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Asia Frontier Capital (AFC) - September 2018


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“People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game."

- Peter Lynch




AFC Asia Frontier Fund USD A1,477.50-1.4%-13.4%+47.8%
AFC Asia Frontier Fund (LUX) USD A


AFC Frontier Asia Adjusted Index3 -1.1%-7.2%+27.2%
AFC Iraq Fund590.49-7.1%+4.1%-41.0%
Rabee RSISX Index (in USD) -4.8%-10.5%-49.3%
AFC Vietnam Fund1,845.40+3.0%-0.5%+84.5%
Ho Chi Minh City VN Index (in USD) +2.7%+0.6%+80.9%
  1. 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.
  2. The return is based on the performance of the AFC Asia Frontier Fund USD A prior to 1st December 2017 and the net return of the AFC Asia Frontier Fund (LUX) USD A after its launch on 1st December 2017.
  3. The index was adjusted since 1st June 2017. Prior to that it reflects 100% of the MSCI Frontier Markets Asia Net Total Return USD Index, and after 1st June 2017 it is 37% of that index and 63% of the Karachi Stock Exchange 100 index in USD.

NAV and performance figures are all net of fees.



Global indices witnessed an improvement in returns this month but underlying investor sentiment in frontier and emerging markets remained tense as there was continued focus on the China-U.S. trade war, with the U.S. following through on its June 2018 decision to impose 10% tariffs on an additional USD 200 billion of Chinese exports to the U.S. As expected, the U.S. Fed went ahead and raised benchmark interest rates by 25 basis points which continued to impact sentiment in frontier and emerging market currencies, with Sri Lanka being one of the latest victims of sudden currency weakness given its large external debt position relative to its peers.

On the trade war and its impact on export-dependent economies in Asia, the focus is on Vietnam given that exports are an engine of growth for the economy and the U.S. is Vietnam’s largest export market, accounting for 19% of total exports. Concerns over export-led growth in Vietnam are valid and it is difficult to argue that in case of a full-scale trade war with global growth slowing down, Vietnam would remain unaffected. However, the important factor is Vietnam’s trade deficit with the U.S. which is 9x less than that of China’s, 3x less than Mexico’s and between 1.6-1.7x less than Germany’s, Canada’s and Japan’s trade deficits with the U.S. From these numbers, it seems that Vietnam is a small fish to fry in the trade war game. Further, another important point to consider is that most of Vietnam’s exports to the U.S. are low-end or low tech such as mobile phones, footwear, and garments and not high-tech manufactured goods such as automobiles. Also, Vietnam’s exports to China which are re-processed and re-exported to the U.S. account for approximately 17% of its exports to China, which is a better position to be in than other economies such as Taiwan which are heavily dependent on their exports to China being re-exported to the U.S.

In addition, we are most likely seeing a structural shift as Vietnam is attracting low cost manufacturing jobs due to its political stability, lower wages, disciplined work force, and improving infrastructure. This is evident from the rising trend of foreign direct investment (FDI) over the past few years with USD 13 billion of FDI being received so far this year. Given Vietnam’s stable politics and attractive demographics as well as its geographical location which fits well into the supply chains of North and South East Asia, it would not be surprising if the country would turn out to be a net beneficiary of the China-U.S. trade war in the long run as more manufacturers based in China shift part of their operations to Vietnam due to higher wages and higher tariffs in China, a trend that we have already seen in the past few years.

Besides Vietnam benefitting from being a low-cost manufacturing location as well as from the China-U.S. trade war, other Asian frontier countries could also benefit in the long run as they also have significantly lower wages compared to China and are seeing improvements in their infrastructure. Other Asian frontier countries within our universe which can benefit from manufacturing jobs shifting away from China are Bangladesh, Myanmar, and Pakistan. Bangladesh, which is now one of the largest readymade garment exporters globally with USD 31 billion of exports annually can be a long-term beneficiary due to its low wages, infrastructure investments in ports and highways, and a large young population as well as relative political stability.

The current uncertainty and negative sentiment continued to keep valuations at attractive levels across Asian Frontier Markets (which we wrote about in our August 2018 newsletter) which makes this an opportune time to invest in the sustained growth of Asian Frontier Markets with the AFC Asia Frontier Fund continuing to trade at a very attractive trailing twelve month P/E of 13.2x with a dividend yield of 3.9%.



