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Asia Frontier Capital (AFC) - December 2017

How does investing in Asian frontier markets improve portfolio returns and reduce overall volatility? Read AFC's monthly newsletter.
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“Value investing was once the purchase of tangible assets at levels below their market value. Value investing today is buying sustainable competitive advantages at a good price.”

- John Kay, British leading economist


AFC Funds Performance Summary

 (USD)Dec-2017Full Year 2017Since Inception
AFC Asia Frontier Fund USD A1,706.94-2.3%+0.2%+70.7%
MSCI Frontier Markets Asia Net
Total Return USD Index
AFC Iraq Fund567.40+1.7%-7.5%-43.3%
Rabee RSISX Index (in USD) +3.1%-11.8%-43.4%
AFC Vietnam Fund1,854.02+0.0%+13.3%+85.4%
Ho Chi Minh City VN Index (in USD) +3.7%+48.4%+79.8%

*The NAV given is for the main share series for the relevant master fund. Investor’s holdings may be in a different share class or series or currency and have a different NAV. See the factsheets and/or your statement for full details. NAV and performance figures are all net of fees.


The team at Asia Frontier Capital would like to wish all of our readers a wonderful and prosperous 2018!

Most stock markets had a year-end rally and ended an eventful 2017 higher, some at all-time highs. The MSCI World Index rose +1.4% with some markets setting new all-time highs, while the frontier markets overall also fared well. The MSCI Frontier Markets Net Total Return USD Index gained +3.1% this month and is now up +31.9% for 2017, while the MSCI Frontier Markets Asia Net Total Return USD Index soared +6.3% and is now up +45.5% for the year.

The AFC Asia Frontier Fund returned -2.3% in December, ending the year flat, and is now up +70.7% since inception, which corresponds to a healthy annualized return of +9.7% p.a. since inception, reflecting the strategy’s ability to generate consistent long-term returns.

The AFC Iraq Fund returned +1.7% in December, while the Rabee USD index gained +3.1%, and the fund’s  performance is -7.5% for the year, outperforming the benchmark which is down -11.8% in 2017.

The AFC Vietnam Fund was flat in December, underperforming the VN-Index in USD terms which rose +3.7%. The fund is now up +13.4% for the year and +85.5% since inception, celebrating its 4th year with an annualized return of +16.6% p.a.

2017 was an eventful year for Asia Frontier Capital and for several of the markets we invest in.

Some of the key developments were:

  • The launch of the Luxembourg-domiciled AFC Asia Frontier Fund (LUX), a SIF fund, which is a parallel fund to the award-winning AFC Asia Frontier Fund (Non-US).
  • The announcement of the Japanese share class for the AFC Vietnam Fund.
  • The redemption notice period for the AFC Vietnam Fund was shortened from 60 days to 30 days.
  • We increased the AUM of the AFC Asia Frontier Fund by 30% to USD 24 mln, and the AFC Vietnam Fund by 50% to USD 44 mln. The firm’s total AUM is now USD 70 mln.
We received several recognitions and awards during 2017 including the following:


Thomas Hugger took the top spot in Citywire’s line-up of best performing frontier markets managers as the CEO of Asia Frontier Capital and Fund Manager of the AFC Asia Frontier Fund, outperforming all other frontier fund managers in Citywire’s database over a 3-year period up to 30th April 2017.



Asia Asset Management honoured us in their Best of the Best 2017 Awards event with the Award in the category “VietnamMost Innovative Product” and in the category “Vietnam – CIO of the Year” for our AFC Vietnam Fund CIO Vicente Nguyen



We celebrated the 5-year anniversary of our AFC Asia Frontier Fund with the prestigious award from CNBC Allocator’s Investors Choice Awards 2017 who voted us winner in the category “Emerging Long Only Equity Fund of 2016”.



Finally, the AFC Asia Frontier Fund was the winner in the HFM Hedge Fund Performance Awards 2017, held in Singapore, in the category “Long/Short equity Asia ex-Japan”.



In 2017 Ari-Pekka Hildén joined the boards of AFC Umbrella Fund and AFC Umbrella Fund (non-US) as an Independent Director, strengthening the boards of directors which now have two independent directors out of a total of four directors.

We look forward to continuing and improving on our track record and our growth for the benefit of our investors in the years to come.

If you have any questions about our funds or would like to receive additional information, please be in touch with our team at This email address is being protected from spambots. You need JavaScript enabled to view it..


AFC Travel

Yangon, Myanmar 9th January – 10th March Scott Osheroff
Ho Chi Minh City 17th – 19th January Andreas Vogelsanger,
Ruchir Desai
Hong Kong 21st – 26th January Andreas Vogelsanger
Dubai 28th February – 1st March Ruchir Desai
Dubai 27th February – 1st March Thomas Hugger
Ho Chi Minh City 12th – 16th March Ruchir Desai
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AFC Asia Frontier Fund - Manager Comment



The AFC Asia Frontier Fund (AAFF) USD A-shares lost -2.3% in December 2017, finishing the year with a performance of +0.2%. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+6.1%) the MSCI Frontier Markets Net Total Return USD Index (+3.1%), and the MSCI World Net Total Return USD Index, which was up +1.4%. The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +70.7% versus the MSCI Frontier Markets Asia Net Total Return USD Index, which is up +98.0%, and the MSCI Frontier Markets Net Total Return USD Index (+60.7%) during the same time period. The fund’s annualized performance since inception is +9.7% p.a. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 8.91%, a Sharpe ratio of 1.07 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.32, all based on monthly observations since inception.
This month was overshadowed by profit taking in Mongolia as the MSE Top 20 Index corrected by 11.8%. There was no major change in the country’s fundamentals, but the 88.7% rally through the end of November 2017 was bound to lead to a small correction. One of the fund’s larger holdings in Mongolia, a cashmere producer, witnessed a heavy amount of profit taking as the stock had rallied by more than 200% through November 2017. This was one of the major drags on performance, however the outlook for this company continues to be positive with a valuation which is not stretched, having a trailing 12-month P/E of 13x.
Pakistan continued its volatile trend due to political noise, with most of the month being weak as the KSE 100 Index was down by 5.2% for the month at one point. However, with valuations at very attractive levels, the market rebounded to close the month in positive territory with a gain of 1.1%. However, the USD currency return was impacted by the much awaited depreciation of the Pakistani Rupee which slid by 5% during the month. Given the rise of the current account deficit over the past year, the depreciation of the currency has been anticipated for the past few months with expectations of another 5% depreciation in the first half of 2018. This currency move is expected to be viewed positively by foreign investors as the currency, besides the politics, is one of the factors that has led foreign investors to remain on the sidelines over the past year.
With respect to Pakistan’s politics, there were also developments which can be viewed positively, namely the Supreme Court not giving its permission for going ahead with investigations against the Sharif brothers, while also not disqualifying Imran Khan from holding political office which has led to a consensus that the upcoming national elections will be a competition between the Sharif brothers’ PML(N) and Imran Khan’s PTI. The currency depreciation and the positive political developments, along with heavily discounted valuations, have given some legs to the market, with the KSE 100 Index up 12.9% in local currency terms since 19th December 2017 (a one year low).
On the economic front, activity continues, despite the political uncertainties, with industrial production growing by 8.8% in October 2017. Geopolitically, the U.S. continues to put pressure on the Pakistani government with respect to Afghanistan. The recent cut in U.S. military aid, could dampen investor sentiment, but the economic impact of this is debatable given the economic relationship Pakistan now shares with China. However, further improvements in the security environment due to pressure by the U.S. could be a longer term positive for Pakistan.
Vietnam ended the year on a positive note with the government divesting part of its stake in Sabeco to Thai Beverage at a premium valuation of around 44x trailing 12-month earnings, while macro related numbers remained robust with 2017 GDP growth at 6.8%, its highest growth since 2007. The foreign direct investment (FDI) story remains strong as FDI commitments increased by 44% in 2017 to USD 35.9 bln and FDI disbursement reached USD 17.5 bln, a growth of 10.8%.
The best performing indexes in the AAFF universe in December were Cambodia (+4.1%), Vietnam (+3.6%), and Iraq (+3.1%). The poorest performing markets were Mongolia (-11.8%) and Laos (-3.0%). The top-performing portfolio stocks this month were all from Mongolia: an oil producer (+101.9%), a duty-free shop (+29.7%), a copper and gold mining company (+28.3%), a bakery (+22%), and a construction materials company (+21.9%).
In December, we added to existing positions in Bangladesh, Mongolia, Pakistan, and Vietnam and we partially sold two companies in Mongolia.
As of 31st December 2017, the portfolio was invested in 114 companies, 1 fund and held 0.8% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (8.2%) and a pump manufacturer from Vietnam (3.5%). The countries with the largest asset allocation include Vietnam (28.0%), Pakistan (20.8%), and Bangladesh (18.1%). The sectors with the largest allocations of assets are consumer goods (30.1%) and industrials (16.2%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 15.32x, the estimated weighted average P/B ratio was 2.67x, and the estimated portfolio dividend yield was 4.13%.

