong performance and the long term opportunities presented by Asia's frontier markets it is good to see both funds continuing to pick up momentum. This month also saw continued interest from individual investors, family offices and private banks which led to the largest monthly capital inflow since each of the fund’s inception. The AFC team would like to extend a warm welcome to all of our new investors who came on board this month.
Were very pleased to announce that the AFC Asia Frontier Fund has won 'New Fund Launch of the Year' at the International Hedge Fund Awards announced in January 2014. This award recognizes the strong returns and successful growth of the fund in 2013 after CEO, Thomas Hugger, acquired the management rights of the fund through an MBO last July. The fund's investment strategy has been under the direction of Thomas Hugger since it was incepted in March 2012 bringing the fund's total track record to 22 months. The fund maintains a volatility profile that is similar to the MSCI World Index and has provided consistent returns that have a low correlation to global as well as emerging markets.
You can access the official publication via the following link here.
We would like to remind all potential investors that February is the last chance to invest in the AFC Asia Frontier Fund at the minimum investment of USD/EUR/CHF 25,000 after the limited offer that featured in the 'Mayer's Special Situations' investment newsletter. In order to take advantage of this temporary reduction in minimum investment the completed subscription forms and bank transfers must arrive with our fund administrators before Monday the 24th of February 2014 at 4pm Singapore time.
We would also like to highlight to our readers that the roadshow for the AFC Vietnam Fund is still ongoing. The AFC Vietnam Fund's CEO, Andreas Vogelsanger, will be in Asia to meet with potential investors on the following dates:
February 2014 - Asia
This was an excellent month for the AFC Asia Frontier Fund (AAFF) which had a very strong performance to start 2014. AAFF USD A-shares gained +7.3% in January, outperforming the MSCI Frontier Markets Asia Index which also ended the month up (+6.2%). The fund continues to offer returns that have low correlation with global as well as emerging markets indices which have come under selling pressure since the start of the year. The MSCI Emerging Markets index (-6.6%) and MSCI World Index (-3.8%) were both down significantly in January.
Alongside a continued appreciation in NAV the AAFF saw the largest capital inflow on record this month. Family offices, individuals and private banks who subscribed this month highlighted that they were primarily investing to gain access to the opportunity for long term capital appreciation as well as diversification offered by the AAFF portfolio. We would also like to welcome on board our new investors who have taken advantage of the temporary reduction in minimum investment that was extended to readers of AFC and Mayer Special Situations newsletters. The last opportunity to invest at the temporary minimum USD 25,000 level is at this month's NAV cut off on Monday the 24th of February 2014 at 4pm Singapore time.
In January, the best performing indexes within the AAFF universe were Bangladesh (+11.4%), Vietnam - Ho Chi Minh City Index (+10.3%), Vietnam - Hanoi Index (+9.4%) and Pakistan (+6.0%). Bangladesh has seen a recovery after the easing of political tensions which saw a rally in AFCs consumer and pharmaceutical holdings which performed well in this environment. Vietnam continues to show strength as valuations adjust towards regional peers. Pakistan saw a rally after favorable large scale manufacturing and credit growth numbers, from June to December 2013, were released this month. Pakistan has now become the second largest country holding in the fund after AAFF stocks saw a significant increase (+23.8%) on a weighted average basis. AFC's holdings in Sri Lanka also had strong weighted average returns (+8.8%) outperforming the country index (+5.7%) which was up after a rise in market sentiment following an interest rate cut. Smaller markets in the AAFF universe were the worst performers this month with both Cambodia (-6.7%) and Mongolia (-1.8%) declining.
The top performing stocks in the portfolio were a beverage company from Pakistan (+100.3%), a Mongolian copper mine (+80.0%), a Pakistani textile company (+37.7%), a Vietnamese beer producer (+32.4%) and a Bangladeshi shoe manufacturer (+28.9%). Many of the existing portfolio holdings were picked up at a discount to current valuations and have taken a step towards levels that are more in line with the earnings and risk profiles calculated by our in house research team. The fund strategy has continued to perform well in up as well as down markets and the diversified country universe allows new capital allocation to take advantage of growth and value opportunities in markets that minimize downside risk based on the fund's top-down filter. When new capital is added to the fund it benefits new as well as existing investors as it allows the fund to accumulate stocks that have moved to attractive price levels without having to sell existing positions. This approach supports returns for investors by keeping overall trading costs low.
