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Asia Frontier Capital's 2018 Review and Outlook for 2019!
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AFC Asia Frontier Fund: 2018 Review and Outlook for 2019

Dear Investors and Newsletter Readers,

Please find below the 2018 Review and Outlook for 2019 for the AFC Asia Frontier Fund.

2018 was a turbulent year for global markets with a number of headwinds such as the China-U.S. trade war, rising U.S. interest rates as well as geopolitical uncertainties. As we enter 2019, taking a three to five year view we are very positive on the prospects for Asian frontier markets as valuations are at multi-year lows while many of the countries within our universe will be amongst the fastest growing globally. Furthermore, countries such as Bangladesh and Vietnam are expected to benefit from any protracted trade war between China and the U.S and which are the two biggest weights for the fund. In addition, Asian frontier markets continue to have low correlations with global markets with the AFC Asia Frontier Fund having a correlation of 0.37 with the MSCI World Index since inception which makes these markets a good portfolio diversification tool and also provides low volatility with the annualized volatility since inception of the AFC Asia Frontier Fund at 9.3%.

Below is also a link to the latest Bloomberg Radio interview with our senior investment analyst Ruchir Desai discussing the 2019 outlook for Asian frontier markets as well as certain relevant links related to news flows from our investment universe.

We hope you find the "2018 Review and Outlook for 2019" useful and thank you for your interest in our monthly newsletters. Please let us know if you have any questions about our article today or our new AFC Uzbekistan Fund that will be launched on 1st March 2019, or would like to have a call with anyone of our team members.

Relevant links:

Bloomberg Radio: Low Oil Prices Good For Some Asian Frontier Markets (Radio) - Interview with Ruchir Desai

Nikkei Asian Review: Trade war buoys apparel industry in Bangladesh and Vietnam

Azernews: Uzbekistan attracts foreign specialist in accession to WTO

Bloomberg: Why Vietnam Could Be Asia's Biggest Trade War Winner

Nikkei Asian Review: The rise and rise of Bangladesh

Honda: Honda Inaugurates New Motorcycle Factory in Bangladesh

Reuters: Pepsi and Coca Cola pouring $1.4 bln into Pakistan - government



2018 Review

2018 was marked by a series of negative global events which resulted in poor performances across our universe. The AFC Asia Frontier Fund’s performance had less to do with stock selection and more to do with global events impacting sentiment across frontier and emerging markets which led to a “risk off mode”. On a bottom up basis, companies in the AFC Asia Frontier Fund’s portfolio remain fundamentally sound with stable earnings growth. Earnings growth on a trailing twelve months basis for the fund’s portfolio companies is at 13% while valuations of the fund, which were already attractive at the start of 2018, have now become extremely attractive in our opinion and trade at a big discount to the benchmark as well as other major markets and indices.



(Source: Asia Frontier Capital)



(Source: Asia Frontier Capital, MSCI) P/E ratios based on trailing 12 month earnings


The positive momentum across global markets witnessed in 2017 continued into the first quarter of 2018, but soon thereafter cracks began to appear in the global rally due to multiple factors: the trade war between China and the U.S. began to ramp up in March, with the U.S. initially imposing tariffs on USD 50 billon of Chinese imports and then following that up with another round of tariffs in the summer which covered an additional USD 200 bln of Chinese imports. The escalation of the trade war has caused a large amount of market uncertainty as it would have a trickle-down effect into Asian exporting economies given the interconnectivity of global supply chains.

Rising U.S. interest rates and the resulting stronger USD also weakened sentiment given that many countries and corporates have had it easy so far, borrowing USD loans at historically low rates as well as funding their current account deficits without much pressure on their currencies. With the USD interest rates and currency scenario changing, countries exposed to large amounts of USD funding and/or wide current account deficits began to see sentiment towards their markets souring. One of the major victims of this was Argentina, which had seen a big run up in its stock market in 2017, but the fundamentals of the economy were not necessarily strong, and were therefore susceptible to any major changes in global market sentiment. The end result was a big correction in both its stock market and currency, which led to the IMF providing a USD 57 bln bailout to Argentina, the biggest bailout provided in the history of the IMF.

The other victim of this changing interest rate and currency scenario was Turkey, which also saw a big selloff in its stock market as well as a price collapse of its currency. The geopolitical tension surrounding the country did not help its cause either.

Therefore, in addition to trade war issues, the major sell-off in large frontier and emerging economies like Argentina and Turkey led to weakening stock markets across the frontier and emerging market universe.

(Source: Bloomberg)

(Source: Bloomberg)


Another headwind for some frontier and emerging market economies, especially during the second and third quarter of the year, was higher crude oil prices. Oil importing countries were faced with a weak currency as well as higher oil prices which resulted in further pressure on current accounts.

2018 has frustratingly turned out to be the “perfect storm” of higher interest rates, higher inflation, currency weakness, and macro, as well as trade uncertainties which have resulted in pessimism across equity markets. The silver lining to this is that valuations across Asian frontier markets and emerging markets are very attractive with some markets and individual stocks trading at multi-year low valuations. Furthermore, the fundamentals of most of the companies in our universe are very stable while their long term earnings growth outlook remains robust given that Asian frontier markets are in our view “a structural growth story”.