(Source: China Statistical Bulletin, Wage Indicator Foundation, Bangladesh Garment Manufacturers & Exporters Association, General Statistics Office of Vietnam)



(Source: General Statistics Office of Vietnam)



(Source: Bloomberg)



(Source: Viet Capital Securities)




Our AFC Iraq Fund CIO Ahmed Tabaqchali presented a keynote at the first joint international forum by the Kurdistan Regional Government (KRG) titled “The Future of the Kurds” held 9-10 October 2018 at the University of Sulaimani & Polytechnic University of Sulaimani. Further information is available on the event website.


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

Thomas Hugger, Ruchir Desai, and Peter de Vries are based in Hong Kong, while Andreas Vogelsanger is based in Bangkok and Ahmed Tabaqchali in London and Iraq. If you have an interest in meeting with our team at their homeports or during their travels, please contact Peter de Vries at This email address is being protected from spambots. You need JavaScript enabled to view it..



Sulaimani / Erbil / Baghdad, Iraq until – 24th December Ahmed Tabaqchali
Hong Kong 

5th – 9th November

 Andreas Vogelsanger
Ho Chi Minh City 

12th – 15th November

 Andreas Vogelsanger
Ho Chi Minh City 

13th– 16th November

 Ruchir Desai

AFC Asia Frontier Fund - Manager Comment


The AFC Asia Frontier Fund (AAFF) USD A-shares declined −1.4% in September 2018. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+0.4%), the MSCI Frontier Markets Net Total Return USD Index (−0.1%), the AFC Frontier Asia Adjusted Index (−1.1%) and the MSCI World Net Total Return USD Index (+0.6%). The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +47.8% versus the AFC Frontier Asia Adjusted Index, which is up +27.2% during the same time period. The fund’s annualized performance since inception is +6.2% p.a., while its YTD performance stands at −13.4%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 9.07%, a Sharpe ratio of 0.63 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.

Though global indices saw a slight recovery in returns this month, investor sentiment in general remained subdued as worries over the trade war between China and the U.S. continued to take up investor attention with an additional USD 200 billion of Chinese exports to the U.S. being imposed with 10% tariffs but this was expected as these measures were announced in June 2018. Which way the trade war goes and when a compromise may be reached is anybody’s guess, but it appears that in the long run certain economies such as Vietnam could benefit from this as it offers a low-cost manufacturing base, has improving infrastructure and is geographically well positioned into the supply chains of North and South East Asia. The trend of Vietnam becoming a manufacturing hub in the region has not been occurring for the past few quarters but this has already been a long-term trend which is reflected in foreign direct investment (FDI) inflows over the past few years with USD 13 billion being received so far this year. Samsung now manufactures a majority of its mobile phones in Vietnam while most well-established Hong Kong-listed textile companies have moved a large part of their production to Vietnam from China or are putting up any new production capacity in Vietnam.

Given the strong FDI and increasing exports, economic growth remains robust with 3Q18 GDP growth reported at 6.9% led mainly by manufacturing growth of 12.0% while export growth remained strong at 13.9% YoY. Tourist arrivals also remained healthy and picked up in September after a soft patch in August to close 3Q18 with 14.9% YoY growth. Market sentiment was also boosted by the announcement by FTSE Russell that Vietnam would be put on its watch list for an upgrade to Emerging Market status. However, being put on the watch list does not guarantee an upgrade but this is a positive signal as it would probably push the authorities to take steps to transition from watch list to actual upgrade.

As a result, the Ho Chi Minh VN-Index gained 2.8% this month and the fund’s Vietnamese holdings were the main drivers of performance which was led by an industrial park operator which is strategically located next to Ho Chi Minh City, has a new industrial park coming online this year and has 63% of its market cap as net cash, while trading at a trailing twelve-month P/E of 3.9x. The fund’s other holdings which led performance in Vietnam were a commodity transportation company which trades at a trailing twelve month P/E of 8.7x and is expected to benefit as new crude oil and coal transportation contracts kick in from 2018/2019, while the fund’s automotive holding company did well for a second month in a row due to good quarterly results on the back of rising sales at Honda Vietnam, in which it has a 30% stake.

The Bangladeshi market witnessed a correction this month as sentiment remains subdued due to the upcoming elections and this affected fund performance while the recent quarterly season of results has been fairly stable with no major negative surprises. On a macro level, remittances have begun to accelerate again with the financial year ending June 2018 witnessing a 17.3% increase to USD 14.9 billion and the July-September quarter seeing a growth of 13.8% YoY. The current account deficit remains a concern as it has crossed 3% of GDP but the country is in a relatively better position to manage this with foreign exchange reserves of close to USD 33 billion, covering around 6 months of imports, while total government debt and external debt at 32% and 18% of GDP are relatively better and much lower than some of its peers in the frontier universe. (More on these topics and on the country in next month’s travel report).

