Asia Frontier Capital (AFC) - March 2014 Newsletter
"I'm a great believer in luck, and I find the
The end of March 2014 marks a very important milestone for the AFC Asia Frontier Fund as it officially passed its two year track record. The fund has been under the direction of CEO and Fund Manager Thomas Hugger since inception and continues to generate excellent returns for investors. The final scorecard has seen a return of +25.5% since inception in combination with a low monthly volatility profile (11.3%) and a low correlation with global (0.29) as well as emerging market (0.26) MSCI indices. Whilst the AFC team is indeed pleased to have this track record on display to reinforce our investment approach it does not change the underlying factors in frontier markets across Asia that will drive growth in the years to come. That being said we do hope however that this milestone gives additional confidence to individual as well as institutional investors who may still be sitting on the sidelines considering an investment.
On a more recent performance related note the AFC Asia Frontier Fund and AFC Vietnam Fund have generated strong results this month returning +2.7% and +2.2% respectively. This brings the YTD performance of the AFC Asia Frontier Fund to +12.1% and +16.1% for the AFC Vietnam. During the same period the MSCI World Index, MSCI Frontier Markets Index and MSCI Emerging Markets Index have returned +0.8%, +5.5% and -0.8% respectively.
AFC has begun adding a summarized version of its website into as many regional and international languages as we can to have our online presence be more representative of the regions in which we invest as well as the origins of our investors!
Click the links below to see the languages we have translated so far:
AFC Asia Frontier Fund (AAFF) USD A-shares gained +2.7% in March 2014 in line with the MSCI Frontier Markets Asia Index (+2.9%) and outperformed the MSCI Frontier Index (+1.6%) as well as the MSCI World Index (+0.1%). This month represents an important milestone for our flagship fund as we sailed passed the two year track record to deliver +12.1% to investors YTD in 2014 and +25.5% since inception. The year ahead is also looking positive as the fund returns have been strong despite continued instability in the BRICs as well as other emerging markets. As we discussed in last month's newsletter (here) the fund's correlation to global markets since inception has been incredibly low and has even become negative since tapering was first announced and caused a shockwave to world markets. Whilst low correlation of your portfolio holdings is a key source of diversification benefits it does not take a rocket scientist to realize that this is best combined by allocating to assets that have good returns also.
In March, the best performing indexes within the AAFF universe were the Hanoi Index in Vietnam (+7.6%) whilst the Ho Chi Minh Index (+0.9%) remained relatively flat. The fund's portfolio in Vietnam (+1.6%) appreciated as our small and mid-cap holdings listed in both Hanoi and Ho Chi Minh began an upward trend. These stocks still remain at attractive prices as they maintain low valuations relative to regional peers and other domestically listed large caps. Other markets such as Pakistan (+5.3%) and Laos (+1.9%) also had a positive month as market sentiment saw a rally hold for the month end. AAFF holdings in Pakistan outperformed significantly (+20.5%) as key consumer stocks saw a significant upward movement.
The poorest performing markets were Bangladesh (-5.4%), which saw a consolidation due to profit taking, and Iraq (-1.8%) was also put under selling pressure. Despite this negative performance by the broader indexes AAFF stocks in Bangladesh (-0.8%) and Iraq (+1.0%) held their ground through the downturn as the fund's consumer focused stocks remained resilient in the face of negative market movements. When looking at the fund track record since inception, the consumer sector focus remains one of the key reasons for not only the continued outperformance but also lower volatility of returns.
This month the top-performing portfolio stocks were a Pakistani consumer goods company (+59.2%), followed by an Iraqi agriculture company (+25.2%), a Mongolian consumer goods company (+22.9%) and a Pakistani beverage company (+17.7%). In March we added to existing positions in Bangladesh, Iraq, Mongolia, Myanmar, Pakistan, Papua New Guinea, Sri Lanka and Vietnam and reduced one position in Mongolia. The fund now also has one company from the Maldives after reclassifying one of our Sri Lankan listed tourism holdings that derives the majority of its revenue from this market. We sold one Mongolian coal mining company completely and added a new Mongolian service company as well as Pakistani media company.