(Source: Bloomberg)

The issues that have affected Argentina and Turkey, as well as the outcomes in these countries, do not in our view have a fundamental impact on Asian frontier markets, as trade links between our universe and Argentina and Turkey are very low. The strong USD has obviously had an impact on most frontier and emerging market currencies and some of our markets were not immune to this, with the Pakistani Rupee (PKR) and Sri Lankan Rupee (LKR) weakening by 26.3% and 14.6% respectively, something that we were expecting. As a result, our exposure to both Pakistan and Sri Lanka were at the lowest levels since the inception of the fund. However, some of the fund’s larger exposure countries like Vietnam and Bangladesh are in a relatively better situation with either large current account surpluses (Vietnam) or low external debt as % of GDP (Bangladesh).


(Source: Bloomberg)


The China-US trade war has impacted sentiment across markets as it has led to uncertainty as to how it might hurt other Asian exporting nations due to the interconnectivity of global supply chains. Vietnam, the fund’s largest country by weight, is also facing such uncertainties due to trade playing an important role in the economy, with total trade (exports + imports) accounting for close to 200% of GDP. However, exports have been robust in 2018, growing 14.4% so far this year. The main factor driving such consistent growth in exports is the fact that Vietnam continues to transform into a low-cost manufacturing base for many companies in the region with Samsung now manufacturing most of their smartphones in Vietnam. Lower wages, a large labour pool, improving infrastructure, and political stability are some of the key reasons for the country seeing an influx of foreign direct investments primarily linked to the manufacturing sector.


(Source: General Statistics Office of Vietnam)

Export data and growth for 2018 is from January-November 2018


Therefore, though the trade war is a concern, this shift of manufacturing jobs from China to Vietnam has been occurring for the last few years and is not a short-term trend. In addition to the South Korean companies like Samsung and LG that are both producing in Vietnam, many garment, shoe, and textile companies that have operations in China have also moved a large part of their production to Vietnam over the last few years. In fact, in the long run, the trade war could actually increase the number of manufacturing jobs moving to Vietnam as companies in China look to reduce their exposure to existing as well as potential U.S. tariffs.

There are concerns about the trade deficit that the U.S. has with Vietnam given the recent U.S. actions against countries with which the U.S. has a high trade deficit. However, it is important to put this in perspective as the U.S. trade deficit with Vietnam is 9x less than that of China, 3x less than that of Mexico, and between 1.6-1.7x less than that of Germany, Canada, and Japan. Vietnam appears to be a “small fish” in this trade war game and furthermore it is becoming an important market for U.S. machinery and high-tech goods (i.e. airplanes and jet engines), while also being a geopolitical partner to the U.S. in the region.


(Source: Bloomberg)

Coming to the stock market performance in Vietnam, the rally of 2017 continued into the first quarter of 2018 as large IPO offerings took advantage of very positive sentiment but valuations, especially for large caps, were extremely stretched and the turning sentiments in frontier and emerging markets from the second quarter onwards were the triggers for a major correction. However, even though small and mid-cap stocks in Vietnam were trading at a big discount to large cap valuations, the market weakness was felt across the board despite bottom up company fundamentals in small and mid-cap stocks being stable. The AFC Asia Frontier Fund has had a mix of small/mid-cap as well as large-cap names in its Vietnam exposure since inception, and below we will further discuss some of the long-term themes that we like in Vietnam.


(Source: Bloomberg)


We believe that the tourism industry offers very good long-term prospects given that Vietnam has begun to emerge as a major tourist destination in Asia (especially for Chinese tourists). The country offers easy visa procedures for a host of countries while the growth of low-cost carriers in the region is making it cheaper to get to and from Vietnam as well as the country’s generally low costs (compared to other tourist destinations) for hotels, food, transportation, and sightseeing. Furthermore, it is located just a few hours of flying time from China, Japan, South Korea, and other ASEAN countries, which makes Vietnam well positioned from a tourism perspective. International passenger arrivals have almost doubled since 2013 and will reach more than 15 mln in 2018. We forecast that over the next five to seven years this number will continue to increase significantly and therefore believe the simplest way to get exposure to the growing tourism industry in Vietnam is through an investment in the country’s largest airport operator as it is a good proxy to the growth of tourism. International and domestic passenger throughput for this company have grown cumulatively by 19% over the last five years while it has further capacity expansion in its pipeline.


(Source: General Statistics Office of Vietnam)

International visitor data until November 2018


In addition to this, the company has a lot of levers to maintain its growth rates as well as improve its margins. The mix between international and domestic passengers is at 35:65, which is almost the opposite of other airport operators in the region. With the increase in the number of foreign tourists as well as the growth of outbound Vietnamese tourists, this ratio should move towards regional standards and help margins along the way as international passengers generate higher fees and spend more in the duty free shops which is a major driver for earnings and margins for other international airports in the region where retail/concession revenues (duty free, luxury goods, food & beverage) account for anywhere between 40-50% of total revenues. However, in the case of the Vietnamese airport operator, this revenue stream is still at a “meagre” 21% of revenues and currently has no major international duty free operator in any of its airports.


(Source: Saigon Securities, Bloomberg, Airports of Thailand, Malaysia Airports Holdings)

ACV (Airports Corp. of Vietnam), AOT (Airports of Thailand), MAHB (Malaysia Airports Holdings)



(Source: Vietcapital Securities, AFC, Bloomberg)
ACV (Airports Corp. of Vietnam), AOT (Airports of Thailand), MAHB (Malaysia Airports Holdings)

With Vietnam becoming further integrated into global supply chains, as well seeing more relocations from higher cost destinations, we believe that industrial park developers should benefit from this trend. The fund holds two industrial park developers with each having a strong position in the North and South of the country as well as ample space to expand into the future as well as having a good set of clients.