The government in Bangladesh this month also revised minimum wages for workers in the garment and textile industry which is the leading exporting industry for the country. From December 2018 onwards, minimum wages will move from USD 63/month to USD 96/month. These wage levels are still very competitive and lower than China, Cambodia, India, Pakistan, and Vietnam while it could be positive for consumption as the Bangladeshi garment and textile industry employs 4 million workers.

Despite significantly reduced exposure to Pakistan, the country was a drag on the fund’s performance as macro concerns continue to take up investor attention, even though the government announced measures to contain the inflated fiscal deficit by increasing natural gas prices which will help reduce the deficit by around 30 basis points. The government also announced an interim budget which is expected to reduce the fiscal deficit by 50 basis points through revenue raising measures such as higher import duties and higher taxes on tobacco products as well as on individuals over a certain income bracket and more controlled development expenditure. Further, as expected, the State Bank of Pakistan raised benchmark interest rates by 100 basis points taking the cumulative increase so far this year to 275 basis points. As of writing, it was also announced that the government will approach the IMF for a loan to help overcome the country’s problems related to its wide current account deficit and low foreign exchange reserves. A potential IMF loan would possibly bring with it further measures linked to currency depreciation, higher interest rates, and further price reform in the power and utility sectors. These developments are not surprising and were expected over the past few months which you can read about here in our previous note.

Sri Lanka also hurt performance this month despite a low exposure to the country as the currency saw a sudden drop on the back of certain research publications regarding the macro health of the economy in light of a stronger USD and rising USD interest rates. The depreciation of the Sri Lankan Rupee by 4.7% during the month hurt performance by 20 basis points while the fund’s Sri Lankan bank holding, despite trading at a price to book ratio of 0.8x at the start of the month, faced a correction of 14.2% due to rising loan loss provision expenses, a trend being faced by the entire banking sector as slower agricultural and construction related growth in 2017 begins to have an effect on non-performing loans. This bank, however, is well capitalised and the current non-performing loan issues facing the sector as a whole should not significantly hurt its capital adequacy position or dividend payment abilities.

Given Sri Lanka’s external debt position as a % of GDP as well as USD repayments/refinancing due in 2019, the government has recently taken measures to control imports by increasing import duties on passenger cars so that the country’s current account deficit and balance of payments does not get out of hand.

The best performing indexes in the AAFF universe in September were Cambodia (+8.0%), Kyrgyzstan (+5.6%), and Vietnam (+2.8%). The poorest performing markets were Iraq (-4.8%) and Bangladesh (-4.1%). The top-performing portfolio stocks this month were: a steel producer from Uzbekistan (+37.5%), a junior mining company from Mongolia (+33.3%), a power distributor from Kyrgyzstan (+29.3%), an engineering company from Uzbekistan (+26%), and a Mongolian real estate developer (+20.0%).

In September, we added to existing positions in Mongolia, Uzbekistan, and Vietnam. We added an airport operator in Kyrgyzstan, and two engineering companies and two cement companies in Uzbekistan to the portfolio. We exited one conglomerate and one cement company from Pakistan, a pharmaceutical company in Vietnam and one department store operator in Mongolia in September. We partially sold one automobile company in Pakistan and four companies in Mongolia.

As of 30th September 2018, the portfolio was invested in 114 companies, 1 fund and held 3.9% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (7.4%) and a cashmere producer from Mongolia (4.3%). The countries with the largest asset allocation include Vietnam (25.5%), Bangladesh (19.9%), and Mongolia (19.0%). The sectors with the largest allocations of assets are consumer goods (30.5%) and industrials (20.0%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 13.24x, the estimated weighted average P/B ratio was 2.47x, and the estimated portfolio dividend yield was 3.90%.


AFC Iraq Fund - Manager Comment


The AFC Iraq Fund Class D shares returned −7.1% in September with a NAV of USD 590.49 which is an under-performance versus its benchmark, the Rabee USD Index (RSISUSD index), which was down −4.8%. Year to date the AFC Iraq Fund Class D shares are up +4.1% versus a loss of −10.5% for the RSISUSD index.

The uncertainty that has prevailed over all economic activity during the last few months is finally coming to an end in a typical Iraqi fashion- extremes of either feast or famine. The parliamentary elections in May, having yielded no clear winner, led to a multi-month paralysis during which the election results were contested in court, subsequently leading to a partial recount of the votes. Increasing the election anxiety were massive demonstrations in Basra and the southern governorates, where citizens demanded reform and investment into basic services, and the proverbial shaking of the political class by raising fears that they would spread throughout the country. Thoughts on the protest movement and its implications are further discussed in the article “The Protest Movement, the Politicians and the Elections”.