As of 31st March 2014, the portfolio was invested in 122 shares, 1 closed-end fund (with 22.2% discount to NAV), 1 GDR (with 63.9% discount) and held 8.7% in cash. The two biggest stock positions are a junior copper mine in Mongolia (4.5%) and a pharmaceutical company in Bangladesh (4.4%). The countries with the largest asset allocation include Vietnam (19.8%), Pakistan (16.9%) and Bangladesh (15.5%). The sectors with the largest allocation of assets are consumer goods (42.1%) and materials (13.6%). The weighted average trailing portfolio P/E ratio (only companies with profit) was 15.44x, the weighted average P/B ratio was 1.53x and the dividend yield was 3.71%.
In March the AFC Vietnam Fund (AVF) gained +2.2%. March started in the same manner as February ended with speculative buying in stocks where foreign ownership limit (FOL) was reached and rumors of an imminent rise in those limits pushed up prices. The rumors continued to build as markets went up and then soured quickly in the following days as the same market participants became skeptical that the change in FOL would happen anytime soon. Welcome to the world of sophisticated investing!
From a long term prospective this is a small blip on the radar and has no serious consequence to Vietnam’s prospects, however, in terms of index comparison to the portfolio this gave us some minor headaches as our strategy does not actively target speculative bets from the rumor mill. As mentioned last month there should be some market consolidation as we move into the next stages of this bull market and this will be an excellent opportunity to allocate new capital to undervalued companies. In last month’s newsletter (click here) we explained why our portfolio structure should hold its ground with more stability during a correction. We were given the opportunity to illustrate this fact during a meaningful correction in the last few days of the month. From the recent closing high on March 24 to April 2 the Ho Chi Minh index lost 4.3%, Hanoi lost 7.9% while our AVF lost approximately 1.5%. The consistent development of the fund performance can also be seen on the Bloomberg graph below which tracks our portfolio on a real time basis:
The fund performance since launch has seen a similar profile in line with our actively traded model portfolio last year which returned +80% on an annual basis.
In line with our active approach research, AVF's CIO - Andreas Karall - attended an important conference in Saigon alongside AFC Asia Frontier Fund's Senior Investment Analyst - Ruchir Desai. The 'Vietnam Access Day', organized by Viet Capital Securities, gave us a good opportunity to find new and valuable information from the ground on the current situation in Vietnam. Even more importantly we had a chance to meet with management of some of our large holdings and established new contacts to deepen our research which should enhance the performance of our investments in the future. Earnings reports from the first quarter of 2014 are starting presently and most companies hold their annual shareholder meetings in April. With this in mind we expect some interesting price movements for many stocks and foresee that there will be a few changes in our holdings as a consequence.
With economic indicators moving in the right direction we hope to see an improvement in company profits following suit, though this will not necessarily happen in the next 1-2 quarters. Whilst there are still some complaints about the speed at which the Vietnamese government is progressing in the opening up of their economy it should be noted that I do not know anybody from any country saying that their government is doing a great job! When addressing problems with state owned enterprises (SOEs) and bad loans at banks I actually think that they are doing quite a good job when compared to the EU in comparison to how they responded to problems in Greece, Cyprus or some bankrupt European banks.
From 2000 to 2013 the numbers of SOE fell from 5,800 to about 3,100. A further 400-500 companies should be privatized over the next two years and the state will maintain control only in certain sectors such as defense, telecommunication, electricity as well as some others by holding stakes of 65-100 percent. Cross holdings in banks look to be reduced as well. With divestments occurring in several listed companies there will be supply in the short term but this will also open up longer term opportunities to get strategic partners as well as M&A activities in general.
Looking into April we see a higher probability of consolidation in the coming weeks which will be good for the market longer term. At the same time companies delivering good results should continue to outperform. As Vietnam's market is primarily made up by domestic investors the market tends to react strongly to results which is a perfect situation for value investors such as ourselves. Despite the fact that markets, especially small markets like Vietnam, are driven by rumors in the short term, stocks in Vietnam reacts stronger on business results than most other markets I have seen so far which is perfect for value investors like us.