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AFC Asia Frontier Fund – 2017 Performance Overview and Outlook for 2018


2017 Performance Overview

The year of 2017 began on an uncertain note for global markets due to the unexpected win for Donald Trump in the 2016 U.S. presidential election. In the run up to the election, as well as in the run up to his taking office in January 2017, Donald Trump had made a number of comments which were, to many observers, anti-trade and anti-globalisation. During his first week in office, President Donald Trump withdrew from the Trans Pacific Partnership (TPP) agreement, but this was expected given his statements in the run up to the election. In addition to the uncertainty over the U.S. President’s trade policies, markets were also anticipating a round of liquidity tightening from the U.S. Fed with expectations of three one-quarter point increases in the federal funds rate and these occurred as expected.
Major commodity prices continued to remain firm on the back of production curbs in China, as well as anticipated production cuts in crude oil by OPEC and non-OPEC members. Given the effectiveness of the production cuts on the oil price, OPEC and non-OPEC members agreed to continue to curb production by 1.8 million barrels for the first nine months of 2018. Further, tensions between Middle East power houses Saudi Arabia and Iran kept a lid on any downward pressure on oil prices. Coal prices also remained firm as China initiated a restructuring of its resources and manufacturing industries which has led to a significant decrease in production, thus leading China to increase imports of coal from Mongolia, Australia, and Indonesia, among others. China having embargoed coal imports from North Korea further buoyed prices. The North Korea dilemma has continued to be a foreign policy constraint for both the U.S. and China, but so far, this geopolitical issue has not yet had any negative consequences besides continued tough talk from both sides.



(Source: Bloomberg)


Despite the uncertain trade policy stance by the U.S. at the beginning of the year, and rising interest rates, global markets did well in 2017 with the US markets rising on the back of strong GDP growth, as well as on the back of the new tax cuts by the Trump administration. Emerging and frontier markets also did well with various economies continuing to show strong domestic consumption and stable GDP growth rates which continued to be backed by global liquidity flowing into these markets.



(Source: Bloomberg) 

GDP growth rates within most Asian frontier economies continued to be robust, driven by a combination of domestic consumption, as well as foreign investment led growth. Within the AFC Asia Frontier Fund’s larger markets, Vietnam, the fund’s largest country holding, posted GDP growth of 6.8% in 2017, driven primarily by industrial production which grew by 9.4 % in 2017.
This is not surprising since FDI (foreign direct investment) led growth has been strong over the past few years with Vietnam receiving FDI inflows of USD 17.5 billon and commitments of USD 35.9 billion in 2017 as the country continues to be an attractive location for low-end manufacturing given its large labour pool at attractive wages, compared to China, as well as due to its geographic proximity to the global supply chain. Multinational companies continue to increase their investments in Vietnam, with Samsung from South Korea pledging to invest another USD 2.5 billion in the country, taking its total investment in Vietnam to more than USD 17 billion (Samsung now manufactures the majority of its mobile phones in Vietnam).
Despite worries over the TPP not going through, which could have had a negative impact on FDI investments, as well as export growth, the former has shown robust inflows as mentioned above while exports grew by 21% to USD 214 billion in 2017, the highest growth rate Vietnamese exports have achieved in the past five years.



(Source: Vietnam General Statistics Office)



(Source: Vietnam General Statistics Office)



(Source: Vietnam General Statistics Office) 

Further, besides foreign investment led growth, the government continued its divestment plans and reduced its stake in multiple enterprises, most notably in Vinamilk and Sabeco, both of which elicited keen interest from foreign investors. In addition to state divestments, there were various IPOs of large companies across various sectors such as HD Bank (Banking), Vietjet (Aviation), Vincom Retail (Real Estate), VP Bank (Banking), and Vietnam National Petroleum Group (Oil Marketing). All of these positive factors led the Ho Chi Minh VN Index (VN Index) to rally by more than 40% in 2017, with the second half of 2017 having a more pronounced rally led mainly by a few large cap stocks, i.e. Sabeco, Vinamilk, Vincom Retail, Vingroup, and the banking stocks. 

Given the positive outlook for GDP growth, the fund’s Vietnamese holdings currently have a higher allocation towards cyclical names in the infrastructure, construction, and real estate sectors. Most of the fund’s Vietnamese holdings have shown low double digit returns in 2017, and therefore our Vietnamese portfolio has lagged the VN Index given our strategy of focusing on value and growth at reasonable prices which unfortunately did not lead us to invest in some of the large cap consumer and banking stocks trading at higher or premium valuations. Gains in the fund’s Vietnamese holdings were led by an agricultural pump company, a mid-end real estate developer, a pharmaceutical company and a construction company. During the year we booked profits in a real estate company, a consumer conglomerate, and an automotive battery company due to them all having had a good run, as well as due to their valuations.
We added a number of new positions in Vietnam this year which results from numerous on the ground research trips. New investments were made in a plastic bag manufacturer focusing on the export market, an infrastructure developer with a dominant position in Ho Chi Minh City, a steel producer with a market share amongst the top two in Vietnam, a medical equipment distributor whose business is turning around, a food products company focusing on building an ice-cream and frozen foods business, an industrial park developer, an oil transportation company with a dominant position in Vietnam, and a mid-end real estate developer.
The rally in the Ho Chi Minh VN Index over the past year, especially in some of the large cap stocks, has stretched the P/E of the index to 19.3x as of 31st December 2017, however the fund’s Vietnamese holdings trade at a discount to the index with a P/E of just 12.4x.
Pakistan, the fund’s second biggest holding, continued to produce very positive economic indicators across the board with auto sales, cement sales, and private sector credit all growing between 15-20% in 2017. This led to GDP growth of 5.3%, the highest in a decade, supported by a significantly improved security situation, China Pakistan Economic Corridor (CPEC) led investments, and lower interest rates. 



(Source: Topline Securities. (FY18: July 2017-November 2017))



(Source: Topline Securities)



(Source: State Bank of Pakistan, IMS Securities)



(Source: South Asia Terrorism Portal)

Paradoxically, this positive economic momentum did not translate into good stock market performance for a number of reasons. Firstly, the much-anticipated upgrade of Pakistan to the MSCI Emerging Market Index did not translate into foreign inflows given the country’s low weight of only 0.1% in the index. More importantly, extreme political noise, especially from the second quarter onwards, led to a large amount of uncertainties in the market given the disqualification of the former Prime Minister, Nawaz Sharif, and legal proceedings against him, his family, and the former Finance Minister, all of whom were party to the “Panama Papers” case which led to their political downfall.

Besides this, continued pressure from opposition parties, including right wing religious parties, added to the political uncertainty. Besides politics, Habib Bank, the country’s largest bank by assets, was fined heavily by U.S. authorities which also soured investor sentiment. In addition to political noise, the macro situation in the country deteriorated during the year due to rising imports against stagnant exports which has led to a rising current account deficit and thus reduced the country’s foreign exchange reserves. However, reserves of approximately USD 13 billion are still above their bottom of USD 5 billion reached in 2013. It is also important to note that the rising imports are primarily due to increasing machinery imports for CPEC related power projects, which will over time turn the current power deficit into a surplus, leading to increased industrial production and improved economic growth. As expected, given the wide current account deficit, the Pakistani Rupee depreciated by around 5% in December 2017 after much government resistance to keep it stable was put to an end.
CPEC continues to have the backing from all quarters of the country given its importance both geo-politically, as well as economically, as the majority of the initial projects are power-related which will help reduce the power deficit and decrease reliance on more costly furnace oil power generation as the upcoming power capacity is either coal or gas based which has a lower cost of generation. The elimination of the current power shortage can boost Pakistan’s GDP growth by 1 to 2% since the lack of power is currently hampering productivity. However, the government would also need to reform the transmission and distribution network in order to efficiently supply the new upcoming power capacity and given the equity returns being offered to these new power projects, the government will most likely be compelled to make incremental improvements in the transmission and distribution network.