The end of the uncertainty came in early October with the appointment of a new president, and a new prime minister in quick succession. This was done at a speed almost unheard of in post-2003 Iraq. While the individuals are two of Iraq’s most accomplished politicians with a lot of promise, the important takeaway is that the process of selecting them broke the mould and ended the political gridlock that bedevilled the country since 2003. This was a continuation of the effects of the same 2015 protest movement that had such a profound effect on how the elections were fought and their subsequent results. The most visible effect was the fragmentation of the prior ethno-sectarian monolithic blocs that dominated over the past 14 years, the root cause of Iraq’s political and social instability since 2003. It is the end of this gridlock that holds the promise for change in Iraq and with it begins the unlocking of the massive reconstruction drive that lies at the heart of the Iraq investment opportunity.

This is made significantly easier for the upcoming new government as the windfall from higher oil prices (based on the year-to-date average Iraqi oil price of USD 65/bbl) could imply that Iraq would have a two-year cumulative surplus of USD 24.5bn, or the equivalent of a 19% stimulus for non-oil GDP by the end of 2018. Conservative assumptions for Iraqi oil prices for 2019 of USD 59/bbl would imply a further surplus of USD 9.3bn by end of 2019, but if Iraqi oil prices were to remain at the current average price then the 2019 surplus could easily double to USD 18.6bn.

The implications of a three-year cumulative surplus of USD 33.8 - 43.1bn by end 2019 are enormous for Iraq’s ability to plan the funding of the reconstruction and to address the country’s structural imbalances. The assumptions above don’t assume that the current rally in oil prices is sustainable, but that Brent would stabilize at about USD 65-70/bbl from the current USD 84+/bbl (Iraqi oil tends to sell at a discount of USD 5/bbl).

However, this is at least a few months away as the new government is unlikely to be formed before the middle of November and as such would not be able to take any action before year end. Given that the county is in the midst of the 40-day Arbaeen pilgrimage, the timing of the new government’s spending programme would coincide with the return of activity following the Arbaeen pilgrimage - hence the earlier reference to the extremes of feast or famine for Iraq’s economy.

The market followed through with its longer-term bottoming process as the July interim bottom continued to be tested this month, in-line with the same trend seen in August and will likely continue for some time. Average daily turnover declined significantly for the month to the lowest levels (by a wide margin) for a number of years as can be seen from the chart below.



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


The poor market action over the summer months should be seen in the perspective of the low turnover coupled with the continuation of the demonstrations that began in July, the prolonged uncertainty over the governments formation and finally the 40-day Arbaeen pilgrimage that brings the country to a standstill as millions of pilgrims take part in “the largest annual gathering of people anywhere on earth.

However, the low activity was not without fireworks as a sell-off by a foreign investor in Mansour Bank (BMNS) set off a frenzy of trading activity in a replay of the sell-off in the Bank of Baghdad (BBOB), as reported in July’s update “Of Frenzies & Market Bottoms”. At the worst point BMNS, was down −40% for the month and its market capitalization was equal to about 0.5x Book Value, 17% of assets and 22% of cash (based on trailing 12-month numbers). In an exact replay of the events with BBOB, once the position was liquidated locals and some other foreigners bought the stock which sent it up +27% to end the month down −24%, and −10% for the year.

However, the financial position of BMNS during the past few difficult years is almost the mirror opposite of BBOB. BBOB suffered from the same forces that crushed the sector’s earnings, as reviewed in the article titled “Of Banks and Budget Surpluses“, in addition to its share of company specific issues and structural weaknesses that were exposed by the pains of 2014-2017, including the recent pressure on FX margins. BMNS on the other hand, weathered the storm mostly unscathed as seen below, and in particular it’s in a strong position to reap the rewards of a recovery given its strong deposit growth, low loan/deposit ratio, and low ratio of non-performing loans (NPL’s) to deposits.

As explained in the abovementioned article “Of Banks and Budget Surpluses”, the banks’ leverage to the economy crushed their earnings. In particular, the double whammy of the ISIS conflict and the collapse in oil prices squeezed government finances as expenses soared while revenues plummeted. The government resorted to dramatic cuts to expenditures by cancelling capital spending and investments which, due to the centrality of its role in the economy, led to year-on-year declines in non-oil GDP of −3.9%, −9.6% and −8.1% for 2014, 2015 and 2016, respectively. Ultimately, the government had a cumulative deficit of around USD 41bn during this period and accumulated significant arrears to the private sector in the process.