In addition to industrial park developers benefitting from Vietnam’s increased trade, we also believe that companies linked to logistics should do well over the longer term and as a result the fund is invested in an air cargo handling company which has a well-established position in Ho Chi Minh City and is expanding its capacity while also having a list of well-known clients. The other company linked to logistics in which the AFC Asia Frontier Fund is invested in is a commodity transportation company. This company ships the majority of the crude oil to Vietnam’s refineries and will also benefit from the full start of the new Nghi Son Refinery at the end of 2018.

As industrial production and GDP growth in general is expected to remain strong for Vietnam over the next five years, we believe that construction and infrastructure companies should continue to provide stable growth as their order book positions remain solid while valuations remain very attractive. Elaborating further, the fund holds the leading construction company in Vietnam which currently trades at a trailing twelve months P/E of 8.0x with 40% of its market cap in cash. The fund also holds one of the leading providers of foundation services which trades at a trailing twelve months P/E of 8.6x. Lastly, the fund owns an infrastructure developer in Ho Chi Minh City which is currently operating a number of toll roads which provide consistent cash flows, while also developing a real estate project with Hong Kong Land in the upcoming district of Thu Thiem in Ho Chi Minh City.

Consumer discretionary is also a sector we like in Vietnam due to growing disposable incomes and increasing urbanisation. The fund has exposure to this sector via an automotive holding company which owns equity stakes in the local operations of Honda, Toyota, and Ford. With passenger car ownership in Vietnam still at very low levels relative to other countries in the region and consumer financing gaining more traction, there is lot of room for growth for the automobile industry in Vietnam. Furthermore, valuations for this automotive holding company are very attractive at a trailing twelve months P/E of 10.1x with a dividend yield of 9.4%.


Motorization Rate: Vehicles per 1,000 people. Assumes passenger and commercial vehicles.

Source: International Organisation of Motor Vehicle Manufacturers


In the consumer staples sector, the AFC Asia Frontier Fund owns a holding company whose consumer business has done extremely well this year (one of the few consumer staple companies which did well in Vietnam this year) while its animal feed business is expected to see a turnaround in 2019.

Bangladesh ended the year as the second biggest weight for the fund and with average GDP growth of greater than 6% since 2010, we are very positive on the long-term prospects for the country as well as the companies the fund holds there. The overall market in Bangladesh has remained weak this year due to nervousness in the run up to the national elections. Additionally, the Central Bank also passed various arbitrary measures which impacted banks’ net interest margins which was a further dampener on stock market performance as the banking sector has a high weight in the local stock market index.

Overall, we are very optimistic on the consumption story of the country due to its large young population and as disposable incomes rise from a low base. The fund is well positioned to capture this opportunity through investments in consumer discretionary, banks, and pharmaceutical companies. Consumer appliance penetration in Bangladesh lags peers and the fund owns one of the leading consumer appliance manufacturers and retailers which is expected to see greater than 20% earnings growth over the next three years.



(Source: Asia Frontier Capital)


Though the overall banking sector in Bangladesh is not in great shape due to the very high percentage of non-performing loans. However this problem is more skewed towards the state-run banks while a number of private sector banks remain well managed. The weakness of the state-run banks is actually an opportunity for the better managed private sector banks to capture greater market share and amongst these, the fund holds one of the leading players which is building out its retail banking business while its mobile financial services platform continues to make inroads into retail digital payments. We would not be surprised if the mobile financial service platform of this bank emulates the growth and scale of M-Pesa from Kenya.



MFS (Mobile Financial Services)

(Source: Bangladesh Bank, Communications Authority of Kenya)


Another consumption theme we like in Bangladesh is the pharmaceutical sector as per capita healthcare expenditures remain significantly below regional peers, which has resulted in a 16% cumulative growth rate for the domestic pharmaceutical industry over the last five years. The fund owns the largest and third largest players by market share and both have grown cumulative earnings by more than 10% over the last five years.


(Source: World Bank)


Besides the consumption theme, Bangladesh’s infrastructure lags that of the region and as investments are being made to improve connectivity throughout the country, we believe that the commercial vehicle industry can do very well over the next few years as the annual sales volume of commercial vehicles in Bangladesh are significantly lower than peer countries in the region. The AFC Asia Frontier Fund invested in one of the leading commercial vehicle distributors in the country who is also now beginning to assemble vehicles which should help to improve margins for the company going forward.

The fund’s third biggest country by weight, Mongolia, started off 2018 on a rocky footing, filing a USD 155 mln tax claim on Rio Tinto’s Oyu Tolgoi (“OT”) copper and gold mine. This happened in near tandem with the government cancelling the Oyu Tolgoi Power Agreement in July which now requires OT to purchase electricity from a domestic supplier (currently power is purchased from China) within four years. The first half also saw a significant slowdown in coking coal exports at the Gants Mod border point with China where export volumes fell by two thirds. However, by mid-year things began to look up for the country, as coking coal exports returned to normal levels, Fitch and Moody’s upgraded Mongolia’s sovereign rating (followed by S&P in November), and the Mongolian government announced plans to list up to 30% of state owned Erdenes Tavan Tolgoi “ETT” (the country’s largest coal mine) on an international stock exchange (New York or Hong Kong). On the back of a return to growth in the economy, the Development Bank of Mongolia issued a new USD 500 mln 5-year bond with a yield of 7.5% in October which was 8x oversubscribed.

