“Investors should always keep in mind that the most important metric is not the returns achieved but the returns weighed against the risks incurred.
Ultimately, nothing should be more important to investors
than the ability to sleep soundly at night."

− Seth Klarman, American Hedge Fund Manager

AFC Funds Performance Summary

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

Dovish comments from the U.S. Fed, a potential trade deal between China and the U.S., and the possibility of further economic stimulus measures in China led global stock markets to recover the losses they faced in the heavy correction of December 2018. Asian frontier markets also fared well with Cambodia, Pakistan and Bangladesh rallying by +22.0%, +10.1% and +8.1% respectively.

Our AFC Asia Frontier Fund, being less correlated with global markets, remained flat for the month while outperforming all the major indices in December 2018 when global markets faced a deep correction. To recap, in December 2018 the MSCI World Index declined by -7.6% while the AFC Asia Frontier Fund returned -0.7% and in January the MSCI World Index increased by +7.8% while AFC Asia Frontier Fund’s performance remained flat.

The performance of the AFC Asia Frontier Fund over the last two months and since inception reflects the lower correlation and volatility with global markets, especially in times of a sudden change in euphoric or bearish sentiments. This is due to the benchmark agnostic approach of the fund towards both country and stock selection and is further reflected in the very low beta of the fund with major indices, as the chart below shows. Our AFC Vietnam Fund also has a low beta of 0.52 with the Ho Chi Minh VN Index.

We continue with our on the ground research and marketing trips in 2019, with upcoming visits in the first quarter of 2019 to Myanmar, Dubai, Uzbekistan, and Vietnam. In 2018, we visited almost every country in our universe and as a team conducted more than 150 meetings with company management teams.

AFC Uzbekistan Fund / Uzbekistan Investor Tour

As mentioned first in our November newsletter, we are progressing well with preparations for the launch of the AFC Uzbekistan Fund sometime in March 2019 in order to capitalize on the once-in-a-generation value the country’s equity market offers. We are currently accepting expressions of interest for investment. 

Additionally, we are organizing an investor tour to Tashkent and Samarkand from 1^st May 2019 to 4^th May 2019.

If you have an interest in the AFC Uzbekistan Fund and would like to receive more information about the fund or the investor tour, please write us at This email address is being protected from spambots. You need JavaScript enabled to view it..

AFC in the Press

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 Iraq and London. 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..

AFC Asia Frontier Fund - Manager Comment

The AFC Asia Frontier Fund (AAFF) USD A-shares remained flat in January 2019. The fund underperformed the AFC Frontier Asia Adjusted Index (+8.2%), the MSCI Frontier Markets Asia Net Total Return USD Index (+4.2%), the MSCI Frontier Markets Net Total Return USD Index (+4.8%) and the MSCI World Net Total Return USD Index (+7.8%). The performance of the AFC Asia Frontier Fund A-shares since inception on 30th March 2012 now stands at +36.4% versus the AFC Frontier Asia Adjusted Index, which is up +15.8% during the same time period. The fund’s annualized performance since inception is +4.6% p.a. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualized volatility of 9.19%, a Sharpe ratio of 0.45 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.36, all based on monthly observations since inception.

Global markets saw a recovery this month on the back of dovish comments from the U.S. Fed, a possible trade deal between China and the U.S. (however issues between the two countries will persist) and the likelihood of further stimulus measures from China. In summary, markets gained back what they lost in December 2018.

When the markets saw a big correction in December 2018, the fund witnessed a large relative outperformance against all major indices while the fund’s performance remained flat this month as markets recovered. The performance of the fund over the last two months is a reflection of its lower correlation and volatility with global markets when there are sudden bearish or euphoric changes in global market sentiment. This is further reflected in the fund’s betas with major indices which are all less than 1. Since inception, the fund’s betas with the MSCI Emerging Markets Index, MSCI World Index, MSCI Frontier Markets Index and MSCI Frontier Markets Asia Index are 0.46, 0.53, 0.60, and 0.61 respectively. This low correlation, volatility, and beta relative to markets is due to the fund’s benchmark agnostic approach to both country and stock selection.
 