The same leverage should work in reverse as the potential budget surpluses of USD 33.8 - 43.1bn for 2017-2019 should stimulate economic activity which ultimately should translate to stronger future earnings for the banks. These were discussed in further detail in the article: “Forget the Donations, Stupid.”

BMNS’ financial performance during the years of conflict can be seen through the three charts below that look at loans and non-performing loans (NPL’s), deposits and trade finance and their association with budget surpluses and deficits (BMNS’ loan and NPL data as supplied by the research team at Rabee Securities is gratefully acknowledged, while other data was taken from the Central Bank of Iraq. Data from 2010-2014 are based on Iraqi accounting standards, while data from 2015-2017 are based on IFRS, and all calculations uses the official USD/IQD exchange rate)

BMNS’ loan book growth peaked in 2015 at the same time that NPL’s peaked. Unlike many other banks in the sector, its loan book was almost flat during 2015-2017 and NPL’s as a percentage of loans declined by almost 50%. At the same time BMNS increased its provisions significantly at almost twice the NPL’s in 2017.


Mansour Bank: Loans & NPL’s 2011-2017



Unlike almost all other banks in the sector, BMNS experienced deposit growth throughout the crisis with growth accelerating during the relative stability in 2017. A flat loan book and sharply increasing deposits resulted in a very low loan/deposit ratio allowing BMNS the opportunity to grow its loans book. Moreover, most of these loans are collateralized by property as most banks’ loans are in Iraq where the norm is for collateral value at 2x the loan.


Mansour Bank: Deposits and Loan/Deposit ratio 2011-2017

(Source: Central Bank of Iraq (CBI), Asia Frontier Capital (AFC))


BMNS’ trade finance declined, however, at much lower rates than those experienced by the sector, while the damage to BMNS’ earnings was mitigated by the relatively small size of the business.



(Source: Central Bank of Iraq (CBI), Asia Frontier Capital (AFC))


It is logical to conclude that the sea change which has taken place in the government’s financial health would reverse the trends that affected the banking sector’s earnings as the significant stimulus to non-oil GDP should lead to sustainable economic activity which should provide the sector with room to recover. Given BMNS’ strong position relative to other banks, it should have an opportunity to grow much faster than the sector as a whole.

As of 30th September 2018, the AFC Iraq Fund was invested in 14 names and held 3.8% 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 (95.3%), Norway (3.7%), and the UK (1.0%). The sectors with the largest allocation of assets were financials (48.7%) and consumer staples (20.0%). The estimated trailing median portfolio P/E ratio was 12.90x, the estimated trailing weighted average P/B ratio was 0.82x, and the estimated portfolio dividend yield was 5.98%.



AFC Vietnam Fund - Manager Comment


The AFC Vietnam Fund gained +3.0% in September with a NAV of USD 1,845.40, bringing the return since inception to +84.5%. This represents an annualised return of +13.7% p.a. The Ho Chi Minh City VN Index in USD gained +2.7%, while the Hanoi VH Index added +3.0% (in USD terms). The broad diversification of the fund’s portfolio resulted in a low annualized volatility of 8.66%, a high Sharpe ratio of 1.50, and a low correlation of the fund versus the MSCI World Index USD of 0.23, all based on monthly observations.

Market Developments

The Vietnamese equity market continues to remain resilient against the ongoing negative media coverage on emerging markets. It now seems that domestic and foreign investors are getting increasingly positive about Vietnam, especially with more analyst reports looking at potential losers and beneficiaries, such as ASEAN, specifically Vietnam, in relation to the escalating trade war between China and the US. FTSE announced that Vietnam, which is currently classified as a frontier market, will be added to the watch list for possible reclassification as a secondary emerging market. It will probably not have the same impact as an MSCI reclassification, but it is definitely something worth noting. We should mention that the composition and performance of the FTSE Vietnam Index is very different to other indices as it has a very high concentration of around 70% (!) in the top five weighted companies. But this news should further improve the market sentiment which is also reflected by the advance/decline ratio, as seen below, with more stocks finally advancing than declining, something we have not seen this year.


Market Breadth

(Source: Bloomberg, AFC Research)


The fear of many investors in relation to emerging markets seems to be due to increased media coverage, specifically on those markets which will be impacted by Trump’s trade war. Though historically, there have always been some emerging market countries in crisis at almost any given time. In fact, 2018 has not been much of an exciting year for global investors thus far. Bond investors have been given very little yield around the world and US bonds tanked heavily with increasing interest rates. Even the strong Dollar (“strong” at least according to media coverage) is up only 2% this year, based on the USD index. When looking at different main market indices around the world, it is hard to find any particularly strong performance this year, with the exception of US markets. But it is exactly the US where we see some potential bubbles; for example, in overhyped cannabis stocks right now where companies with a few hundred employees and little business are valued at several billion dollars. This is just one of many such cases in the late stage of the US bull market.