While the mid-year performance was robust, the final months of the year turned rocky again as the Bank of Mongolia raised its policy rate by 100bps to 11% in order to combat inflation which has inched towards 7% and to support the Mongolian Tugrik which fell by 8.4% against USD during the year. Issues at the Gants Mod border again arose as China required an upgrade to customs procedures in November which saw coal exports nearly grind to a halt for several weeks, followed by a gradual increase into the end of the year. While the media highlighted new customs policies by China being the cause for the slowdown, the more likely scenario may have been related to China having reached its coal import quota for the year, approximately 60 days early. On the capital markets front, Mongolia saw 4 IPO’s come to market in 2018 and the market capitalization of the Mongolian Stock Exchange increased to USD 887 mln.

Amongst the fund’s Mongolian holdings, a stock we are very positive on is the country’s largest cashmere producer which is also the fourth largest integrated cashmere producer in the world. The company is continuing to grow rapidly, benefitting from the weaker Tugrik, and trades at a trailing twelve-month P/E of 13.0x. Another stock we like is a company which owns one of the largest hotels in Ulaanbaatar and is located on prime real estate in the city center, trading at a trailing twelve-month P/E 4.5x and P/B of 0.4x.

The fund’s exposure to Pakistan was reduced significantly this year due to the many issues the country has been facing. Political uncertainty in the run up to elections in July 2018, a widening current account deficit, depleting foreign exchange reserves, higher interest rates, a weaker currency, and slowing GDP growth were the major factors that resulted in the fund having its lowest exposure to Pakistan since inception.

Valuations on a bottom up basis are looking very attractive now in Pakistan, with blue chip names across the auto, banking, cement, energy and healthcare sectors trading at a big discount to their five-year average multiples. However, even though the fund’s exposure to Pakistan is at its lowest since inception, the 26% depreciation of the PKR in 2018 cost the fund 3.6% in terms of performance.


(Source: Asia Frontier Capital)


In Myanmar, we added two new positions, a diversified conglomerate which has investments in real estate, food & beverages, financial services, and automobiles, and a junior miner with access to possibly one of the best polymetallic mines globally. We believe that despite the negative press, Myanmar offers a large untapped consumer opportunity as it has a sizeable population of 53 mln people with per capita incomes rising from a low base of USD 1,350 and demographics remain favourable with the median age of the population at 28 years.


(Source: Boston Consulting Group)


We reduced the fund’s exposure to Sri Lanka in 2018 further and luckily much before the current political crises started as most of our share sales occurred between the first and third quarters of the year. Though valuations have remained attractive for some companies in Sri Lanka, the coalition politics has clearly had an impact on policy making. During the year the fund exited a construction contractor, a diversified conglomerate, a consumer conglomerate, and a tobacco company. The fund’s largest position in Sri Lanka is a telecom company which has the highest market share in the mobile services segment and though a weaker Sri Lankan Rupee (LKR) is expected to impact upcoming quarterly results due to the USD debt on its books, the core business and overall fundamentals of the company remain stable with its mobile data and fixed broadband business both growing by 28% YoY so far in 2018. Valuations also remain very attractive for the company at a trailing twelve months P/E of7.9x and EV/EBITDA of 3.3x, a big discount to other frontier market peers who are in a similar competitive advantage position.


(Source: Bloomberg)


The fund exited its two Cambodian positions this year, a port operator and a junior mining company, while exposure to Laos and Papua New Guinea did not see any major change over the year. However, during the year the fund initiated its coverage of Central Asia as the markets in this region are still in the early stages of development and are very under-researched and ignored. The fund is currently invested into the Central Asian countries of Kazakhstan, Kyrgyzstan, and Uzbekistan, with Uzbekistan having the highest weight among the three.

During 2018, Uzbekistan’s President, Shavkat Mirziyoyev, continued his robust economic and social reforms. As Uzbekistan seeks to attract significant foreign direct investments (FDI) sector wide, the country signed over USD 30 bln of investment agreements with multiple countries this year, including the U.S., Saudi Arabia, France and Russia, and saw USD 2.4 bln in FDI disbursements. On 16th May 2018, President Mirizyoyev visited President Trump in the White House with the likely intent of creating a “third neighbor policy” to balance Russia and China’s influence in the region.

One of the major initiatives of the government during the year was to work with Fitch, Moody’s and S&P to get a sovereign rating. It is likely to be received in the first quarter of 2019, and thereafter the government is expected to float a sovereign bond of between USD 500 mln to USD 1 bln, with the intention that this bond will be used as a benchmark for international financiers.

On the tourist and consumer sectors, Uzbekistan introduced an e-visa regime for 101 countries on 15th July 2018 which is expected to accelerate already robust tourist growth, as the first half of 2018 saw tourist arrivals grow by 91.6%. On the consumer front, several international franchises entered the Uzbek market including KFC, Baskin Robbins, Gloria Jeans Coffees, Wendy’s and Dunkin’ Donuts. This trend is expected to continue as there is pent up consumer demand in the country of 33 mln  people who have had little previous exposure to western consumer brands.