(Source: Bloomberg)

Bangladesh led performance as there was an anticipated post-election rally with the Dhaka Stock Exchange Index gaining +8.1%, making it one of the best performing markets in Asia this month. We believe the country’s stock market is well-positioned for good performance as a stable government backed by strong GDP growth of 7% and very favourable demographics are good tailwinds for corporate earnings growth going forward. On the macro front, there are also positive developments with the current account deficit for the July-December 2018 period falling by 39% YoY due to softer import growth and a pick-up in garment exports and increasing remittances which have grown by 15.7% and 8.1% respectively in the same period. The fund’s Bangladeshi holdings are well positioned to capture future economic growth in the country with investments in consumer discretionary, financial services, and pharmaceutical companies.

Robust manufacturing growth continues in Vietnam with January 2019 growth reported at 10.1% YoY. However, the Ho Chi Minh VN Index did not track the rally in Asia due to softer exports in January 2019. Though mobile phone exports, which account for 20% of total Vietnamese exports, have been weak over the last few months, this month’s overall soft export figure could be due to the Lunar New Year holidays and we therefore expect that export growth should normalize going forward. Also, on a relative basis, Vietnam’s export growth over the past year has been exceptional compared to the rest of the region.

From a performance perspective, the fund’s Vietnamese automotive holding led returns as it declared very good quarterly and full year results for 2018 with both Toyota and Honda benefitting from increased demand for passenger cars and motorcycles. This led to a 26% rally in the company’s stock price. Earnings growth was also very strong for the fund’s other Vietnamese holdings across sectors, namely, an airport operator, a pump manufacturer, an industrial park developer, a consumer staples company, a logistics company, and a cargo handling company. However, performance in Vietnam was negated by a construction company which declared lower than expected quarterly net profits and this impacted sentiment in the stock.

Pakistan witnessed a 10.1% rally in the KSE100 Index but one should not get carried away with this as the market recovered what it lost in December 2018 when it was down 8.5% with the current index level back to where it was at the end of November 2018. Normalised earnings growth (ex-banks and oil & gas) for 2019 is expected to be around 5% given the expected slowdown in GDP growth. Talks with the IMF for a possible deal are still ongoing while the State Bank of Pakistan raised benchmark interest rates by 25 basis points with market participants expecting no change. The move by the Central Bank is not surprising to us given the large current account deficit which is yet to face the full impact of the Pakistani Rupee (PKR) depreciation while the interim budget announced by the government did not see any major revenue raising measures given the large fiscal deficit. We remain underweight Pakistan.

Uzbekistan hit the proverbial ground running in the new year when it announced that from 1^st February 45 countries will be granted 30-day visa-free entry to Uzbekistan and citizens of 76 more countries (currently 101 countries) will be able to apply for E-visa’s online. This is part of the government’s initiative to make tourism a key pillar of the economy and increase the tourism sector’s contribution to GDP to 5% from the current 2.3%. Clearly the visa liberalization over the past year has worked as 2018 saw a 230% increase in arrivals, reaching 6.4 mln.

In perhaps an even bigger development, the government has announced that from 1^st July 2019, legal entities and residents of Uzbekistan will be entitled to privatize land under homes and buildings as well as vacant land plots. This is part of the government’s plan to see the privatization of land throughout the country with the exception of agricultural land and is a welcome move which will bring Uzbekistan in line with many post-Soviet satellite countries, and it is expected this will further increase property rights as well as investment into the sector.

In the universe of listed companies, the government has drafted proposed legislation which could see the privatization of their holdings in the vegetable and animal fat industry. With multiple listed vegetable oil producers, this could mean a marked increase in liquidity, increase in capacity utilization (with raw material imports not taxed), as well as other tax cuts. We are optimistic on this industry as it provides direct exposure to the country’s 33 mln consumers who, with increased income, will increase their consumption of vegetable oils-namely cottonseed, sunflower, rapeseed and soybean oil.

The parliamentary saga in Mongolia continued during the month with Speaker Enkhbold Miyegombo forced to resign, having faced pressure since a no-confidence vote against the prime minister in November. The shakeup against corruption gained further steam as several other individuals were either put under investigation or detained. This went so far as for the June 2009 agreement between Turquoise Hill and the Mongolian government on the Oyu Tolgoi copper/gold project to be investigated after the previous finance minister, Bayartsogt Sangajav, was re-arrested for reportedly holding shares in either Turquoise Hill or Rio Tinto in anticipation of signing the deal. On a more upbeat note, GDP for 2018 clocked in at 7.1% due to increased exports of namely coal and copper, a robust turnaround from the past several years.