YTD return (%) in local currency

(Source: Bloomberg, AFC Research)


On the other hand, Europe (Eurostoxx, Germany, UK, etc.), Japan and Hong Kong are all either hovering around year-end 2017 levels or are down, not considering that most currencies are weaker against the USD as well. The same can be said for Vietnam where the index is little changed this year, also on a slightly weaker currency.


VN30 Index July 2017 – September 2018

(Source: Bloomberg)


We therefore see no particular weakness in Vietnam in contrast to almost every other market. With a combination of strong economic numbers and many undervalued stocks, we feel very confident with our Vietnam exposure. Recently, we saw a growing number of our stocks moving up, despite that the majority of small- and midcaps are still being ignored by the market. Talking about an unexciting year for investors so far, we must keep in mind what people also have to accept in exchange when hoping for returns – risk! Looking back to the beginning of the year, people around the world were positive and markets headed higher without paying too much attention to valuations, before an eventual retracement. Risk is something we carefully monitor and try to mitigate as much as possible in the interest of our investors and of course for ourselves. Our risk, measured by the volatility of the fund price, or simply called “volatility” is far below the market average and other funds, and it has been such since we started the fund in late 2013.


(Source: Bloomberg, AFC)


During September we continued to do some minor rebalancing in our portfolio before the results for the third quarter are released next month. As Vietnam is now accepted by most observers as one of the very few beneficiaries of the trade conflict between the USA and China, manufacturing companies are increasingly looking to shift production and trade from China into Vietnam. This can already be seen in the garment sector where some listed companies preannounced good business results and increasing orders. Some of these stocks which were neglected for months – and in some cases years –jumped 20-60% in a matter of just a few weeks.

Vietnam’s garment industry benefits from the US China trade war

China is the largest textile and readymade garments “RMG” exporter to the US with USD 41.28 billion in 2016, equivalent to 36.3% of total clothing imports of the US. Though, on 24th September 2018 the new tariffs on USD 200 billion worth of Chinese goods were set at 10% and will be increased to 25% as of 1st January 2019, something which may impact their future market share.

Vietnam ranked second in textile exports to the US, with USD 11.45 billion in 2016, equivalent to 10.1% market share. In the last few years these exports have grown strongly from USD 6.1 billion in 2010 to a record of USD 12.3 billion in 2017. In the first 9 months of 2018, textile exports to the USA reached USD 7.69 billion, +11.3% yoy. The US is now Vietnam’s largest client with more than 47% of total textile exports in 2017.


Vietnam’s textile exports to USA (USD billion)

(Source: GSO, AFC Research)


Due to the 10% tariff on China’s goods, Vietnam is benefitting from the trade war, at least in the short term. Producers in China are now looking for new OEM’s in Vietnam to avoid these tariffs and hence positively impacted new orders of garment companies in Vietnam in the first 9 months of this year.

There are two garment companies in our top 10 holdings, one of which is the largest garment factory in Vietnam. Due to higher demand from increasing new orders, net profit in the first half 2018 of these two companies surged by 22% and 63%, respectively. We actually bought one of these two companies not long after the inception of our fund. This company was trading at 3.8x (!) earnings at the beginning of the year and we added to our position in late spring and early summer. Now, after a 50% price jump and most likely upside adjustments to our optimistic 2018 growth assumptions of 25%, the company still has a very attractive valuation of only around 5.5x earnings. With several sectors now trading at unusually low valuations, we see huge opportunities across our stock universe, similar to when we launched the fund back in late 2013. 


A Vietnamese garment factory

(Source:, AFC Research)


It is interesting to note that FDI (Foreign Direct Investment) into the textile and garment industry attracted an astonishing USD 2.5 billion in the first 6 months of 2018, compared to USD 0.7 billion for the whole of 2017.


FDI into textile and garment industry (USD billion)

(Source: VITAS, AFC Research)


Vietnam’s garment sector will probably grow faster than other countries in the region mainly due to the following key advantages:

  • Vietnam has political stability
  • Vietnam has a driven workforce of more than 54 million people
  • Attractive labor costs and a skilled work force combined with high productivity
  • Electricity cost in Vietnam is very low at around USD 0.07 per kWh, much lower than in Cambodia for example
  • Vietnam has competitive infrastructure with a coastline of over 3,000km and several deepwater sea ports which makes it easier to ship goods

Apart from the ongoing manufacturing shift from China into Vietnam, the country will also start benefitting from the European Free Trade Agreement which will come into effect in January 2019 and eventually also the TPP.