As part of the government’s pledge to decrease its involvement in the economy, it is proceeding with plans to divest all non-core investments and assets. This process has already begun and during the year dozens of properties, movable assets, and shares in companies were sold off, paving the way for an increase in private sector participation. Part of this divestment process resulted in Uzbekistan’s first ever IPO on 11th April 2018 of a local construction and bottle glass manufacturer which is currently undergoing a USD 70 mln expansion. All this good news coupled with our positive view on the expected future development of Uzbekistan has prompted us to plan for the launch the AFC Uzbekistan Fund on 1st March 2019. Please let us know if you would like to know more about this fund.

In Kazakhstan, the fund has one position, a bank which is the largest in terms of assets and which also has a very strong capital position and is a good proxy for stable economic growth going ahead given that the macro situation in the country has stabilised after the oil price crash of 2014/2015. Kazakhstan is also expected to benefit from the rail link from Western China to Europe which could lead to increased trade throughput via the country, possibly leading to a positive economic spill over which should benefit the banking sector.

In Kyrgyzstan the fund owns two stocks, an airport operator which manages the country’s international airport, and a power utility.



(Source: Carnegie Endowment for International Peace)


(Source: Asia Frontier Capital)


From a sector allocation perspective, the major increase in exposure during the year was to the industrial sector which had a weight of more than 20% by the end of 2018 compared to 17% at the end of 2017. Besides positive returns for the fund’s Vietnamese industrial park operator and air cargo handling company (added in January 2018), the other factors for a higher industrial sector allocation were due to the fund adding a Vietnamese airport operator and Bangladeshi commercial vehicle assembler. The entry into Kyrgyzstan and Uzbekistan also increased exposure to the industrial sector as most of the new positions were built in this sector.

The exposure to the healthcare sector was reduced as the fund exited a Pakistani pharmaceutical company, a Vietnamese pharmaceutical company, and a Vietnamese medical devices company during the year.

The exposure to the materials sector was reduced due to the sale of two Pakistani cement companies, in line with reduced exposure to the country. Material sector exposure was further reduced due to the sale of a Vietnamese cement company and a Bangladeshi paint company.


(Source: Asia Frontier Capital)


From a stock selection perspective, the fund continued with its benchmark agnostic approach and this is one of the reasons that the fund has been able to maintain annualised volatilities at lower levels relative to the benchmark and other major indices. Furthermore, this approach has also helped maintain lower correlations for the fund with emerging and developed markets. This point also helps to remove some of the misconceptions about frontier markets in general being risky, as frontier markets have very low correlations with developed markets and therefore as a combined asset have provided lower annualised volatilities over the last five years as the chart below suggests.


Annualised volatilities based on monthly returns since inception of AFC Asia Frontier Fund
(Source: Asia Frontier Capital)


In addition to following a benchmark agnostic approach focused on value and “growth at reasonable price” (GARP) investments, the fund is well diversified across countries and positions. However, we would also like to point out that the number of positions in the fund (currently 112) gives an incorrect picture regarding our diversification strategy. The top 30 positions of the fund account for more than 60% of the portfolio and thus the fund has a good balance between concentration and diversification.

The high number of stock holdings is simply due to investing in extremely illiquid stock markets like Mongolia and Uzbekistan and therefore building a portfolio in both these markets requires us to buy a basket of companies and hence increasing the number of overall holdings, but this does significantly reduce the concentration levels. The fund’s portfolio turnover over the last five years has been on average less than 20%, which is a reflection of our strategy to take long term calls and not trade or change positions every quarter depending on which way the wind is blowing.


(Source: Asia Frontier Capital)



2019 Outlook for AFC Asia Frontier Fund Universe

As we enter 2019, the major worry for global markets is the China-U.S. trade war and the implications for global economic growth, and in particular the growth of Asian countries in Southeast and Northeast Asia that are integrated into the supply chains of China-U.S. trade. Though slower economic growth is a concern for the global economy, it is important not to put all countries and regions in the same basket. One concern amongst investors has been the outlook for Vietnam due to its high dependence on foreign trade. It is a valid concern, but there are positive long-term trends that have been taking place with respect to Vietnam transforming into a manufacturing hub. It has lower wages relative to China, Malaysia, and Thailand, as well as improving infrastructure, a stable political environment, and a strong position into the supply chains of Southeast and Northeast Asia. Furthermore, unlike countries such as Taiwan, where a large part of its exports to China are reprocessed and re-exported to the U.S., for Vietnam, 17% of its exports to China consist of raw materials/intermediate goods which makes it less exposed to reprocessed exports from China to the U.S.

In addition, even though the U.S. and China are Vietnam’s largest and third largest export markets, exports to both of these countries have grown by 15% and 23% this year respectively and these numbers do not reflect a sign of any major slowdown. Besides, the majority of Vietnamese exports to the U.S. are low-tech or low-end products such as mobile phones, footwear, and garments which are not being specifically targeted by tariffs.


(Source: Vietcapital Securities)


Furthermore, the trade war may only lead to further relocation from higher cost destinations into Vietnam as companies try to avoid the U.S.-China conflict. We are already seeing China-based textile companies producing a large part of their goods in Vietnam and any new capacity that is expected to come up would be produced in Vietnam or other lower cost destinations. This is a very important trend, as besides Vietnam benefitting from higher cost jobs moving to the country, other countries within our universe are also expected to be long term beneficiaries of a protracted trade war such as Bangladesh, Cambodia, Pakistan, and Myanmar. Bangladesh is already the second biggest garment exporter globally and in the latest financial year its exports to the U.S. have grown by 22%, a sign of the country benefitting from lower costs as well as the trade war.