(Source: IMS Securities)

In our “2016 annual review and 2017 outlook”, we had written about political noise in the run up to the 2018 national elections, as well as currency depreciation. However, the political extremity has been greater than expected and even though the real economy continues to do well, the environment surrounding the economy was not conducive to stock market performance. As a result, Pakistan was our biggest negative contributor to performance during 2017. Post the 20%+ correction in the KSE 100 Index from it's peak this year, the trailing 12-month P/E for the index stands at 7.9x as of 31st December 2017, close to a five year low and almost where it was prior to the 2013 elections.

Pakistan’s KSE100 Index valuation is close to a 5 year low (P/E in green)



(Source: Bloomberg)

Even though Pakistan faced uncertainties during the year, we continued our research with a trip to the country in October 2017. We initiated positions in four Pakistani companies, namely, an oil marketing company which is expanding its presence in the country and a paint company which has significantly lower margins compared to regional players and what we think has room for improvement as volumes will grow on the back of on-going construction activity in the country. We also added a technology company which is looking to IPO one of their valuable businesses in the U.S. market, making their local listing extremely undervalued. Finally, we added a packaging company which services leading consumer companies and is expected to benefit from strong consumption growth of fast-moving consumer goods.
We also reduced the fund’s biggest position in Pakistan, a pharmaceutical company which has been the fund’s best performing stock since the inception of the fund as its valuation had become very stretched at a P/E of 40x. We reduced the majority of this position, but in hindsight we should have sold all of it given the market correction after our partial sale.
The fund’s third biggest country weight, Bangladesh, continued to deliver consistent economic growth of 7.2% in 2017 as the improvement in political stability over the past 18 months has led to a pick-up in private sector credit, as well as consumption. Even though worker remittances have been weak over the past year due to an economic slowdown in the Middle East, from where the majority of remittances come from, consumption growth has been strong as reflected in the results of consumer companies, as well as in the uptick of private sector and consumer loans. Despite the fund not holding any banks given that some of the well-run banks have rallied this year, performance of the fund’s Bangladeshi holdings was good with a gross return of 14.2% led by the fund’s largest holding, a GDR of a Bangladeshi pharmaceutical company, as well as a tobacco company and a telecom holding which the fund purchased during the first quarter of 2017. During the year, the fund exited a pharmaceutical company and consumer food products company due to high valuations.



(Source: Boston Consulting Group)

Our contrarian view on Mongolia over the past two years continued to make it the fund’s fourth largest holding as the country saw a positive change in fortunes on the back of rising commodity prices and exports. This subsequently saw the Mongolian Stock Exchange (MSE) have the second-best performance among global stock markets (behind Venezuela). Confidence in Mongolia was further bolstered by its agreement to take a USD 5.5 billion IMF-led bailout package on 19th February 2017. This has subsequently provided stability to the country’s finances and enabled Mongolia to both refinance and issue new sovereign debt at competitive interest rates. In July, Mongolia held its presidential election where, unexpectedly, a member of the opposition party—Kh. Battulga—won with just over 50% of the votes. Fortunately, the ruling Mongolian People’s Party (MPP) has a supermajority in Parliament and is therefore able to override any potential vetoes. As a result of the outcome of the Presidential election, the MPP decided to form a new government which saw the election of U. Khurelsukh as the new Prime Minister on 25th September 2017.
Since July, Mongolia has seen China restrict the number of coal-carrying trucks which can enter the country, falling from ~1,200 per day to ~500. However, after Mongolian Foreign Minister Damdin Tsogtbaatar’s visit to China in early December, the Chinese decided to lift the quota of trucks to 850 trucks per day. This should therefore cause Q1 2018 Mongolian GDP to show either stable or a modest improvement over Q4 2017.
The key drivers of the MSE-index performance were the rise in Tavan Tolgoi JSC, a coking coal mining company which saw its average realized sales price for coal increase during the year, and APU JSC, the country’s largest beverage manufacturer, which merged its business with Heineken’s existing Mongolia beverage assets. APU continues to produce its own dairy, soft drink, vodka, and beer brands, and it also now produces and distributes the locally made Tiger Beer which is from Singapore.



The Mongolian stock market was the second-best performer globally in 2017

* All in USD (However we assume that Bloomberg is using the “official” Bolivar rate and not the black-market rate which would result in a very different and lower return for Venezuela)

(Source: Bloomberg)



The Sri Lankan market started the year on a positive note, but unforeseen factors such as a drought and floods in the first half of the year impacted consumer incomes which were already hurt by the Value Added Tax led price increases. The government continues to try and balance growth with fiscal consolidation which has led to an improvement in foreign exchange reserves over the past year. The political coalition government did not help market sentiment much, but as discussed in our review last year, as well as in our May 2017 travel report, valuations were very attractive and this resulted in us increasing our weight slightly this year.
Even though Sri Lanka is the fund’s fifth largest country position, the fund’s Sri Lankan holdings delivered a 17.5 % gross return with most of the holdings outperforming the broader index. Gains were led by a consumer conglomerate, a bank, and a tobacco company. The fund also entered into the largest diversified conglomerate in Sri Lanka due to extremely cheap valuations, an infrastructure developer given the ongoing construction activities in the country, a household goods product manufacturer which is looking to make inroads into the ASEAN market, and a consumer conglomerate with a strong presence in the retail tea market, as well as in the wholesale and retail of pharmaceutical products. We exited an alcoholic beverage company towards the end of the year as the government policies for this sector continue to change every few years which gives us a lack of confidence on future earnings growth.
From a country allocation perspective, there was not a lot of change compared to the end of 2016. Vietnam, Pakistan, Bangladesh, and Mongolia continue to be the Top 4 country allocations, similar to last year, while the major changes were the increases in the weights of Sri Lanka for the reasons mentioned above, as well as a slight increase in the weight of Iraq as the market there could be poised for a recovery given the downfall of ISIS in the region and also due to rising oil prices. Broadly, the largest contributors to positive performance this year were Vietnam, Bangladesh, and Mongolia, while the largest negative performers were Pakistan and Iraq.
In terms of sector allocation, the consumer group (consumer staples/consumer discretionary) continued to be the largest. The second largest sector allocation is now to industrial stocks compared to healthcare stocks at the end of 2016. This is due to increased exposure to industrial stocks in Vietnam given the positive outlook for GDP growth, while the healthcare allocation has come down due to the fund significantly reducing its position in a Pakistani pharmaceutical company, as mentioned earlier, which was the fund’s second biggest position at the end of 2016.
In line with our process of on the ground research, our team continued their research trips throughout the year with visits to Bangladesh, Cambodia, Iraq, Laos, Mongolia, Myanmar, Pakistan, Sri Lanka, and Vietnam. In 2017, our team conducted 172 face-to-face meetings with management teams across our markets, including site visits to production facilities/factories of various companies. The fund’s diversified approach continued to keep annualised volatilities lower than various benchmarks, while correlations with global markets were also low and therefore these factors continue to make a compelling investment case for Asian frontier markets.



(Source: Asia Frontier Capital, Bloomberg)



We continued to focus on our benchmark agnostic approach, as well as on our focus towards value and “growth at reasonable price” related investments. Since the inception of the fund, the country and sector allocation have deviated significantly from that of the benchmark since we prefer to pick stocks across the universe and not just focus on names that can give us “comfort” in being closely aligned to the benchmark. However, in 2017 there was an even greater divergence between the fund allocations and that of the benchmark since Pakistan, a historically large weight for the fund since inception, was upgraded to the MSCI Emerging Markets Index in June 2017 whilst we continued to invest in Pakistan as it continues to have all the attributes of a “truly frontier market”.
To put this into context, as of 31st May 2017, the last day that Pakistan was part of the fund’s benchmark (the MSCI Frontier Markets Asia Index), its weight in the index was 63.1%, and Vietnam’s weight was 15.9%, while as of 31st December 2017, Pakistan was no longer part of the benchmark (due to the upgrade to the MSCI Emerging Markets Index), while Vietnam’s weight jumped to 77.8%. Further, the top 10 stock constituents of the benchmark currently account for 82% of the index, up from 62.4% as of 31st May 2017 with the largest weight currently being Vinamilk from Vietnam at 28.8%, while as of 31st May 2017 the largest weight of a single stock was at 9.6% (Habib Bank from Pakistan). Therefore, over the past six months the fund’s benchmark has seen a significant change in concentration levels, while the fund’s allocations have not moved towards that of the benchmark given our strategy. The table below compares the fund’s allocations with that of the benchmark as of end of 2016 and end of 2017.