The best performing indexes in the AAFF universe in January were Cambodia (+22%), Pakistan (+10.1%), and Bangladesh (+8.1%). The poorest performing markets were Iraq (−3.1%) and Laos (−1.3%). The top-performing portfolio stocks this month were a chemical company from Uzbekistan (+55.2%), an oil and gas servicing company from Uzbekistan (+37.5%), a Mongolian junior oil & gas company (+36.6%), a cement company from Uzbekistan (+30.4%), and an engineering company from Uzbekistan (+26.3%).

In January, we added to existing positions in Mongolia, Uzbekistan, and Vietnam and added two new companies from Uzbekistan: a wine company and a cooking oil company. We exited one junior oil & gas company from Mongolia, a Pakistani household goods producer and a Pakistani insurance company. We partially sold two Mongolian companies and each one company from Pakistan and Vietnam.

As of 31^st January 2019, the portfolio was invested in 109 companies, 1 fund and held 3.9% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (7.6%) and a pump manufacturer from Vietnam (5.5%). The countries with the largest asset allocation include Vietnam (26.2%), Bangladesh (21.3%), and Mongolia (17.5%). The sectors with the largest allocations of assets are consumer goods (30.3%) and industrials (21.7%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 12.39x, the estimated weighted average P/B ratio was 1.99x, and the estimated portfolio dividend yield was 4.05%.

AFC Iraq Fund - Manager Comment

The AFC Iraq Fund Class D shares returned −0.4% in January with a NAV of USD 585.22 which is an outperformance versus its benchmark, the Rabee USD Index (RSISUSD index), which returned −3.1% for the month.

The Iraq Stock Exchange (ISX), as measured by the Rabee Securities RSISUSD Index, started the year not with a bang but with a whimper, as befits the ending of the Chinese year of the Dog, by going mostly sideways on a continuation of the low turnover of the last few months.

However, the emergence of a moderate foreign seller took the index down to about −5% for the month before buyers emerged to absorb some of the selling, taking the market to a decline of −3.1% by the end of the month.

The real economy on the other hand is showing increasing signs that liquidity is returning as the healing effects of higher oil revenues over the last two years are having a positive effect. As reported last month, this was seen in the recent recovery in broad money, or M2, which acts as a proxy for economic activity. Driving the recovery in M2 has been the growth in the monetary base M0-defined as “the sum of currency in circulation and reserve balances in Iraqi Dinars (IQD) held by banks and financial institutions with the Central Bank of Iraq (CBI)”.

The clearest evidence of this nascent recovery is seen in the IQD Current Account (C/A) component of banks’ reserves with the CBI, which has been behind the recovery in M0 as seen in the chart below.

The IQD C/A component of banks’ reserves with the CBI reversed its multi-year decline in late 2017 and began a recovery that picked-up momentum in May 2018, with the latest data as the end of December 2018 showing a continuation of this trend. This in turn is driven by the level of customer deposits (consumers, businesses and government) held with the banks. The early evidence of increased private sector deposits was discussed a few months ago in “Of Banks and Budget Surpluses”, however the granular data for private sector deposits is only available for the end of 2017. The rise in deposits for 2018 is likely to have been driven by government deposits, which should lead to a rise in private sector (consumers and businesses) deposits as the government begins its spending programme as discussed later in this report.

The current trends indicate a continuation of this recovery, and as such to a continued recovery in M2. The latest M2 figures from the CBI for October and estimates for November (based on MO figures for November and recent M2/M0 multiplier figures) support this as can be seen from the chart below.

The prospects of increased economic activity got a boost with the end of the government’s spending paralysis, as parliament finally approved the 2019 budget in mid-January. The budget, however, is heavily skewed towards current spending, as opposed to investment spending, as both parliament and government are under pressure to appease the population with some immediate rewards from the end of conflict and the recovery of oil prices. (For a review of the budget see the appendix in this report).

The government’s financial firepower is considerable, as the latest Ministry of Finance (MoF) budget report of October 2018 shows a surplus of USD 21.5 bln for the first 10 months of 2018. As such, in addition to the surplus of USD 1.5 bln for 2017, this means that the government could easily achieve the estimates made here over the last few months — a two-year surplus of USD 24.5 bln by end of 2018.

The immediate consequence of government spending would be improvements in consumer and business sentiment leading to a pick-up in consumer and business spending, and subsequently an economic recovery as the multiplier effect works through the economy. The long-term sustainability of the upcoming economic recovery would be driven by the implementation of the government’s non-oil investment programme for 2019 of about USD 12.5 bln, which would be equivalent to about a 7.5% stimulus to the estimated non-oil GDP for 2019.

