(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.
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.