(Source: Asia Frontier Capital, MSCI)
AAFF: AFC Asia Frontier Fund, MXRA: MSCI Frontier Markets Asia Index


Though the significant change in the benchmark did impact relative performance, the fund’s absolute performance was also below par and it was impacted by a number of factors. The fund historically has not had a large weight in banking stocks, but this year both Bangladeshi and Vietnamese banking stocks did well as loan growth picked up in both of these markets. However, the Bangladeshi bank that we wanted to buy had already rallied in the first few months of 2017 and we therefore believed we could buy it in the event of some profit taking, but this did not occur and the stock continued to rally, and as a result it was not a very good idea to chase this stock at a higher valuation. Regarding some of the other banking names in the country, we were not so sure due to their historical non-performing loan issues.
In Vietnam, even though we believed that banks would do well in 2017, the well-run banks which we wanted to buy were, and still are, fully foreign owned and paying a premium to market price would impact the fund’s NAV overnight. This is something (paying a premium to market price) we have avoided since the inception of the fund. Further, we would rather buy a bank which we like, rather than getting banking exposure through any bank as this is not necessarily the most prudent way to manage the fund. Therefore, given the pick-up in loan growth and GDP growth, we instead focused on investing in cyclical names in the infrastructure, real estate, and construction space which would benefit, and these names have also done well for the fund in 2017.
In addition to banking stocks in Bangladesh and Vietnam, which the fund did not have exposure to, it also did not have exposure to some of the large cap Vietnamese stocks that did well in the second half of 2017, namely, Sabeco, Vinamilk, and Vingroup, whose rallies were primarily event driven. The rally in the first two names was linked to the government selling down their stake at a high valuation which led to a rally, while in Vingroup the rally was primarily due to the listing of its subsidiary, Vincom Retail, also at a high valuation. As discussed previously, given our approach of value and growth at reasonable prices, the above three names were beyond our comfort level in terms of valuations and this worked against us in 2017.
It is also important to note that although the fund did not hold some of the names in Bangladesh and Vietnam that impacted both absolute and relative performance, the fund’s holdings in both these countries have delivered an average return of 23.6% and 29.9% over the past three years respectively. Every year there will be some “hot” stock or “hot” sector to invest in, and while at times we may be wrong, we overwhelmingly prefer to buy and accumulate returns rather than changing the portfolio every quarter based on what is most “En Vogue”.
Further, despite not having some of the names in Bangladesh and Vietnam that outperformed their respective markets, the fund’s Bangladeshi and Vietnamese holdings did return between 15-20%, however, most of these were non-benchmark names which does not really get reflected in relative performance.
The correction in the Pakistan market is what impacted both absolute and relative performance the most, with the KSE-100 Index correcting by more than 20% between May and December 2017. The Pakistan market has had a good run over the past few years and though a correction was warranted, it was exacerbated by a number of factors in a very short period of time between June and August 2017. These factors were the upgrade to the MSCI Emerging Markets Index which did not bring in the expected foreign flows due to the low weight of Pakistan in the index, the disqualification of the former Prime Minster and the resulting political uncertainty, the steep increase in the current account deficit and the fine paid by Habib Bank (the largest bank in Pakistan) to U.S. authorities. All of these factors occurred in tandem, leading to a quick correction in the market despite the longer-term story, as well as economic momentum in the country still being strong. Reducing the fund’s weight in Pakistan would mean selling at the bottom and would also be against our conviction that the story in Pakistan is one of the better one’s in Asia over a 3-5 year horizon and it is now trading at its lowest valuation since the beginning of 2013.
The fund also did not have many major “winners” unlike previous years where the fund had a number of stocks returning more than 100% in multiple markets. The fund did have stocks returning more than 100% in Mongolia, but in Bangladesh, Sri Lanka, and Vietnam the higher ranges of stock returns were between 30%-60%.
Going forward, despite 2017 having multiple factors working against the fund, we will continue with our focus on stock selection as that is what has delivered a cumulative return of 9.7% since the inception of the fund and importantly, the fund’s valuations are attractive and significantly below the benchmark, which positions the fund appropriately in terms of delivering sustainable returns not only in 2018, but also in the long run.
We believe this to be the case as Asian frontier markets are attractively positioned to achieve sustainable economic growth due to very attractive demographics, rising disposable incomes, increasing urbanisation, improving infrastructure and political and social reform backed by attractive valuations. In addition, Asian frontier markets continue to be under researched, as well as misunderstood relative to their larger emerging market peers which leaves room for generation of sustainable alpha in the longer run.

The fund is trading at a big discount to the benchmark
      AAFF MXRA    
    P/E (x) 15.3 27.1    
    P/B (x) 2.7 4.4    
    Dividend Yield 4.1% 1.5%    


 (Source: Asia Frontier Capital, MSCI)
AAFF: AFC Asia Frontier Fund, MXRA = MSCI Frontier Markets Asia Index


Outlook for Key Markets

Like in the past few years, the New Year begins in anticipation of interest rate tightening from not only the US Fed, but also from the EU (European Union). However, with economic growth picking up in the US, as well as in the EU, the worries similar to the previous year should be more muted. Further, economic growth in both frontier and emerging markets is expected to be robust going into 2018. Within our universe as well, rising rates in developed markets should not be as big of a threat as had been previously because (1) the markets have been anticipating these moves (2) most corporates in our fund/universe do not have a lot of USD denominated debt and in fact are not very leveraged, while on the sovereign level most of the government debt is denominated in local currency. Of the foreign currency debt, the majority of it is long term in nature and/or multilateral related.
Higher commodity prices continue to be a risk for commodity importing countries with respect to their current accounts and therefore their currencies. It would not be surprising to see some currency weakness for commodity importing countries in the frontier and emerging Asia regions in the event that commodity prices, especially crude oil, witness a further increase from current levels. Given rising commodity prices over the past 12 months, we are also expecting to see a manageable increase in inflation in our universe which could lead to a trend towards rising rates in some of our markets such as Pakistan.
Worker remittances for economies in South Asia are expected to remain soft given the economic slowdown and political turmoil in the Middle East. It seems that these economies appear to have adjusted to this event as remittances have been weak for more than 12 months. Surprisingly, despite the lower remittance inflows, the impact on consumer spending has been muted as both Bangladesh and Pakistan have seen strong consumer discretionary spending this year.

Geopolitically, we expect political tensions to continue, most notably in the Korean Peninsula and in parts of the Middle East. Which way the U.S-North Korea standoff goes is difficult to judge given the continuous hard-line comments from both sides, while in the Middle East the standoffs between Qatar and its neighbours, and between Iran and Saudi Arabia, continue and any escalation there may potentially lead to short term spikes in the oil market.

Despite geopolitical concerns, we expect that the global economy will be led by frontier and emerging markets in terms of economic growth not only in 2018 but over the next decade and Asian frontier markets continue to stand out in terms of economic potential due to their large, young population, rising disposable income levels, increasing urbanisation and greater political and social reform.

More importantly, the China led “One Belt One Road” (OBOR) initiative is expected to have a positive economic impact on many Asian frontier countries, most notably Pakistan due to the China Pakistan Economic Corridor (CPEC) which is the showcase of the OBOR initiative. Other countries within our universe which are expected to benefit from OBOR are Bangladesh, Myanmar, and Sri Lanka which will most likely see greater infrastructure investments via OBOR which should be positive for their economies.

Besides the impetus from OBOR, Asian frontier economies are also benefitting from the shift of higher wage jobs from China as these markets offer an untapped labour pool with lower wage costs. As discussed above, Vietnam is a key beneficiary of this trend, but countries such as Bangladesh, Cambodia, and Myanmar are also benefitting. In Bangladesh, garments now account for approximately 80% of the country’s exports.