In January the fund added to existing positions in Mongolia, Papua New Guinea and Vietnam and reduced some positions in Mongolia. We sold a position in a Pakistani holding company and bought an insurance company from Pakistan as well as a construction company from Sri Lanka.
As of 31st January 2014, the portfolio was invested in 110 shares, 1 closed-end fund (with 25% discount to NAV), 1 GDR (with 66.3% discount) and held 3.7% in cash. The two biggest stock positions are a financial institution (4.3%) in Laos and a pharmaceutical company in Bangladesh (4.3%). The countries with the largest asset allocation include Vietnam (20.6%), Pakistan (17.8%) and Bangladesh (16.5%). The sectors with the largest allocation of assets are consumer goods (50.4%) and financials (11.9%). The weighted average trailing portfolio Price/Earnings ratio (only companies with profit) was 12.43x, the weighted average Price/Book ratio was 1.57x and the Dividend Yield was 4.16%.
The AFC Vietnam Fund (AVF) has continued its strong upward trajectory since its launch last month gaining +8.8% in January 2014. Since the fund began investing on the 23rd of December 2013 AVF has continued to outperform the VH Index (+8.7) and VN Index (+9.5%) returning +11.1% to investors. In the first full month of trading there was some turbulence as January was a challenging month for emerging markets around the world. Vietnamese equities proved to be resilient which demonstrates the lower correlation of frontier markets in Asia with global markets. The correlation of the VH Index (Hanoi) and VN Index (Ho Chi Minh) with the MSCI World Index has been historically very low at 0.35 and 0.40 respectively based on the past 10 years of monthly data.
Looking at the market this month Vietnam saw foreign inflows into ETFs and good macroeconomic news as well as overall positive media sentiment. The market was also supported by the news that the rating agency Fitch has raised Vietnam's sovereign credit rating from stable to positive. The Vietnam team was kept very busy updating forecasts in our earnings models with two thirds of current holdings releasing their Q4/2013 earnings data during January. Only two companies disappointed with the vast majority meeting or exceeding expectations which supports our existing views on these companies. Some new companies have also been added to the fund investment universe after displaying characteristics that allow their inclusion in our investment model.
The fund has more than 100 stocks being monitored and has already invested in 60 different stocks. Further capital will be committed to companies which delivered good earnings and promise further gains. The fund's actively managed, diversified portfolio consists of companies that will have to double from current valuations to be on par with regional peers. The fund portfolio is currently underweight large caps relative to the VN Index, VH Index and major ETFs due to more favorable valuations in small to mid-cap stocks. Based on 2013 earnings we see a long way to go from here which looks to be the early stages of a bull market in Vietnam.
At the 31st of January 2014 the fund's largest positions were: Sam Cuong Material Electrical and Telecom Corp (3.7%) - a manufacturer of electrical and telecom equipment, Cat Loi JSC - a materials/packaging company (2.8%), Son La Sugar JSC (2.8%) - a sugar producer, Pharmedic Pharmaceutical Med (2.5%) - a pharmaceutical manufacturing company and VNDirect Securities Corporation (2.5%) which is a securities brokerage company.
As of 31st January 2014 the portfolio was invested in 60 shares and held 10.2% in cash. The sectors with the largest allocation of assets were consumer goods (33.7%) and industrials (18.0%). The fund's weighted average trailing Price/Earnings ratio (only companies with profit) was 7.07x, the weighted average Price/Book ratio was 1.02x and the Dividend Yield was 6.83%.
"In the short run, the market is a voting machine,
We attended the Pakistan Investor Day in Hong Kong in January and it provided us with a great opportunity to meet with company management teams as well as policy makers. These are our key takeaways from the event.