(Source: Asia Frontier Capital)


(Source: Dream International, Yue Yuen Industrial, Orient Securities)
Non-China locations are primarily in Vietnam


(Source: Bangladesh Garment Manufacturers & Exporters Association)


Though some of the countries in our universe are dependent on exports, there is a large domestic consumer base that is seeing income levels rise from a very low base. The Asian frontier universe on the whole has very attractive demographics, with a median age of 26 years, which makes these markets very impressive long-term domestic consumption plays. Despite worries over global trade, the stable domestic base of these economies gives us comfort for sustainable GDP growth of over 5% for the next three to five years. Bangladesh, Myanmar, and Vietnam will be amongst the fastest growing economies globally over the next few years, which makes us confident that Asian frontier markets will overcome some of the short-term uncertainties that frontier and emerging markets are facing in general at this point in time.


(Source: IMF)


(Source: United Nations Population Division)


Rising U.S. interest rates will continue to play on investors’ minds, but with most rate hikes already having occurred and the markets factoring this into valuations, this should not be as big an issue as it was in 2018. Crude oil prices could also hurt oil importing countries if prices go back to the USD 80/barrel level seen in October 2018, but if they stay in the current range of USD 50-60/barrel then this would provide a lot of comfort to the current accounts of Bangladesh, Pakistan, Mongolia, and Sri Lanka.

From a sector allocation perspective, we do not expect any broad changes, but from a country allocation perspective, there could be some shifts as we see very attractive valuations in both Pakistan and Sri Lanka. Valuations for some companies in both of these markets are at a big discount to their five-year average multiples.

Despite numerous global headwinds faced by our markets in 2018, we believe the fund’s portfolio has a good set of fundamentally sound companies which have the ability to show consistent earnings growth over the next three to five years due to solid economic growth and/or very favourable demographics and once the markets begin focusing on fundamentals again, we are confident of our fund reverting back to the mean with a strong positive performance. Furthermore, correlations between Asian frontier markets and global markets remain very low which makes investing in Asian frontier markets a very sound diversification strategy.


(Source: Bloomberg. Based on 5 years monthly data)



There has been lot of noise throughout the year due to the upcoming national elections as well as issues in the banking sector which have led to negative market returns this year. However, once elections are done on 30th December 2018, we expect overall market sentiment to improve and some of the problems surrounding the banking sector to be resolved which should lead to a pick-up in loan growth.

The Bangladeshi Taka (BDT) could weaken in 2019 but we are not expecting a free fall due to stable foreign exchange reserves of USD 31 bln, which cover almost six months of imports, and stabilisation of the current account deficit. If a stable government is in place in 2019, which we expect, corporate earnings should be very strong over the next three to five years on the back of average GDP growth of 7% between 2019-2023.

As a result, as written in last year’s outlook, we continue to be positive on consumption-driven companies in the consumer discretionary, financial services, and pharmaceutical sectors. Given the infrastructure push of the government, we are also positive on the commercial vehicle sector.


(Source: IMF)



Cambodia’s GDP growth is expected to be 7% in 2019, similar to 2018. The country continues to be the recipient of robust FDI from private and government-related Chinese and Japanese companies with a focus on manufacturing and infrastructure. The country is also projected to see a further increase in tourist arrivals as its main cities become more interconnected regionally, by both land and air. There are plans for an expressway between the capital, Phnom Penh, and Ho Chi Minh City, Vietnam, the construction of a Chinese-funded airport in the casino and industrial town of Poipet at the border with Thailand, as well as the addition of new flight routes to the port and beach resort town of Sihanoukville. Due to the rapid influx of foreign investment over the past several years, Cambodia’s property market is in need of a pause as prices in certain areas of Phnom Penh are nearing those in the central business district of Bangkok and could pose a potential risk to the economy in the short-term. Cambodia in 2018 followed Ukraine (+82.3% in USD) with a +32.6% performance, making it the second best performing stock market in the world. Many of the stocks are fairly valued and we do not expect a continued rally in 2019.


Iraq’s brighter outlook at the start of 2018 - marked by the end of the ISIS invasion and the recovery in oil prices – was postponed for much of the year by political uncertainties surrounding the May 2018 parliamentary elections.

The political uncertainties before the elections continued following the indecisive election results as the different political parties negotiated the formation of a coalition government. Adding to this mix of uncertainty was the eruption of massive demonstrations in the south, where protesters demanded reform and investment into basic services. These uncertainties started coming to an end in early October with the promise of appointments of a president and a prime minister in a fashion that broke the failed mould of the past. These were followed with the formation of a working government which, while still incomplete, can begin to act on the needed spending for a post-conflict recovery.

Paradoxically, while the political uncertainties paralyzed the government process, the government’s revenues soared thanks to the recovery in oil prices with the result that the government was on course for a two-year accumulated surplus of up to USD 24.5 bln by the end of 2018. The oil market’s decline from unsustainably high levels of the summer is an unwelcome development but should not alter the positive revenue momentum as long as the government continues with the fiscal discipline brought on by the IMF’s 2016 Stand-By Arrangement (SBA).