(Source: IMF)


OBOR expected to be a boon for Asian frontier markets




(Source: Merics)



(Source: Wage Indicator Foundation)

In addition to positive economic prospects, valuations across Asian frontier markets remain attractive, especially that of Pakistan where valuations for the KSE100 Index are close to a 5-year low. Asian frontier markets continue to be under researched relative to larger emerging markets which provides the opportunity to take a longer-term view on our investments, as well as benefit from an early mover advantage since most Asian frontier markets witness relatively lower foreign investor participation. We expect to continue with our benchmark agnostic and value/growth at a reasonable price approach given the opportunities across our markets and also because this strategy has worked in the long run, despite last year’s setback, delivering an annualised return of 9.7% the since inception of the AFC Asia Frontier Fund.

Below is the outlook for the markets within the AFC Asia Frontier Fund.

We expect the positive economic momentum in Bangladesh to continue into 2018. Political stability has prevailed over the past two years leading to a rise in private sector credit growth and consumer spending. With elections expected to be held in early 2019, it is too early to judge whether there will be any political noise in the run up to the elections. Luckily, thus far there has not been any sign of political uneasiness in the country. Inflation could pick up or stay at elevated levels due to the recent floods which impacted agricultural production, while the rise in the current account deficit due to an increase in machinery imports and rice is expected to keep the Bangladeshi Taka slightly weaker. However, despite some expected macro weakness in 2018, Bangladesh will continue to have sizeable foreign exchange reserves of around USD 32 billion plus which cover approximately 8 months of imports and thus gives us enough comfort. We continue to like the consumption led story in Bangladesh due to its large, young population, rising disposable incomes from a low base, a burgeoning middle class, increasing urbanisation, and under-penetrated consumer markets.
We strongly believe that consumption driven stocks in the consumer staples, consumer discretionary, financial services, and telecom sectors can generate consistent long-term returns. We further believe that if the current political stability experienced over the past two years becomes a consistent feature in the country, the corporate earnings will show a strong growth in the coming years as most segments of the economy are growing from a low base and remain under-penetrated.
2018 is likely to see a modest slowdown in Cambodia’s rapidly growing economy as 2018 is an election year which has historically trended towards moderated growth prospects. Further headwinds include credit growth retreating from the 30%+ annual growth it has experienced over the past several years, as well as rising wages for manufacturing jobs due to strong labour unions in the country which will likely give factory owners reason to second guess expanding into the Kingdom in lieu of more favourable destinations such as Bangladesh, Myanmar, or Vietnam.
On 1st January, 2017 the new minimum wage for employees in the garment and manufacturing sector came into effect rising 9.2% from USD 153 to USD 170. This increase has now made Cambodia one the most expensive manufacturing destinations in frontier Asia. Expectations of this increase have caused existing factory owners to explore new, lower wage markets in order to remain competitive and Cambodia is likely to see both new factory entrants decrease, as well as some existing factories cease operations.
The tourism front is much brighter with the Minister of Tourism having announced an initiative for Cambodia to receive 2 million Chinese visitors per year by 2020. This is significant since the Kingdom saw only 5.7 million visitors in the full year 2016. No wonder, tourism continues to be a growth driver for the economy, in line with a robust real estate sector which is seeing a never-ending construction of casinos, hotels, and luxury apartment buildings throughout the country.
Interest in the Cambodian Stock Exchange remains tepid among foreigners and locals alike with only 5 listings, and with the exception of one, the other listings don’t show either much value or potential for robust growth at the present time in our view. As of today, we don’t see many investment opportunities in 2018, save for the resource and minerals sector whose companies are listed on overseas exchanges.
For the first time in a number of years, the new year outlook for Iraq is brighter with improving fundamentals after a number of extremely difficult years. The ISIS invasion that nearly tore the country apart in 2014, and consumed all of its resources over the last 3 years has been wound down as the year came to an end. Similarly, the outlook for oil prices, the main source of its income, is improving as the excess supply that crushed prices over the last 3 years has been reduced by a combination of OPEC production cuts and improving global growth prospects. Moreover, the regional backdrop is showing signs of stability, after being marked by civil war in Syria which itself is winding down.

Iraqi companies’ own fundamentals have bottomed over the last 6 months and encouraged by tentative signs of recovery, have over the same period announced attractive dividends. In particular, high-quality banks offer dividend yields of up to 11% and mobile operator Asiacell offers a 14% dividend yield.

The equity market has yet to discount these positives, down -11.8% for the year on the back of consecutive declines of -17.3% and -22.7%. The primary reason is, unlike the negatives of the liquidity crunch in 2014 which were felt in relatively short order, the positives of the revival in liquidity will take longer to filter through to the economy and ultimately to the equity market. All of these points underscore the opportunity to acquire attractive assets that have yet to discount a sustainable economic recovery.