The recovery in M0 that is leading to a gradual recovery in M2 seems to be happening in a mirror image of Ernest Hemingway’s phrase on going broke, i.e. “Gradually and then suddenly” (attributed in error here in the last few months to Mark Twain), and so the next few months should see this translate into actual economic recovery.

If we are to go on similar experiences in other frontier markets (of declining markets while fundamentals show gradual recovery following a long basing period) then the market’s declining trend of the last few months should be followed by a sharp reversal and the beginning of a new upward trend.

As of 31^st January 2019, the AFC Iraq Fund was invested in 14 names and held 6.3% 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 (89.6%), Norway (3.4%), and the UK (0.7%). The sectors with the largest allocation of assets were financials (47.9%) and communications (20.1%). The estimated trailing median portfolio P/E ratio was 13.28x, the estimated trailing weighted average P/B ratio was 0.94x, and the estimated portfolio dividend yield was 7.55%.

AFC Vietnam Fund - Manager Comment

The AFC Vietnam Fund returned −1.6% in January with a NAV of USD 1,747.73, bringing the return since inception to +74.8%. This represents an annualized return of +11.6% p.a. The Ho Chi Minh City VN Index in USD gained +2.4%, while the Hanoi VH Index lost −1.0% (in USD terms). The broad diversification of the fund’s portfolio resulted in a low annualized volatility of 8.68%, a high Sharpe ratio of 1.24, and a low correlation of the fund versus the MSCI World Index USD of 0.30, all based on monthly observations.

The start of trading in the new year was very slow in terms of market volume, just the opposite of last January. Most market action was concentrated in companies releasing their annual results. Because of a hiccup in the largest stock on the HSX, Vincom, (limit down on the last trading day in December and strongly up on the first trading day in January), the stock market in HCMC outperformed and ended up with a gain of +2% while the index in Hanoi suffered a loss of -1.3% and was more in line with the general market, which weakened, especially in the second half of the month.

Market Developments

The first month of 2019 saw the slowest trading volume in years at about 50-60% below the 12-month average. If we consider that many large companies were listed over the past 2 years, the average volume for stocks listed before the IPO-wave is even worse than this number. Additionally, both indices in HCMC and Hanoi are still trading at around their summer 2018 lows and about 25% below their peak of April 2018.

Despite the very favourable macro statistics of Vietnam, many people took profits in what we see as an interim correction in a long-term uptrend. The bottoming process can be quite painful as investors throw in the towel and institutional investors have to sell at almost any price in a declining market with low volume. With around 2/3 of our companies having reported their annual results, we were pleased to see that majority of our holdings met our earnings expectations. There are only a few stocks where we need to adjust our position and given the low market volume, we will do this rebalancing carefully and less aggressively than during high volume periods.

With many local Vietnamese investors currently on the sidelines, the stock market is showing very little activity and is mainly driven by moves from a few highly capitalized stocks, or the lack thereof, as shown in the chart below. Vingroup, the biggest contributor to most Vietnamese indices, is a good example of this. Hitting an all-time high along with the index in April 2018, the stock has gone mostly sideways on declining volume since then, while most stocks have fallen 20-40% from their peaks. The trading pattern of Vincom over the past two months is even more astonishing during a time of high volatility in all markets, as this high P/E stock (trailing P/E of 85x) is showing very unusual stability – except for the two trading days around New Year’s Eve where it shaved off almost 1% of the index’s performance for 2018 but helped the index for almost the same amount on the first day of 2019.
 

Vingroup, 11/2017-01/2019

We certainly try to reduce the volatility of our portfolio as much as possible through broad diversification, and hence avoid risks such as companies with high valuations and strong concentration. We acknowledge that average valuations came down significantly, but we hardly see much diversification in most index-tracking ETF’s or other funds. The main reason lies in the high weighting of a few stocks in the indices which causes those funds to have similarly high exposure due to their aim to track the indices. We see enormous potential ahead for the Vietnamese economy, not only but also because of the ongoing shift from manufacturing production into Vietnam with the support of geopolitics. Picking tomorrow’s winners today is a combination of knowledge, research and ultimately a good amount of luck and therefore certainly justifies a broader diversification into different sectors and market segments.

Most investors are probably not aware of the challenges ETF’s and other funds in Vietnam are facing when they try to track an index. One of the difficulties is that foreign ownership limits make it very difficult for foreign funds to replicate some indices efficiently, since quite a few of the important index constituents have no more foreign room left. Another hurdle is the way some of these indices are constructed, with a handful of overpriced index heavyweights dominating the index and hence its price movements.