(Source: GSO, SBV, AFC Research)


At the end of September 2018, the fund’s largest positions were: Agriculture Bank Insurance JSC (3.9%) – an insurance company, Sametel Corporation (3.0%) – a manufacturer of electrical and telecom equipment, Vietnam Container Shipping JSC (3.0%) – a container port management company, TanCang Logistics and Stevedoring JSC (2.2%) – a logistics company, and Pharmedic Pharmaceutical Medical JSC (2.1%) – a pharmaceutical company.

The portfolio was invested in 70 names and held 6.0% in cash. The sectors with the largest allocation of assets were industrials (31.5%) and consumer goods (30.3%). The fund’s estimated weighted average trailing P/E ratio was 9.56x, the estimated weighted average P/B ratio was 1.53x and the estimated portfolio dividend yield was 7.48%.



In line with our process of being on the ground in the countries we invest in, Fund Manager and CEO Thomas Hugger travelled to Pakistan recently in order to meet with management of portfolio- or shortlisted companies. All photos are by Asia Frontier Capital.

There is not much choice in flights when planning a trip to Pakistan nowadays. It is astonishing that from South East Asia and North Asia only Thai Airways is still flying to Pakistan (Islamabad, Karachi and Lahore) and from Europe only Turkish Airlines. All other major airlines stopped flights to Pakistan years ago. However, Chinese airlines started flights to Pakistan and there are now flights from Beijing, Guangzhou and Urumqi to major Pakistani cities, which is again a sign of continued interest from the Chinese government and Chinese companies in Pakistan.

I arrived late in the evening on Sunday at Lahore International Airport and to my surprise it was still raining upon arrival which caused a bumpy landing as we flew through a large thunderstorm when approaching Lahore, mainly over Indian airspace. The old Airbus A-330 plane was completely full (mainly with Pakistani citizens) and about 30 passengers lined up after disembarkation at the two immigration counters for foreign passport holders at Allama Iqbal International Airport. It took me about 20 minutes to pass the immigration counter and thereafter a hotel shuttle bus took me to the Pearl Continental Hotel, about a 30-minute drive away. On our way to the hotel we drove through the “Beijing Underpass” which is 1.3 kilometres long and was built in only 125 days, having been inaugurated in December 2017. Even though it was past midnight, the streets were still full of cars and many more motorbikes (with entire families on them) which was very different compared with my last visit exactly two years ago when the roads were basically deserted at midnight. Arriving at the entrance of the hotel was reminiscent of my visits to East Germany in the 1970’s and 80’s: very strict control and a thorough search of the vehicle while about 20 heavily armed male and female security guards observed the process and area – even at 1am in the morning.


We spent the day meeting with companies either in their offices or at our hotel. Lahore is the capital of Punjab province and with 11.2 million people, it is the second largest city in Pakistan. Lahore is also referenced to as the “City of Gardens,” which becomes clear when driving through the city.


Lahore: City of Gardens


The new Prime Minister, Imran Khan, was also visiting Lahore on the same day we were in town and we passed by the building where he was having meetings.


Election propaganda in Lahore for the upcoming by-elections


One of the companies we met that day was a previous “darling” of foreign investors about two years ago. The company produces air conditioners, refrigerators and freezers, as well as power equipment such as transformers and meters which we thought at that time should benefit from better power supply and investments in the power sector and generally low penetration of refrigerators (only 47% of households have a refrigerator and 52% a washing machine). However, the company has been especially hard hit in the last few months since the Pakistani Rupee was devalued from around 105 to the USD to the current 128 and generally companies in Pakistan cannot hedge their foreign currency exposure. For this company, an increase of 1 PKR against the USD is equal to 150 million Rupees in additional costs which the company has been able to only partially pass onto customers. Additionally, a relatively new Chinese entrant in the aircon market was able to gain significant market share in only 5 years and is now the major player. Other companies we met in Lahore were in the insurance and cement sectors, the latter being one of the dominant industries in Pakistan. The cement sector in Pakistan especially benefitted from the heavy Chinese infrastructure investment into the China Pakistan Economic Corridor (CPEC). The Chinese government and Chinese companies have committed so far to invest over USD 60 billion into infrastructure projects in Pakistan, including roads, ports, bridges, railways, dams and especially power generation (mainly coal fired). The cement industry grew in 2017 on average by 15% compared with 5% on average over the past 25 years. Thanks to the boom in the cement sector many companies announced and started expansion projects, especially in the south which allows them to export some of their cement or clinker to neighbouring countries, East Africa or even to South Africa. Despite the increased supply, the price of a bag of cement has increased this year from 515 Rupees to currently 570 Rupees in the north of the country. However, profit margins are under pressure due to the weaker currency and a higher coal price (most coal for cement production in Pakistan is imported from South Africa) or higher gas prices which the new government announced a few days earlier (see further below). On the positive side, continued investments in CPEC related projects and especially a “5 million housing project” which should be announced by Imran Khan’s government in October, will be very beneficial for cement companies in the medium term.