When you tell someone that you are investing in Pakistan, you are usually met with surprise, given the media's general depiction of the country. This spotlight on Pakistan's shortcomings and security issues does not tell the whole story however.
It is important to put things in perspective. Pakistan has a population of roughly 183 million, a median age of 22, and 52% of the population is between the ages of 15-49, an age linked to income generation. The country's GDP is USD 237 billion with the informal economy accounting for about 37% of GDP (as per a 2010 World Bank study). Literacy rates, though low, have improved in the past decade and are comparable to the country's peers in the region. More importantly, literacy rates in urban areas (which comprise 37% of the total population) are much higher at 75% compared to 65% in 1999. Overall literacy rates were 45% in 1999 and have now improved to 55%.
All of these statistics suggest that Pakistan cannot be ignored in terms of investment opportunities. There is a sizeable population that is getting more educated and looking to earn an income which will lead to greater consumption in the coming years. The fact that fear and negative publicity have deterred many foreign investors provides opportunities to buy companies trading at valuations which are extremely attractive!
The economy has had its fair share of problems since 2008 due to a combination of security issues, poor governance, and a shortage of power. The shortage of power has been a contributing factor for the sluggish economic growth and Pakistan has been producing well below its potential GDP. The lack of power is estimated to have knocked off 2 percentage points from 2013 real GDP growth, with power outages of 8-10 hours a day at times of peak demand.
During December 2013, for instance, the total peak demand in the country was 13,652 MW but supply was 9,580 MW, a shortfall of 4,072 MW. A combination of factors such as inefficient public sector power plants, lack of adequate gas supply, dependence on imported and high cost furnace oil, and government subsidies have led to the current power crisis. The critical factor that has caused the current power shortage crisis is the lack of gas supply, which has led power producers to use high cost furnace oil that needs to be imported. This has increased the cost of production, leading to a mismatch between revenues and cost as the government provides subsidies to energy users and creating a pile up of receivables in the energy industry. This pile up of receivables, also called 'circular debt', reached about 4% of GDP as of June 2013.
Power generation capacity has not increased in past 5 years.
Besides the power shortage situation, the macro scenario has also not been great as foreign reserves have decreased due to lower foreign investment over the past few years. This led to a balance of payments problem in 2013 leading to the IMF providing an assistance package of USD 6.7 billion which will be disbursed in phases over 36 months.
This funding from the IMF requires the government to take various measures to reform the power sector and the economy in order to get things back on track. As a result, the current government has already increased electricity and gas tariffs for both industrial and commercial consumers. The government has also reduced the 'circular debt' in the power sector leading to an improvement in the fundamentals of companies engaged in the energy industry. Going forward, the government is also expected to pass measures to expand the tax base as well as reduce its stake in various public sector companies that it controls.
In light of the issues the country has been facing, the performance of the stock market and of the various companies tells a different story. The KSE 100 index gained 49.4% in 2013 and 49.0% in 2012, outperforming most emerging and developed markets. The key reason for this has been (1) very attractive valuations (2) healthy fundamentals of companies in spite of the country having macro issues and (3) improving sentiment due to a new business friendly government. The P/E of the KSE 100 index in 2012 was 7.6x and in 2013 was 9.5x with a dividend yield of 6.5% and 5.7% respectively. RoE's for companies in the KSE 100 index were 19.4% and 19.8% in 2012 and 2013 respectively. These numbers are hard to ignore in spite of all the noise about drone attacks and the Taliban in the media.
The bottom line is that there are companies in various industries that are performing well, are fundamentally sound, and above all are available at very attractive valuations! When you come across companies showing double digit earnings growth, free cash flow, and healthy return on equity without leverage, Pakistani companies' valuation is compelling relative to some other emerging market names. There are various companies operating in businesses such as consumer food, consumer beverage, cement, and textiles which have been performing well over the past few years. These companies have been around for more than two decades with a proven ability to conduct business in a tough environment. Furthermore, there are quarterly and annual disclosures by listed companies and getting information is not difficult. In terms of liquidity, relative to other frontier markets like Mongolia or Iraq, Pakistan's daily volumes are quite high and were USD 72 million on average in 2013.