However, significant challenges remain with the huge demands for reconstruction, winning the peace, defeating a likely emerging ISIS insurgency, and controlling violence, all the while resolving the Kurdish issue. Finally, the upcoming parliamentary and provisional elections in May 2018 will likely be the main focus of the market, causing a potential delay in the resolution of other issues.
Laos is expected to continue experiencing robust growth in 2018 as the country continues to develop its natural resource and agricultural sectors, in addition to a renewed focus on developing its tourism sector. Laos has launched a marketing program “Visit Laos Year 2018” where the country is aiming to achieve tourist arrivals of 5.2 million, which would create jobs for locals and also provide a robust influx of foreign currency to help to close its current account deficit.
Infrastructure will also be a big story in 2018 as China continues construction of a railway connecting Yunnan Province in China with the Laotian capital, Vientiane. The railroad is expected to be completed in 2021.
For the Laos Stock Exchange, 2018 is expected to see the listing of several more companies which should add further clout to this underappreciated market. With Bangkok Bank now offering custodial services, it is anticipated that in due course foreign investors will take notice of some of the six currently listed companies, some of which are trading at significant discounts relative to their peers in Vietnam and Thailand, while also boasting dividend yields in certain cases in the high single digits. 
Political uncertainties continued to impact overall tourism inflows with important markets such as China continuing to show weak tourist inflows for a third year in a row. Tourism inflows are not expected to pick up significantly as long as the political situation remains on edge and we therefore continue to not have any exposure to the country. In the past, the fund had exposure to the Maldives via Sri Lankan hotel listings. 
Entering 2018, the Mongolian economy faces several headwinds, namely China limiting the number of coal carrying trucks able to enter across the Gants Mod border crossing on a daily basis. If the border issue continues it will create a drag on economic growth as this border crossing is where over 70% of Mongolia’s coal and copper is exported from. Luckily, we saw signs of a thaw at the border late last year where China increased the quota of trucks to 850 after the Mongolian Foreign Minister paid a visit to China. Mongolia still needs to advance towards the eventual construction of a railroad to transport coal to China if Mongolia seriously wants to grow their economy, as this would make Mongolia the most competitive foreign supplier of coking coal to China and subsequently be positive for some of the listed coal mining companies with operations in Mongolia.
On minerals and tax legislation passed in late 2017, the government needs to provide clarity on taxes, specifically those relating to the sale or transfer of shares in companies which own mining licenses (currently the tax is 30%). In due course we expect the legislation to be amended as there are several working groups among various chambers of commerce currently educating the government on the need for straight forward legislation to attract significant and prolonged interest in the resource sector, which in Mongolia also means meaningful amounts of FDI.
Due to its geographical proximity to China and China’s national campaign to cut overcapacity in the coal sector and improve environmental standards, Mongolia is potentially very well positioned moving into the new year.
2017 saw the passing of the Companies Act which is set to replace the Companies Act of 1914 and among other benefits will enable foreigners to own up to 35% of a local company. However, after its passage and signing into law by the President, the government stated it would not be enforced for at least eight months (expected in August 2018) as bylaws need to be drafted to ensure proper enforcement. This is a major setback for Myanmar which has struggled to attract FDI as many foreign investors have been waiting for the new Companies Act before entering the country. Though, there is still generally robust interest in the country as Myanmar hosts a significantly under-penetrated consumer market on all fronts, not to mention the country has the potential to host multiple world class resource deposits, being rich with everything from tin to rubies to gold and copper.
It is expected that once the new Companies Act comes into effect, the Yangon Stock Exchange will then permit foreigners to trade, which will provide much needed liquidity, as well as likely also encourage other local companies to IPO.
Economically, Pakistan performed as expected with GDP growth of 5.3%, its highest over the past decade, backed by low interest rates, an improving security environment, and China Pakistan Economic Corridor (CPEC) led investments. Last year, we wrote that we expected political noise in the run up to the 2018 national elections, but the extremity of the political noise was more than we anticipated. We also expected some currency weakness in the Pakistani Rupee due to pressure on the current account, but due to the political sensitivity the central bank only let the currency slip in December 2017.
Though Pakistan enters 2018 with concerns surrounding the macro and political environment, we like to point out that earnings for companies within the KSE-100 Index have grown at a CAGR of 16% over the last decade and this cycle covers periods of military rule, political instability, security concerns, as well as positive economic momentum. With the current valuation of the KSE-100 Index at a trailing 12-month P/E of 7.9x, the market is the cheapest since prior to the 2013 elections when economic growth was soft, the security situation was poor and there was no CPEC. At present, the outlook for GDP growth is 5% compared to 3.6% in 2013, the security situation is better than it has been in the last decade, and the CPEC is being executed.
Even though politics will continue to take up most of investors’ attention, the real economy will continue its positive momentum into 2018 as private sector credit, including fixed investment loan growth, has been growing at double digits over the past year, which should lead to increased output in 2018. Besides a continuation of the economic momentum, the CPEC continues despite the political noise with 7% of CPEC projects being completed and 28% under construction with a majority of these projects being power related with the aim of reducing the shortfall in power. The Pakistani Rupee could depreciate some more in 2018 given the pressure on the current account which could lead to higher inflation and a slight uptick in interest rates.
Relations between Pakistan and the U.S. are also expected to remain tense given President Trump’s comments towards the country and this could impact investor sentiment, but it does not significantly change the bigger picture story for the country in terms of it moving ahead economically, as well as in terms of security. Further, Pakistan’s economic and political proximity to China should act as somewhat of a counterweight to significant increased pressure from the US administration.
With a scenario of currency depreciation, higher oil prices and rising interest rates we think oil & gas and banking stocks could deliver relatively better performance as oil & gas companies derive their revenues in USD, while rising rates could see banks improve their net interest margins which have been depressed over the past year. Though currency weakness could negatively impact companies in the consumer discretionary sector in the near term, the structural demand story for the automobile sector is strong given the under penetrated market, as well as the launch of new models which should drive demand. Importantly, auto companies in Pakistan also have pricing power through which they can eventually pass on higher input costs to the consumer. Lower cost producers of cement also offer value post their recent stock price correction as past incidents of cement price competition have not been beneficial for the industry and have therefore led back to pricing discipline.
Pakistan is now amongst the cheapest markets in Asia and although worries over currency and politics remain, the country is in a much better position than it was in the early part of this decade. We prefer to take a 3 to 5 year view on the country and not a 2 to 4 quarter view and hence remain long term positive on Pakistan.
Papua New Guinea
The country continues to recover from the impact of lower commodity prices, as well as a severe drought, with a GDP growth outlook of close to 3% in 2018. However, the country still suffers from a not fully resolved shortage of foreign currency reserves. The government has initiated a plan to reduce expenditure and the fiscal deficit, but in the near term given the recent end to the large LNG investment, growth rates would still take a while to recover as the government focusses more on fiscal consolidation. We do not expect to increase our holdings in the country significantly.
Sri Lanka
Compared with last year, Sri Lanka starts 2018 on a stronger economic footing compared to the previous few years as foreign exchange reserves have improved while the fiscal deficit has been controlled. Since the current account deficit and fiscal deficit have been stabilised, consumer incomes may still remain stretched into the early part of 2018 due to the floods and drought impacting purchasing power, in addition to being hurt by the Value Added Tax led price increases. Measures announced in the recent budget in November 2017 may also lead to higher prices at a time when consumer incomes are soft. Infrastructure related activities should continue moving forward led by the Colombo International Financial City. Valuations remain attractive with the Colombo All Share Index trading at a trailing twelve-month P/E of 11.8x compared to its five year average of 14.3x and thus we expect to maintain our positions in the country.
Vietnam enters 2018 on the back of both robust economic and stock market performance, with the economic momentum expected to continue into 2018, led by high loan growth, FDI investment led industrial growth and higher exports. 2017 was the year of the large caps in Vietnam and valuations for some of these companies are on the higher side so it would be debatable as to whether or not large cap companies can see another rally in 2018. However, a number of large cap IPOs are expected to be launched which could keep interest going in such names. Valuations amongst the small and mid-caps are still very attractive and we expect to see a rally in the small and mid-cap sector as investors look for other opportunities besides the large caps given the positive growth outlook for the country. We continue to like companies within the cyclical sectors such as construction, infrastructure, and industrials due to the outlook for robust economic growth, as well as attractive valuations. We also favour companies in the transportation infrastructure and retail infrastructure sectors, but would look at such names at more attractive valuations. Overall, 2018 should continue to be a good year for Vietnam as it stands out amongst frontier market peers due to its political, as well as macro stability.

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AFC Iraq Fund - Manager Comment



The AFC Iraq Fund Class D shares returned +1.7% in December with a NAV of USD 567.40 which is an underperformance versus its benchmark, the RSISUSD index, which gained +3.1%. The fund is now down -7.5% for 2017, outperforming the RSISUSD index which lost -11.8% during the year.
The market continued to build on the November recovery, up +3.0% for the month, with locals picking up the buying interest from foreigners, whose recovery in buying activity in November was mostly a re-investment of dividends and partly fresh inflows as the spike in the chart below shows.

Foreign Buying (green), Foreign Selling (red) & their moving averages, as percentage of total buying & selling respectively



(Source: Iraq Stock Exchange (ISX), Asia Frontier Capital (AFC))


Foreign selling continued along the same lines of November as the spike in foreign buying ran its course. The increased local liquidity led to a +14% increase in average daily turnover versus the average of the March-October decline as can be seen from the chart below. Nevertheless, it is only in-line with the YTD average daily turnover, and significantly below that seen during the powerful October-February rally.


Average daily turnover Index on the ISX (green) vs RSISUS Index (red)



(Source: Iraq Stock Exchange (ISX), Rabee Securities, Asia Frontier Capital (AFC))


It’s looking increasingly likely that the market’s correction that began in March has run its course (see chart below). By October, the correction took the index down -31% from the February high, yet it was a positive sign that even at that low, it was still about 12% above the important May 2016 low. The higher lows, May 2016 and October 2017, should signal the end of the bear market that took the market down -68% from the February 2014 high.
From a technical perspective, the downtrend line marking the major bear market from February 2014 until May 2016 acted as support for the index during the current decline as can be seen from the grey lines in chart below, which would support the above line of reasoning.

 RSISUSD Index (red) vs its 200 day Moving Average (green)



(Source: Iraq Stock Exchange (ISX), Rabee Securities, Asia Frontier Capital (AFC))


Outlook for 2018 and Review of 2017


"You can only predict things after they have happened"
Eugene Ionesco


For the first time in a number of years, the new year outlook for Iraq is brighter with improving fundamentals after a number of extremely difficult years. The ISIS invasion that nearly tore the country apart in 2014, and consumed all of its resources over the last 3 years has wound down as the year came to an end. The military campaign, with its escalating costs has ended with the liberation of all ISIS held territories within Iraq.
Similarly, the outlook for oil prices, the main source of Iraq’s income, is improving as the excess supply that crushed prices over the last 3 years has been reduced by a combination of OPEC production cuts and improving world growth prospects. The MSCI Emerging Market Index, MSCI Frontier Market’s Index, Copper, and Brent crude, can be thought of as proxies for world growth: Emerging and frontier markets are driven by export growth, while copper and oil are direct beneficiaries of demand recovery, both highly dependent on resumption of world growth. The chart below shows a significant recovery in 2017 for MSCI Emerging Markets Index, MSCI Frontier Markets Index, copper, and Brent crude after a 5-year bear market that ended in early 2016.