The first of the companies to emerge from the severe economic contraction of the last few years were telecoms, with two major mobile operators out of three national operators reporting third quarter earnings that display the markers of recovery in earnings, margins, and profits. Among the two, AsiaCell voiced its confidence in its recovery with a 12% dividend on the back of last year’s 14% dividend – which in absolute terms is about one third higher than that of last year. Other sectors, in particular banking, should begin to show similar patterns of recovery through 2019.

The delayed economic recovery continued with its negative effects on the equity market, down -16.6% by the end of November on the back of consecutive annual declines of -11.8%, -17.3%, and -22.7%. An upcoming economic recovery coupled with a reversion to the mean should bring with it a market recovery which is also paced by an earnings recovery across listed companies.

However, significant challenges remain with the huge demands for reconstruction, winning the peace, defeating a likely emerging ISIS insurgency, and controlling violence. In particular, the fragmented politics of the new parliament will continue to be a marker of risk for the government’s future stability which would in turn pose a risk to economic recovery.


We can expect stable economic growth from Kazakhstan as higher oil prices compared with two years ago have helped stabilize the economy, while the banking system continues to be cleaned up which has led to an easing of interest rates by the Central Bank. With a debt to GDP ratio of 26% and foreign reserves of USD 86 bln, the current macro environment will allow the government to undertake reforms to diversify its economy in the long run. Additionally, the rail link between China and Eastern Europe could lead to a positive economic spillover for the rest of the country. We expect to maintain our position in the bank which the AFC Asia Frontier Fund holds as it is a good proxy to economic growth given the bank’s size as well as strong capital buffers.


Kyrgyzstan is projected to grow its GDP by 4% in 2019, an acceleration from the projected growth of 2.5% in 2018. This expected increase in growth will mainly be attributed to an increase in industrial output and remittances from overseas workers. However, with a debt to GDP of 50% (44.7% of which is held by China) and a projected budget deficit of 3.8% in 2018, Kyrgyzstan will remain subject to potential economic or political shocks in South Korea, Kazakhstan, or Russia since these are the countries where the majority of its overseas workforce, who remit capital home, are located. Remittances comprise approximately 25% of GDP.


Laos’ GDP is projected to grow by 6.9% in 2019, an acceleration from projected growth of 6.6% in 2018, as the country continues to attract mainly Chinese and Vietnamese investments, the former of who are constructing the USD 6.7 bln, 409-kilometer Laos-China railway, part of the railroad network envisioned to connect Kunming, China to Singapore. While the railway is touted by the Laos government as an important artery and economic achievement in the country, it is the leading contributor in the World Bank’s estimate of the Laos government’s debt/GDP, which is projected to reach 70% by 2022. The development of economic zones near the capital, Vientiane, is attracting SME factories from China who are looking to relocate to regions with cheaper labor and who in turn are helping to diversify the economy. Perhaps the most encouraging addition to the Laos economy this year will be the completion of the Xayaburi hydroelectric dam on the Lower Mekong River which will have an installed capacity of 1,285 MW. EDL Gen Co., listed on the Laos Stock Exchange, owns 19% of the project and should generate substantial income for the country. The AFC Asia Frontier Fund holds this company as it is currently providing a dividend yield of 7.3%.


Mongolia’s GDP is projected to grow by 4.3% in 2019, a decent increase from the projected growth of 3.8% in 2018. So long as the border points with China, specifically the Gants Mod border point where the majority of Mongolia’s coal and copper concentrate is exported through, remain open, Mongolia should continue to improve its foreign exchange reserves and be able to maintain its good standing with the IMF. This is then likely to result in a continued rebound in local consumption and the real estate market. The government plans to IPO at least 30% of the state-owned Erdenes Tavan Tolgoi coal mine “ETT”. If this does occur, it will most likely be listed in either New York or Hong Kong and enable the government to build, with the IPO proceeds, a railroad from the coal mines in the South Gobi to the Chinese border, drastically decreasing transportation costs of the country’s most important export product. The key risks to Mongolia during the year will remain the potential for China to restrict commodity imports, a potential fall in commodity prices, and increasing political turmoil in the run up to 2020 parliamentary elections.


Myanmar’s GDP is projected to grow by 6.4% in 2019 which will be one of the highest growth rates in the region despite the negative press reports it has received lately.

Myanmar also faces the challenge of an increasingly insolvent banking system which will need to be restructured. The Central Bank, recognizing this issue, has recently permitted foreign banks to own 10% of local banks, as well as permitting foreign banks to lend to local corporate clients. The big story for 2019, however, will be the potential development of the China-Myanmar-Economic-Corridor (CMEC). The CMEC includes an integrated transport and industrial zone network stretching from the Myanmar-China border in Shan state through Mandalay to Yangon and west to the port city of Kyaukpyu, the latter of which is seeing the construction of a Chinese-funded deep water port and a special economic zone.

The Myanmar government’s creation of a new Ministry of Investment late last year is intended to operate on a “one window policy” expediting licensing of foreign businesses in a bid to cut down on bureaucracy and increase FDI. If operated properly, this ministry could be a game changer, helping Myanmar to receive increased investments in the agricultural and manufacturing sectors, especially as the China-U.S. trade war continues. In the insurance industry, it is expected that several foreign insurers will be granted licenses in 2019 to operate independently in Myanmar. This could lead to a significant capital inflow, similar to the USD 3 bln in FDI when the telecom sector was liberalized, as well as lead to the demand for new investment products for insurers to invest into.