In March the fund's largest positions were: Sam Cuong Material Electrical and Telecom Corp (3.8%) - a manufacturer of electrical and telecom equipment, VICEM Gypsum and Cement (2.8%) - a cement company, Kim Long Securities Corp (2.5%) - a securities brokerage company, FLC Group JSC (2.4%) - a real estate development company and Bentre Aqua Product Import & Export (2.4%) - a seafood exporter.
As of 31st March 2014 the portfolio was invested in 64 shares and held 7.5% in cash. The sectors with the largest allocation of assets were consumer goods (34.2%) and industrials (16.5%). The fund's weighted average trailing P/E ratio was 7.28x, the weighted average P/B ratio was 1.02x and the average dividend yield was 5.95%.
Since Sri Lanka's three decades long civil war ended in 2009, the government has pursued ambitious economic policies in attempts to spur growth on the island. Sri Lanka's economy expanded by 8% in 2011, and after a slight lull in growth due to weak external demand, is expected to grow at an average of 7.7% a year through 2016. Economic growth will be concentrated among investment in reconstruction efforts (particularly in the north and east), large infrastructure projects, real-estate development, and assorted business investment as companies seek to capture market share amid rapid economic expansion. Private consumption, fuelled by rising incomes and consistent flows of remittances, is also driving economic expansion. Sri Lanka's 91% literacy rate and life expectancy of 75 years rank well above those in the region (including India, Bangladesh, and Pakistan), making the labor force attractive for both manufacturing and service jobs, which already compose 57 % of GDP.
The Colombo Stock Exchange (CSE), established in 1985, currently lists 289 companies representing 20 sectors. The CSE has a market capitalization of US$19.2 billion and a PE ratio of 13.6x as ofMarch2014.
Country snapshots for all of AFC's markets can be found on our website
In line with AFC's process of being on the ground in the countries we invest in, AFC's CEO & Fund Manager, Thomas Hugger, travelled to Sri Lanka to conduct company visits and meet with investors in Colombo.
I have always found travelling to Sri Lanka to be one of the more fascinating international destinations and can see why tourism has been such a booming industry in a country that was only recently in the midst of a civil war. We flew into Colombo Bandanaraike International Airport which began its life as a British military airbase during WWII. Colombo International Airport has seen some upgrades since then and now has 8 aero-bridges which were opened in November 2005. Otherwise the rest of the airport remains basically the same since my wife and I first visited Sri Lanka on our Christmas holiday in 1985. The trip itself was very pleasant but the circumstances facing the country at the time made it bittersweet as this was during the height of the civil war which started on 23rd July 1983 and lasted for 26 years until it ended in May 2009.
The only other international airport, Hambantota, is located in the southern region of Sri Lanka where the current President of Sri Lanka, Mahinda Rajapaksa's, has his origins. It started operating on 18th March 2013 after investments in the amount of USD 210 million were made and currently only Sri Lankan Airlines and Fly Dubai are using the southern airport for regular international scheduled flights.
At the immigration counters our passports and visas were checked by a smiling all female staff wearing the traditional saree dress in stark contrast at departure a few days later when we were checked by unmotivated all male immigration staff. We then proceeded towards the luggage hall, passing by dozens of duty free shops almost all of them selling washing machines, ovens, cookers and other household equipment and white goods. Apparently Sri Lankan nationals returning after an overseas trip benefit from tax reduction when buying these goods at the airport. We received our luggage within a few minutes and after clearing the customs we were greeted by our hotel representative who guided us the short walk to the hotel car waiting for us outside of the terminal building.
In the past, the 35 km trip from the airport to the hotels in the city centre through small suburban villages would take anything between 1 to 2 hours depending on the time of the day. This time our driver navigated the car through the bustling arrival area and after a 2 minute drive we were on the brand new 25.8 kilometre long Katunayake Expressway linking Negombo and the airport with Colombo. The highway was opened on 27th October 2013 and is the nation's second highway. The toll is 300 Rupees (USD 2.30) and we reached the end of the highway in less than 20 minutes. The E03 has two lanes in each direction built to the standard of the German Autobahn after an investment of approximately USD 300 million most of which is funded by the Exim Bank of China. The majority of the new infrastructure spending like ports, highways, hydroelectric power stations and railway lines is funded by China.