 MSCI EM Index, MSCI FM Index, Copper, & Brent Crude



(Source: Bloomberg)

While Iraq is not a component of the MSCI Frontier Market Index, it has started to correlate with it from 2012 when it first witnessed meaningful foreign fund inflows. Correlations are never perfect nor constant, yet the RSISUSD Index diverged in 2016, and looks like it is lagging the MSCI Frontier Markets & Emerging Markets indices by about 6 months as seen from the chart below. In particular, it shows that the MSCI Emerging Market and MSCI Frontier Market Indices bottomed in early 2016, but within 12 months corrected to 20% and 7% above these lows, having peaked few months earlier.

 MSCI EM Index, MSCI FM Index & RSISUSD Index



(Source: Bloomberg)

The RSISUSD index, has also diverged from its historic correlation with Iraq’s Euro Bond (USD 2.7 bln bond issued in 2006, due in 2028 with a 5.8% coupon) and Brent crude (see chart bow). Both Iraq’s Euro Bond and Brent were up about +16.7% and +17.1% in 2017 vs. the RSISUSD’s decline of -11.8%. This happened in the first half of 2016, but then the RSISUSD resumed its correlation after a lag, yet it still ended 2016 down -17.3% vs. Iraq’s Euro Bond up +23.3% and Brent up +63.1%.

 Rabee Securities’ RSISUSD Index (green), Iraq’s USD 2.7 bln Bond (gold) & Brent Crude (red)



(Source: Bloomberg)

Low liquidity in the equity market accounts for both divergences, as a result of the continued absence of foreign investors and still constrained local liquidity. Foreign inflows accounted for a part of the recovery in emerging and frontier markets, while Iraq’s Euro bond trades institutionally & internationally and is not subject to the constraints of the local liquidity. The chart below is a proxy for net portfolio inflows into the equity market vs. the RSISUSD Index, which clearly points to a lack of inflows, and continued outflows.

 RSISUSD index (green) vs Net Proxy Portfolio Flows (red)



(Source: Iraq Stock Exchange (ISX), Rabee Securities, Asia Frontier Capital (AFC))

Local liquidity has been almost non-existent as a function of the significant time lag between recovery in oil revenues and liquidity filtering down into the real economy, and ultimately into the equity market. The time lag varies due to the state of the economy at the time, but has tended to be about 3-6 months. The chart below suggests that the equity market has yet to reflect the significant recovery in oil revenues. However, current oil market sentiment is extremely optimistic, which suggests that oil prices are due for a correction. Yet the changed supply-demand dynamics suggests the medium-term prices are likely to be in range of USD 55-60/bbl for Brent, which should have a sustainable positive effect on the economy. The first visible beneficiary of the recovery in oil prices has been the country’s foreign reserves, which increased to USD 49.0bln by end of November vs USD 45.2bln at end of 2016, and IMF’s estimates of USD 41.5bln by end of 2017.

 Iraq’s Oil Revenues (green) vs the RSISUSD Index (red)




(Source: Iraq’s Ministry of Oil, Rabee Securities, Iraq Stock Exchange, Asia Frontier Capital)
(Oil revenues are as of November with estimates by AFC for December)

Iraqi companies’ own fundamentals have bottomed over the last 6 months, and encouraged by tentative signs of recovery they have announced attractive dividends. In particular, high-quality banks declared dividend yields of up to 11% and mobile operator Asiacell a 14% dividend yield. In both cases, these attractive valuations come with improving fundamentals as the companies begin a recovery from the triple whammy that the ISIS conflict brought. In the case of the banks it was increasing NPL’s (non-performing loans), declining deposits and negative loan growth. While for Asiacell it was a loss of the third of the country, accompanied by subscriber losses and higher operating costs, decreasing ARPU’s (average revenue per user) that accompanied the roll out of 3G in 2015, and finally weakened consumer spending made worse by the introduction of VAT on SIM cards in 2016.
The regional backdrop is also promising for the first time in 3 years, and is showing signs of stability, after being marked by civil war in Syria which itself is winding down. While the recent Iranian demonstrations are a source of instability, it is worth noting that the demonstrators are in the thousands, unlike the millions who took part in the massive 2009 demonstrations. The common thread running through current demonstrations is economic dissatisfaction with demands for redirecting resources to the domestic economy away from foreign activities. While the demonstrations are likely to be contained, yet coming from the regime’s support base, these demands would likely lead to a decreased Iranian involvement in the region. In time, this should have positive implications on the proxy conflicts that plagued the region over the last few years.
However, the most significant regional development to look for in 2018 is the furthering of the realignment of interests of regional players in dealing with the root causes of the conflict, i.e. the deep economic and political disenfranchisement, that were such fertile grounds for the rise of extremism. This furthering should lead to long-term solutions which will involve significant investments in infrastructure to bring much-needed development and create prosperity.
The first to emerge is the Iraq-Saudi Arabia alliance, in which Saudi Arabia, to be followed by the UAE, is to take the lead in funding the reconstruction of the liberated areas, i.e. the western part of the country from Mosul, spreading into Anbar and beyond. Its significance is the economic revitalization of the liberated areas first through trade and then reconstruction. The first steps were the resumption of trade, through re-opening of the Iraq-Saudi Arabia border crossing and the Iraq-Joran border crossing. There are no data on the volume of trade with Saudi Arabia given the closure of the route in the 90’s following the First Gulf War. But data for 2014 show that, prior to the emergence of ISIS and the border closures, imports from Jordan accounted for about 24% of all Iraq’s imports. Their loss had a devastating economic impact on the area, i.e. Anbar, including the surrounding areas in Nineveh and Salah Ad-Din. This exasperated their disenfranchisement since 2003, but the resumption of these trade-links with their associated economic activities will provide a huge boost to the local economies. The reconstruction, even if the alliance is more modest than hoped for, will build upon and magnify the economic revival until it becomes self-sustaining. The economic rehabilitation of the liberated areas would be a crucial component in winning the peace and would go a long way towards the return of stability to the country. The rehabilitation of local economies would include these neighbouring Iraq, especially the ones associated with these trade routes, which ultimately leads to greater regional stability.
However, significant challenges remain for Iraq: the huge financial demands for reconstruction, winning the peace, defeating a likely emerging ISIS insurgency, controlling violence, and resolving the Kurdish issue. Finally, the upcoming parliamentary and provisional elections in May 2018 will likely be the focus of the government over the coming months. This could lead to delays in addressing the country’s challenges.
Yet, a change of direction is at hand, which underscores the opportunity to acquire attractive assets that have yet to discount a sustainable economic recovery. The prospects of the economic recovery following the ISIS conflict are discussed in AFC’s Ahmed Tabaqchali’s recent research piece as a non-resident fellow at the Institute of Regional and International Studies (IRIS) at the American University of Iraq in Sulaimani (AUIS): “Iraq's Economy after ISIS: An Investor's Perspective”. However, the recovery will likely be in fits and starts with plenty of zig-zags along the way as liquidity is still scarce with a time lag before it can filter down into the economy and ultimately into the equity market.
As of 31st December 2017, the AFC Iraq Fund was invested in 14 names and held 3.0% in cash. The fund invests in both local and foreign listed companies that have the majority of their business activities in Iraq. The markets with the largest asset allocation were Iraq (97.3%), Norway (2.2%), and the UK (0.5%). The sectors with the largest allocation of assets were financials (54.1%) and consumer staples (22.4%). The estimated trailing median portfolio P/E ratio was 11.18x, the estimated trailing weighted average P/B ratio was 0.88x, and the estimated portfolio dividend yield was 5.43%

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AFC Vietnam Fund - Manager Comment



The AFC Vietnam Fund returned +0.0% in December with a NAV of USD 1,854.02, having a return since inception of +85.4%. This represents an annualised return of +16.6% p.a. The December performance of the Ho Chi Minh City VN Index in USD was +3.7% while the Hanoi VH Index gained +1.9% (in USD terms). Since inception, the AFC Vietnam Fund has outperformed the VN and VH Indices by +5.6% and +26.4% respectively (in USD terms). The broad diversification of the fund’s portfolio resulted in a low annualized volatility of 8.89%, a high Sharpe ratio of 1.83, and a low correlation of the fund versus the MSCI World Index USD of 0.28, all based on monthly observations.