However, foreigners are still not allowed to invest in the local stock market, with 5 stocks listed currently, and it is still not certain that this will change in 2019.


In 2018, the PKR depreciated by 26%, domestic benchmark interest rates rose by 425 basis points, a new Prime Minister (former cricket hero Imran Khan) was democratically elected, and economic growth slowed down.

As we enter 2019, expectations are that an IMF loan program of about USD 4 to 5 bln will be approved, since in the last few months the newly elected government has taken some tough decisions such as raising gas prices, devaluing the PKR, and reducing public expenditure in order to meet IMF requirements. History shows that after an IMF program is in place, the stock market generally has positive returns (see table below). Given the current environment, our strategy in Pakistan will focus on bottom up opportunities as companies across sectors are trading at valuations significantly below their five-year average multiples. We like selected companies in the auto, banking, cement, and energy sectors.

Though the near term outlook is not favourable, we don’t lose sight of the fact that the country has a sizeable population of 200 mln people with a median age of 23 and this clearly presents a solid case for opportunities in consumption-related sectors.


(Source: IMS Securities)

Papua New Guinea

Higher energy prices have helped to improve the macro-environment in Papua New Guinea, and going forward the country is expected to have a large current account surplus as it takes in the benefits of LNG exports. If ExxonMobil’s plans to double its LNG capacity go ahead, it will be very positive for the country in the long term. However, we do not expect to increase our current PNG exposure in the AFC Asia Frontier Fund significantly.

Sri Lanka

We expect political uncertainties to continue as we enter 2019 but this has been the case for Sri Lanka over the last few years resulting in an underweight allocation in the AFC Asia Frontier Fund. We are not planning any significant change in our exposure unless there is a stable government. However, from a bottom up point of view, there are good opportunities in the banking sector since the price to book ratio of the top three private sector banks are all below 1.0x, which is a big discount to their average ten year historical ratios. Furthermore, these three banks are well capitalised despite an increase in provision expenses for NPLs. From the table below, the fund holds Sampath Bank.


(Source: Bloomberg, CT CLSA Securities)
CAR (Capital Adequacy Ratio)
IFRS9 is a new accounting rule which would increase provision expenses


Uzbekistan’s GDP is projected to grow by 5% in 2019, a modest deceleration from the projected growth of 5.5% in 2018, after robust growth over the past several years. In recent years credit growth accelerated to over 30% per year and thus the IMF is projecting CPI inflation to reach 18-19% during 2019 if the Central Bank of Uzbekistan does not contain credit growth. While a slowdown in both inflation and credit growth to more sustainable levels is a priority of the President and the Central Bank, 2019 is the year where investors will see how effective the government is in implementing its reforms. The most important reform, in our view, is the removal of the restriction on currency convertibility for foreign invested capital. Increased FDI, thanks to support from government ministries and the removal of restraints on currency conversion, will likely lead to a surge in foreign investment across the tourism, agriculture, and resource sectors. In the first quarter of 2019, Uzbekistan aims to issue its first ever USD denominated sovereign bond, which will then be followed with the creation of a local yield curve in order to establish a risk benchmark which the government hopes will lead to a decrease in the cost of capital.


The country enters 2019 after another year of robust economic performance backed by strong industrial production, export growth and stable foreign direct investments. With a very strong current account surplus and stable foreign exchange reserves, the macro outlook for Vietnam remains robust even though the China-U.S. trade war worries hamper sentiment. With Vietnam’s transition into a manufacturing hub expected to lead to strong industrial production as well as increasing disposable incomes, we continue to be positive on our automotive, construction, infrastructure, and logistics holdings. Furthermore, as the country continues to attract more tourists, we like tourism plays, such as the airport operator which the fund is holding. Given the positive cycle the country is in, GDP growth in 2019 is forecast to be between 6.5%-7%.

Valuations for Vietnamese banks have come off in the second half of 2018 but are still at a large premium to regional valuations. One can argue that the banking sector in some of the other countries in the region is not in the best shape or that the growth profile of the regional banks is not as good as in Vietnam, but we believe that there are some better opportunities to buy banks in other markets such as Bangladesh and Sri Lanka where some very well run private sector banks are trading at more attractive valuations with similar growth prospects.

Trade deals such as the free trade agreement between Vietnam and the EU, as well as the Comprehensive and Progressive Agreement for Trans Pacific Partnership (CPTPP), should further integrate Vietnam into global trade and are expected to be a long term positive for the country’s manufacturing sector.


(Source: Asia Frontier Capital)


While volatility and drawdowns are par for the course in equity investing, we believe that the solid economic growth that we continue to see in our investment universe coupled with the attractive demographic trends will drive business growth in the companies we invest in and therefore in the fund’s performance over the medium and long term. With our portfolio companies now trading at very attractive levels, we are looking forward to a much better 2019. Adding the low correlation of the fund with the world markets, the AFC Asia Frontier Fund makes for a solid investment choice in a globally diversified portfolio and during times of temporary drawdowns, dollar cost averaging can further enhance overall returns.



I hope you have enjoyed reading this annual review and outlook for the coming year. If you would like any further information, please get in touch with me or my colleagues.

The entire AFC team wishes our investors and newsletter readers a peaceful 2018 Holiday Season and positive returns in 2019!

With kind regards,
Thomas Hugger
CEO & Fund Manager

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