These attractively-valued companies are the types of stocks the AFC Asia Frontier Fund has invested in and whom we met with on the Pakistan Investor Day. Currently the AFC Asia Frontier fund is invested in companies in Pakistan across sectors such as cement, consumer, financials, healthcare, utilities, and textiles. The conference had representation from companies in the banking, cement, consumer, fertilizer and oil & gas industries. The management teams that we met displayed deep knowledge of their businesses and the discussions we had were equivalent to interacting with company management teams from other emerging/frontier markets such as India or Sri Lanka. There was also representation from the Pakistan Central Bank which helped give a different perspective on the way forward for Pakistan's economy. The key takeaways for us from the conference were that (1) management teams of businesses in the cement, consumer, and oil & gas industries are positive on their outlook (2) the economy appears to be getting back on track in light of the reform measures (this seems to be reflected in the recent manufacturing industry and credit growth numbers) and (3) the security situation linked to the US pull-out from Afghanistan is something to watch out for.
Unfortunately, there was no representation from the textile industry in the conference but there have been some important developments for the Pakistan textile industry over the past few months. The country was recently granted GSP Plus status by the EU which provides for full removal of tariffs for imports into the EU. Given that Pakistan will receive this status from January 2014 onwards, industries such as the textile industry are poised to benefit as the EU accounts for 28% of textile related exports from Pakistan. There has also been news that China-based Shandong Ruyi group is expected to invest USD 2 billion in the Pakistan textile industry in order to take advantage of the EU GSP Plus status. There exist profitable textile companies in Pakistan with revenues of greater than USD 200 million and trading at P/E ratios of 2x-6x and not heavily leveraged. These valuations are at a significant discount to textile companies in most emerging markets.
Pakistan Textile Exports to Benefit from EU GSP Plus Status
Source: Pakistan Bureau of Statistics
There is also expectation that trade with India can open up further going forward. Pakistan could possibly open up its market to more Indian products in the future and vice-versa. This could create some competitive pressure in the long run for Pakistani companies but it would also open up a big market like India for Pakistani companies.
Despite its negative media coverage and ongoing uncertainty with regard to security, Pakistan's Karachi Stock Exchange (KSE) has been one of the best performing bourses in the world for the second consecutive year, posting a 49% gain (37% in USD terms) in 2013. Investor confidence was boosted in May of last year when the country experienced the first democratic regime change in Pakistan's history with reasonably free and fair elections. Nawaz Sharif of the Pakistan Muslim League-N (PML-N) was elected the new Prime Minister, an outcome that was applauded by investors, as the PML-N has historically been business-friendly and pro-investment. The peaceful political transition has encouraged greater investment in Pakistan's stock market, and for good reason: Pakistan's 2013 return of 49% compares favorably with the country's 10-year and 20-year average annual return of 28% and 22%, respectively.
The robust performance of Pakistani equities has been all the more impressive given the economic challenges persistent in the country. The IMF forecasted a GDP growth rate for Pakistan of just 3.6% in 2013 and 2.5% in 2014, largely due to macroeconomic factors and recurring energy shortages that have hindered the country's key export industries. Pakistan's foreign currency reserves, disturbingly low at USD 4.3 billion, have been the target of an IMF reform program, consisting of a USD 6.7 billion loan agreed upon in September 2013 and a structured plan to facilitate much-needed economic growth. On 9th February, the IMF announced in a periodic review that the reform program is on track and Pakistan had met most of its quantitative performance targets.
With a population of approximately 183 million people and increasingly internationally-competitive export industries, Pakistan has continued to attract foreign direct investment (FDI). Dr. Miftah Ismail, Chairman of Pakistan's Board of Investment, has stated that the target is to increase foreign investment to 20% of GDP in five years. Currently, FDI into Pakistan is roughly 14% of GDP.
China has ramped up its business interests in Pakistan, recently announcing a program of USD 22 billion in preferential and medium term soft loans to the country in exchange for contracts to build a number of coal, hydropower, and transmission line projects to address the endemic problems in Pakistan's energy sector.