After the correction at the beginning of the month, a few selected index heavy weights such as Vinamilk (+6%), FLC Faros (+33%) and VCB (+18%) rallied strongly over the last two weeks and brought the index in HCMC to a monthly gain of +3.6%, while the broader market was almost unchanged. Banks and petrochemical stocks were the reasons for the index gain in Hanoi of +1.9%.


Market Developments in 2017


The first few years following the big bear market of 2007-2012 saw a revaluation of the completely oversold and undervalued stock market. This was especially true of small and mid-caps which were extremely undervalued and thus showed a nice recovery from a very low base. Fast forwarding to 2016, the year showed a more balanced advance in stock prices, while the long-awaited wave of privatizations started to accelerate in 2017. This was the year that foreign interest in new listings and auctions in state owned enterprises took off as brand names entered the market and foreign strategic investors replaced (often absent) value investors as the major buyers during the year. Other investors jumped onto this bandwagon and revalued many of those companies with heavy weights in the index such as Vinamilk, Vincom, and Sabeco.

In 2017, Vietnam became the most successful IPO market in the region with equities worth more than USD 7 bln (including Government divestments) successfully placed with investors.


Significant IPO deals in 2017

No Company Value
(USD mln)
1 Sabeco 4,834 Government divestment
2 Vincom retail 743 IPO
3 Vinamilk 395 Government divestment
4 VPBank 381 IPO
5 HDBank 300 IPO
6 Vietjet Air 189 IPO
7 FPT retail 130 IPO
8 DIG Group 108 IPO
  Total 7,080  
 (Source: Viet Capital Securities, AFC Research)


Vietnamese stock market capitalization 2006-2017 (USD bln)



(Source: Bloomberg, VCSC, AFC Research)

The market capitalization of the Vietnamese stock market increased by almost 2/3, from USD 85.6 bln to over USD 149 bln during the calendar year. Meanwhile, most market participants were focused on only a few stocks, ignoring the majority of the smaller and mid-sized stocks which didn’t perform at all in 2017, despite much lower valuations. By the end of the year the discount of small and mid-caps relative to the average index valuation widened from 35% to almost 50%, a valuation gap we have not seen since the lows a few years ago.

Government divestments were certainly positive for the development of Vietnam’s financial markets as the country has received more attention from international investors. Talk of an MSCI upgrade of Vietnam from a frontier market to an emerging market added positive momentum, especially from institutional investors. However, an actual upgrade is likely to take some time.

For valuation reasons, we are not trying to chase the very expensive index heavy weights such as VIC, ROS or SAB - no matter if they were recently driven by pure market speculation or surprises of M&A activity. Their bitcoin-like volatility has given us yet another reason to remain on the sidelines. Sabeco for example, which has the 5th- highest weight in the main index, showed price swings unlike any of the 70+ stocks in our portfolio.

 Sabeco Q4/2017



(Source Bloomberg)

After the Government divestment plan was announced, the stock price of SAB jumped from VND 260,000 per share in October and peaked at VND 347,000 per share in late November, which pushed up the index strongly. After the divestment, SAB dropped by around VND 100,000 within 3 weeks.
2017 was absolutely not the year for investments outside of those “story driven stocks”. Of course, that is not what we like to see as value investors, as our portfolio did not move very much in the second half of the year when we saw expensive stocks get more expensive and cheap stocks get cheaper. While this is frustrating to watch at the moment, we continue to look at the fundamentals where we see great value instead of playing momentum in questionably valued stocks.
On the other hand, we are also looking at nice developments within our portfolio. The five best stocks in our portfolio gained 102%, 59%, 56%, 56% and 56% in 2017. That compares to 84% (VIC), 81% (MBB), 80% (BID), 68% (REE) and 66% (VNM) as the biggest winners of the VN30-index. While the index valuation rose drastically over the past 12 months, our portfolio valuation moved sideways despite performing +13.4%.
Liquidity strongly improved
The liquidity on the Vietnamese stock market also strongly improved, with the average daily trading value (ADTV) increasing from USD 135 mln in 2016 to USD 248 mln in 2017, +84%, surpassing the Philippines (USD 139 mln).

Average Daily Trading Value 



(Source: Bloomberg, AFC Research)

Derivatives Market

In August, Vietnam launched a derivatives market in a bid to draw more investments into its capital markets. Since then, the number of contracts and trading value have grown strongly every month, from 58,444 contracts in August and a value of USD 192 mln to 357,612 contracts, valued at USD 1.5 bln in December. The derivatives market in Vietnam is still in its infancy and very limited, but we strongly believe that it will grow fast in the coming years as we have seen in other markets around the world.


Monthly derivatives trading value (USD mln)



(Source: HNX, AFC Research)

Economy had an impressive recovery

The economy showed impressive strength in 2017 with GDP growth increasing from 6.2% in 2016 to 6.81% in 2017, the highest since 2011. The largest driver of this growth came from the industrial sector which jumped to 9.4% in 2017 from 7.4% in 2016.

GDP growth Vietnam (%)



(Source: GSO, AFC Research)

Outlook for 2018

According to the Vietnamese Government, the economy is expected to grow at 6.7% in 2018, similar to the Asian Development Bank which has revised upward its GDP growth forecasts for Vietnam to 6.7% in both 2017 and 2018, compared to its previous forecasts of 6.3% and 6.5%.
On the stock market, we do not see a much longer continuation of the trend from 2017 where index heavyweights led the market. With higher valuations the opportunities for both private equity investors and buyers in the IPO market will become more difficult as sellers will adjust their selling price expectations accordingly. We still see a couple of interesting bigger deals in the primary market pipeline, but minority sales in the energy sector are certainly less “sexy” than airlines or breweries for example.
Many stocks which have driven the index in 2017 are trading at high earnings multiples of 25x-100x. Sometimes it is hard to explain to investors that earnings and valuation have a strong impact on the future potential in the long run when multiples are going from 20x to 30x-40x or more, where history has shown that the risks outweigh any short-term potential. Our top 5 holdings are expected to grow their earnings in 2017 by an average of around 30% and are trading at only 9.8x earnings. To double the price of Sabeco for example, which is expected to grow less than 10% in 2017, the P/E would have to rise from 38 to 76. In comparison, our largest holding, ABI, would have to double in price to merely trade at the still attractive P/E multiple of 10x.
Like all other market participants, we do not know today what 2018 will bring for stock markets around the world, including Vietnam, but we are trying to position ourselves to get the best long-term risk/reward ratio for our investors.
Vietnam’s GDP growth in 2017 has beaten all forecasts, reaching 6.81%, the highest growth rate since 2011. Industrial production growth has also seen a strong improvement and grew at 9.4% compared to 7.4% in 2016.
FDI registration and disbursement both reached a record high at USD 29.7 bln (+44.2%) and USD 17.5 bln (+10.8%), respectively.
The trade surplus recorded a new high of USD 2.67 bln. Export turnover continued to increase strongly to USD 213.8 bln (+21.1%), meanwhile imports were up 20.8% to USD 211.1 bln.

Foreign reserves jumped sharply and reached a new record high of USD 51 bln thanks to the successful government divestment of Sabeco, worth USD 4.8 bln, and strong FDI inflows.
CPI was below the government’s target, at 2.6% YoY, and credit growth in 2017 reached 16.96%.
Vietnam is estimated to have attracted nearly 12.9mln foreign tourists in 2017, up 29.1% year over year



(Source: Viet Capital Securities, AFC Research)

At the end of December 2017, the fund’s largest positions were: Agriculture Bank Insurance JSC (3.5%) – an insurance company, Sam Cuong Material Electrical and Telecom Corp (2.3%) – a manufacturer of electrical and telecom equipment, Global Electrical Technology Corporation (2.3%) – an electrical equipment company, VNDirect Securities Corp (2.1%) – an online brokerage firm, and Cantho Pesticides JSC (2.0%) – a manufacturer of agricultural chemicals.

The portfolio was invested in 75 names and held 2.9% in cash. The sectors with the largest allocation of assets were consumer goods (34.1%) and industrials (28.5%). The fund’s estimated weighted average trailing P/E ratio was 10.00x, the estimated weighted average P/B ratio was 1.69x and the estimated portfolio dividend yield was 6.20%


I hope you have enjoyed reading this newsletter. If you would like any further information, please get in touch with me or my colleagues.

With kind regards,
Thomas Hugger
CEO & Fund Manager

This email address is being protected from spambots. You need JavaScript enabled to view it.

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