When exiting the highway and driving through the more established roads we noticed two major changes compared with our previous five visits to Colombo: The buildings, roads and public areas were in much better condition and everything in view was cleaner. We were told by our driver that the defence ministry had previously deployed soldiers as a means of tidying up the city. The military presence was formally one of the biggest nuisances when visiting Sri Lanka in the past where road blocks and checks were set up roughly every 1 kilometre in the city and every 5 to 10 kilometres in the countryside. This is a thing of the past and during our one week long stay we did not come across a single checkpoint on the road. The situation was the same in front of our hotel and other major buildings where the security presence has been significantly relaxed. This is a big step and a very positive sign for the country's growing tourism industry which saw tourist arrivals increase by 27% in 2013 to 1.3 million.
We spent the first two nights at the Cinnamon Lakeside Hotel which has an idyllic location at the Beira Lake in the middle of Colombo. The purpose of my visit was to attend a 3 day investment seminar organized by Seraph (www.seraph.vc) where I was given the opportunity to present Asia Frontier Capital and our funds to accredited investors from the US, Asia and Europe. The first part of the seminar was held in Colombo where we also visited the Colombo Stock Exchange "CSE" and the Securities and Exchange Commission. The "CSE" is located in one of the two World Trade Center Towers which are currently the tallest buildings in Colombo. This will certainly change over the next couple of years as there are several high rise buildings in construction or in planning. Major hotel chains like Hyatt and Shangri-La have also started constructing new hotels near the beautiful sea front promenade or Galle Road. These new buildings and the two new planned casinos - one of them the Crown Casino by Australian casino king James Packer - will definitely change the still colonial looking city centre of Colombo in the future.
The second and third days of the seminar were held in the Bentota Beach Hotel in the southern part of Sri Lanka approximately a two hour drive from Colombo. Despite a newly built 128 km long Southern Expressway Colombo-Matara "E01" the drivers decided to take us to Bentota using the old main road "A2" along the coast and passed through several towns which my wife Manuela and I knew from our previous five visits to Bentota. It was interesting to see the small changes on the way. As expected the traffic was heavier, the cars newer (mainly Japanese and Korean cars) and some parts of the road were upgraded from two lanes to four. Also the buildings along the road were renovated to be cleaner and neater to look at than a couple of year ago. The small seaside resort of Bentota is about 8km south of Beruwala in the Galle district and hosts about 50 smaller hotels but also more luxurious hotels such as the Taj Bentota Hotel from the prestigious Indian Taj hotel chain or boutique hotels like Saman Villas.
Most of these hotels have been renovated or newly build after the 26th December 2004 Tsunami which had also hit Sri Lanka and killed 30,196 people including a number of foreign tourists in Bentota. The main attraction is the beach which is several kilometres long and provides good surfing during high tide. At the seminar organized by Seraph interesting investment proposals were presented and there were some interesting offerings: a spice farm in Cambodia, hydro power generation in Nepal, a graphite mine in Sri Lanka, a coconut drink sourced in Sri Lanka and marketed in the US, a pre-IPO fund and a fund investing in cryptocurrencies and cryptopayment systems. Seraph operates like a club where the members can decide to co-invest alongside the promoters Chris and Marc.
The last three days of our stay in Sri Lanka were used to visit Asia Frontier Capital's brokers and meet with companies' that the AFC Asia Frontier Fund has an interest in. On Thursday morning we drove back from Bentota to Colombo, this time using the newly built Southern Expressway. To my surprise I had to tell the driver to use the Expressway several times which he finally did after I told him that I was willing to pay additional 500 Rupees. This toll-highway was opened on 27th November 2011 and has four lanes comparable to a German Autobahn. Most of the highway is elevated in order to avoid flooding during tropical rains or monsoon period. However there was hardly any traffic on the highway and according to statistics only 9,000 vehicles used the expressway on average per day in 2012. The exit to Colombo is still 20 kilometres away from the city centre so we still had to navigate quite a bit of city traffic upon exiting the highway.