Japan is another emerging player in Pakistan, and a recent study by the Japan External Trade Organization (JETRO) ranked Pakistan as second in the world in terms of business growth. Japanese developers are planning to soon commence the construction of the Karachi Circular Railway, a USD 2 billion project.
Most significant to export industries is that Pakistan was recently granted GSP Plus status by the European Union, which allows full removal of tariffs for imports into the EU. Effective as of January 2014, the GSP Plus status will be a huge boon for the country's export sectors, in particular its textile industry - the EU accounts for 28% of textile related exports from Pakistan. Foreign investor interest has risen in response and the UK, for example, is hoping to increase its trade with Pakistan to an annual value of GBP 3 billion by 2015.
Growing foreign investor interest in Pakistan has also been reflected in the country's bourses, and 2013 saw a net inflow of USD 403 million from foreigners, compared to USD 125 million in 2012. In total, foreign investors hold roughly USD 4.4 billion of Pakistan equities, accounting for 36% of free-float and 8% of market capitalization.
One of the contributing factors to the rise of Pakistani equities is a new amnesty put into place in January 2012 seeking to increase investment in the stock market as a way to increase the government's tax revenue. Pakistan has historically struggled with tax collection, and authorities seeking to bolster the government's tax income introduced the new amnesty which allows investors to buy shares without full disclosure of where their money came from. The amnesty, set to expire in June 2014, has helped boost trading volume and introduce new funds to the country's bourses, supporting the rally of the Karachi Stock Exchange in 2012 and 2013. But in a country mired in corruption, some worry that the relaxed standards enabled by the amnesty may underscore other risks in the market.
Two major concerns for Pakistan moving forward will be the security situation and how the country is affected by the Federal Reserve's tapering of quantitative easing. Addressing extremism and violence is crucial for the government to rebuild business confidence in Pakistan and its economy. Relations with the United States appear to be stabilizing as on 25th January, 2014 the US approved the payment of USD 352 million to the Coalition Support Fund (CSF) to assist Pakistan in restoring stability and address the ongoing violence that has damaged the country's economy and reputation. To ensure continued economic growth and the attraction of foreign investment, the government must tackle the tough challenge of restoring peace to Pakistan.
Another uncertainty has been the ongoing tapering of quantitative easing. In response to the Fed's recent announcement that it plans to taper off its stimulus and cut bond purchases by USD 10 billion, emerging markets equities tumbled and major questions have been raised about how these countries will cope with capital flight as interest rates in the US climb. Pakistani equities however exhibit a lower correlation with developed markets and did not see a significant impact due to the Fed announcement as foreigners are still not big participants in the country relative to other Asian markets such as India, Thailand and Indonesia. In light of Pakistan's macroeconomic difficulties and issues with the country's energy sector and security situation, the healthy performance of the KSE has been even more remarkable. With foreign interest growing as investors realize that the KSE lists a broad spectrum of companies with sound fundamentals trading at discount prices, the outlook is bright for Pakistan's stock market and Asia Frontier Capital remains optimistic about the opportunities that Pakistan presents, especially if the country is able to improve its macroeconomic situation and continue to attract overseas investment.
With kind regards,
This document does not constitute an offer to sell, or a solicitation of an offer to invest in AFC Asia Frontier Fund, AFC Asia Frontier Fund (non-US), AFC Vietnam Fund or any other funds sponsored by Asia Frontier Capital Ltd. or its affiliates. We will not make such offer or solicitation prior to the delivery of a definitive offering memorandum and other materials relating to the matters herein. Before making an investment decision with respect to our Funds, we advise potential investors to read carefully the respective offering memorandum, the limited partnership agreement or operating agreement, and the related subscription documents, and to consult with their tax, legal, and financial advisors. We have compiled this information from sources we believe to be reliable, but we cannot guarantee its correctness. We present our opinions without warranty. Past performance is no guarantee of future results. © Asia Frontier Capital Ltd. All rights reserved.
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