Later in the afternoon we took a flight from Lahore to the country’s largest city and commercial centre, Karachi, on Pakistan International Airlines (PIA), which is still 85% owned by the Government (Ministry of Defense) and last year lost USD 30 million each month. The company just changed its CEO and he wrote in the in-flight magazine that he will turn PIA around and the airline will have the “best entertainment system in the world” – let’s see! The aircraft was an old Boeing 777-200 and several signs such as the exit, restrooms and no smoking are still written in Vietnamese, maybe because the previous owner of the aircraft was Vietnam Airlines. We also noticed a Vietjet (a Vietnamese budget airline) aircraft on the tarmac right next to us which was obviously “wet leased” to PIA. We arrived safely in Karachi after a 1 hour and 20 minutes flight, and the hotel bus drove us through heavy traffic on the three-lane highway with many newly built bridges and flyovers to our hotel in Clifton.

Over the following two days we met with several companies from various sectors: banking, car manufacturing, cement (of course), chemicals, food, insurance, pharmaceuticals, steel, technology and textiles. Many of these companies are suffering from the Rupee deprecation and higher raw material costs and thus their net profit margins are depressed and generally the expectation is that the currency will weaken further, putting more pressure on those companies in the short term.

One sign of optimism came from a CEO of one of the leading textile companies in Pakistan. They received in the past several weeks more orders from U.S. textile buyers, especially for low end products as imports of low-cost textiles from Pakistan, Bangladesh or Vietnam will face a 0% duty, while imports from Chinese factories will be taxed at 10%. This particular CEO was also of the opinion that textile companies in Bangladesh and Vietnam are working at almost full capacity which is not the case in Pakistan since Pakistani textile companies cannot compete with Bangladesh due to, in his view, the overvalued Pakistani Rupee.

Most of the meetings were held at the Movenpick Hotel in Karachi and I was looking forward to our final two meetings which were with a food/snack company not far from the hotel and a pharmaceutical company, based in one of the industrial areas situated near the Karachi Port. The drive to the pharmaceutical company was unique as in the middle of the congested roads it is still possible to come across carts pulled by horses, donkeys and even camels. Also, very unique to Pakistan are the colourful painted buses and trucks which dominate the roads in busy Karachi.


Passengers on the roof of a colourful bus in Karachi


Lots of optimism but also realism”

Obviously in almost every conversation with C-level executives the topic of the new government under the leadership of the newly elected and former cricket player, Imran Khan, came up. Imran Khan assumed office on 18th of August 2018 and his government is already meeting a lot of high expectations from the public. Khan needs to quickly resolve some pressing economic issues like the low US Dollar reserves that are currently just 9 billion USD due to a chronic current account deficit which puts the Pakistani Rupee under further devaluation pressure as well. Khan already increased the gas prices for individuals and industries in order to reduce the subsidies and it is further expected that the price for electricity will be increased soon too. The new government is continuing to implement an existing policy introduced by the previous government which requires passenger car buyers to provide their tax filing number when purchasing a car in order to bring in more individuals to the tax net.

Generally, it is expected that interest rates will rise further, back to double digit levels, and that the Pakistani Rupee needs to devalue further against the USD from the current level of 124 to about 135 to 145 in order to make the country competitive again for exports (mainly textiles at the moment).

One of the most important and urgent economic tasks for Imran Khan’s government is the decision of how to finance the ever-growing current account deficit (due to higher imports and stagnant exports) and to stock up on their depleted foreign exchange reserves. Khan has basically two options: go to the IMF (again for the 22nd time in the history of Pakistan) or ask for additional loans from China and/or Saudi Arabia. In this respect, everybody I asked was of the same opinion: bite the bullet and go to the IMF. Therefore, it is not surprising that the government has just announced that they plan to begin talks with the IMF for a loan program.

One CFO of a diversified conglomerate described the expectation of the new government as “lots of optimism but also realism”: voters are optimistic that the Imran Khan-led government can change the country’s course towards a better future, but the same people are also realistic that it will be a huge challenge to overcome the current financial situation Pakistan faces at the moment.


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

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