My first company visit in Colombo was to the local subsidiary of a US oil major which produces and distributes lubricants - mainly for vehicles and heavy engines used in thermal power stations. The company is facing sales volume decline due to the government policy to phase out polluting thermal power and replace it with more environmental friendly hydro, wind and solar power. Additionally the increased replacement of old cars with new cars that use fewer lubricants combined with the entrance of new competitors is going to put pressure on sales. The only upside I see for this company is a possible future distribution of their products in Bangladesh or India. The company is still paying almost all of its profits to its shareholders in form of a cash dividend - as with most other international subsidiaries - and has a dividend yield of 6.8%. Despite this I was glad that I sold the fund's shares in May last year with a nice profit at 316 Rupees (share price today 266).
My next company visit took me to one of our portfolio's favourite holding's which is also one of Sri Lanka's leading construction companies. We first met this company during the "Sri Lanka Investor Day" in Hong Kong in September 2013 when we had the chance to interact with the Chairman. We wrote about this experience in our September 2013 newsletter which is available via this link. This time I was able to meet with the CEO - which is a privilege most boutique fund managers rarely experience in developed markets when running a niche fund as I currently do - and our positive view on the company was confirmed by our meeting which continued for over one hour. We will certainly increase our exposure in the company in the future and since my visit the fund has already taken new positions.
My next visit was another company my analyst Ruchir "discovered" recently and we have never met before. Before buying a new stock we normally try to see the management of the company first or at minimum conduct a conference call with the company or research analysts we respect. It is a small diversified conglomerate established in 1948 as a distributor for pharmaceutical products. Over the time the group has added several other divisions. However the second largest division today is "FMCG" (fast moving consumer goods), a sector we generally like to invest in. I met with the CFO and I was able to receive detailed information about financials, strategy of the group and outlook. This meeting confirmed our positive view and it would not be surprising to see value unlocking from the balance sheet of this company at some point in time since the current holding structure format of the company leads to a discount in valuations relative to the market/peers.
My next meeting was with a conglomerate of tile companies which was arranged by our friendly Sri Lankan brokers whom I have known personally for over 20 years. We have invested in two tile companies in Sri Lanka expecting that these two companies should benefit from higher infrastructure spending and high GDP growth. To our surprise one of these companies took over the other in May last year. When I met with the CEO (of the acquired company) he explained the current situation of the take-over on the company's business outlook. The CEO was exceptionally honest about the merger integration and outlook so our analyst Ruchir and myself need to dig a little deeper into these stocks to decide about our future strategy in this sector.
The most difficult meeting to arrange was with the company we currently have as our largest investment holding in Sri Lanka - an automobile distributor. The company normally does not meet with investors and only thanks to the excellent connections of our broker with the CEO were we able to get a meeting with the company's CFO. He briefed us in detail about the company's financial performance and outlook but also about the future developments like new products and brands. It was a very helpful and informative meeting. However like in the past meetings I heard again that the consumer sentiment currently in Sri Lanka was not the euphoric whirlwind which could be assumed when simply looking at the available economic figures.
My last meeting was with a cement company which I already met last year in Hong Kong during the same "Sri Lanka Investor Day". I was informed about the latest developments and future outlook of their markets and the outlook for this company was very optimistic - similarly to the construction company I had visited earlier. Since the end of the war, the Sri Lankan government has been spending a great deal on infrastructure development and it is therefore not surprising to hear optimistic outlooks from construction related companies. This information received will help us to update our internal financial models which Ruchir has been building and fine tuning over the past several months. These meetings were extremely helpful in making an up to date and duly informed decision about our current and possible future investments in Sri Lanka.
In line with focussing on a country in each month's newsletter, we cover Sri Lanka this month and discuss its economy and future prospects. We previously wrote on Sri Lanka in our September 2013 newsletter in which we touched upon on the country's thrust on rebuilding the nation as well as the growing prospects for its tourism industry. The country continues to be on track with respect to these developments as these parts of the economy continue to grow.
The Sri Lankan government is making a huge effort to build up the country's infrastructure by building new highways, expressways and ports. A major initiative of the government is the development of expressways linking important parts of the country or making connectivity within cities more efficient. The major expressways which are already in operation or in the planning stages are the Southern Transport Development Project, Colombo-Katunayake Expressway Project, Outer Circular Highway Project and North East Expressway Project.
The Southern Transport Development Project also called the "Southern Expressway" is already operational and links Colombo - which is in the Western Province - to Matara, a town in the Southern Province. The distance of 126 kilometres can now be covered in 2 hours as compared to 4.5-5 hours before the road was built. There are also plans to extend the Southern Expressway to Hambantota which is seeing the development of new port as well as an international airport.
The Colombo-Katunayake Expressway is also operational and this has significantly improved travel time between the Colombo international airport and the city. The 25.8 kilometre expressway began operations in October 2013 and has reduced travel time from the international airport to the city to only 20 minutes.
The Outer Circular Highway which is currently under construction will be a link to have seamless connectivity between the Colombo-Katunayake Expressway and the Southern Expressway and the first phase of this project is expected to be completed in May 2014.
Another expressway in the planning stage is the 99 kilometre North East Expressway Project which will link Colombo in the West to Kandy in Central Sri Lanka and will allow greater connectivity to the North and East of Sri Lanka.
The development of these new expressways is a reflection of the growing importance the government is placing on infrastructure as a means to take the Sri Lankan economy forward. This commitment is also reflected in the government's plan to rebuild existing or develop new roads and highways especially in the Northern and Eastern parts of Sri Lanka which were affected the most by the civil war. Some examples of such projects are the Pro Poor Eastern Infrastructure Development Project, Northern Road Connectivity Project, Northern Road Rehabilitation Project and Conflict Affected Region Emergency Project. Most of the new expressways, roads and highways being built or planned are funded by the Government of Sri Lanka, EX-IM Bank of China, the Asian Development Bank and the Japan International Cooperation Agency.
Another major infrastructure project in the country is the development of the Hambantota port in Southern Sri Lanka. The first phase of the project was completed last year at a cost of USD 361 million and the second phase is expected to be completed by October 2015 at a cost of USD 808 million. Hambantota port could see itself becoming strategically important due to its location and therefore could develop into a transhipment port.
The government's emphasis on infrastructure has had an impact on overall GDP growth rates as the construction industry has been growing at double digit growth rates since 2011. In 2013, the construction industry contributed 1.3% to overall GDP growth.
The tourism industry has also seen a big improvement since 2009 as tourist arrivals crossed the 1 million mark in 2012 and grew by 27% in 2013 to touch 1.27 million tourist arrivals. The tourism industry now generates more than USD 1 billion in revenue and directly employs close to 70,000 people. Improving infrastructure and development of new attractions such as the casino projects by the Crown Group and John Keells Holdings could see the number of tourist arrivals increase in the coming years as Sri Lanka is still a tiny tourist market compared to other Asian tourist markets such as Thailand, Malaysia, Indonesia, Cambodia and Vietnam.
Overall, the economy appears to be moving in the right direction but the government would need to watch its finances as it does run a fiscal deficit which is not small but it has come down from the levels seen in 2009/2010. The Central Bank of Sri Lanka has been in an accommodating mode as deficits and inflation have been under control so there is a possibility that domestic consumer demand could increase in 2014.
With greater emphasis given by the Sri Lankan government to infrastructure development and future growth prospects for the tourism industry, the AFC Asia Frontier Fund has researched and invested in companies linked to these industries and the fund continues to look for other potential opportunities in Sri Lanka.
I hope you enjoyed reading our monthly newsletter and remain 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.
The representative of the Fund in Switzerland is Hugo Fund Services SA, 6 Cours de Rive, 1204 Geneva. The distribution of Shares in Switzerland must exclusively be made to qualified investors. The place of performance and jurisdiction for Shares in the Fund distributed in Switzerland are at the registered office of the Representative.
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