VN30-Index: combines the biggest stocks of both exchanges, and given the stock exchanges of HCMC and Hanoi are strongly rumoured to merge soon, this index is becoming more and more important.

Biggest downside risks: Many of the stocks are hard or impossible to buy because they have reached their foreign ownership limit, top 3 holdings index constituents represent 40% of the index

Highest weightings: Vingroup 17.5% (P/E >50), Vinamilk 12.7% (P/E 23), Vietcombank 11% (P/E 14)

www.investing.com/indices/vn-30-components

FTSE Vietnam: only large cap stocks, but also takes into account that they are investable by foreigners.

Biggest downsides: Top 6 stocks account for 74% of the index, Vingroup including subsidiaries alone for 38%            

Highest weightings: Vingroup 15% (P/E >50), Vinamilk 15% (P/E 23), Vinhomes 15% (P/E 30)

www.ftse.com/products/indices/Vietnam

VanEck Vietnam ETF (VNM): trying to replicate the index performance but limited to shares which are available for foreigners.

Biggest downsides: Invests in Vietnamese equities outside of Vietnam (latest information shows around 30% of the fund is allocated abroad), local investors always front-run the rebalancing of the fund as it is published in advance.          

Highest weightings: Vingroup 8% (P/E >50), Vinamilk 7.6% (P/E 23), Vinhomes 6.6% (P/E 30)

www.vaneck.com/etf/equity/vnm/index/

AFC Vietnam Fund / VN30 / FTSE Vietnam / VNM ETF (USD base) since 31^st December 2013

Past performance is never a guarantee of future performance, but the much lower valuation combined with much broader diversification of our fund keeps us confident that we will see a revaluation of our portfolio again as soon as the broader market starts to perform again.

Just one example is our current and biggest holding, Agriculture Bank Insurance Corporation (ABI), which just released its financial numbers for 2018. It is trading at just 5.2x current earnings. Over the past 3 years this company increased its revenues by 75% and net profit by 110%. Along with most other mid- and small-caps, the stock price was slightly lower in 2018, but it is a perfect example of the tremendous future potential we see for our portfolio. Different to other listed insurance companies, ABI focuses on retail clients. About 70% of total revenue comes from retail clients. ABI sells its products through the banking system of the parent company, Agriculture Bank, which has one of the largest branch networks in Vietnam at over 2,500 locations.

Based on the unaudited financial statements for 2018, ABI reported a net profit of USD 7.4 mln. The cash balance is around USD 72.6 mln and liabilities amount to around USD 59.8 mln which equates to a net cash position of an astonishing USD 12.8 mln, compared to a total market cap of USD 38.7 mln. It is interesting to note that around 80% of the liabilities are insurance provisions which will be booked as reserves at the end of the respective insurance policies as long as there are no pay-outs. ABI sold more than 1 mln insurance policies to retail clients with an average insurance premium of around USD 40 per contract in 2018. It also has one of the lowest pay-out ratios on their flagship retail insurance product (we estimate around 25% of total premium income for 2018) in the industry and the average pay-out amount is around USD 4,200 per client.

(Source: ABI financial report in 2018, AFC Research)

Stock Exchanges closed for TET Holidays

The stock markets were closed from 4^th February to 8^th February due to TET Holidays in Vietnam. TET is the most important family event for Vietnamese people. During TET Holidays there are a lot of outdoor activities such as TET flower festivals around the country and most importantly, people visit their relatives during the first 3 days of the holidays. In all of the streets you will see many women wearing their traditional Ao Dai dresses and they are normally quite happy, posing for photos with many tourists around.

Economy

Vietnam’s public debt to GDP has decreased over the past two years to 61% in 2018 from 63.7% in 2016.

Public debt to GDP

At the end of January 2019, the fund’s largest positions were: Agriculture Bank Insurance JSC (3.4%) – an insurance company, Vietnam Container Shipping JSC (3.3%) – a container port management company, Sametel Corporation (3.0%) – a manufacturer of electrical and telecom equipment, TanCang Logistics and Stevedoring JSC (2.6%) – a logistics company, and LienViet Post Joint Stock Commercial Bank (2.4%) – a bank.

The portfolio was invested in 67 names and held 4.8% in cash. The sectors with the largest allocation of assets were industrials (34.2%) and consumer goods (29.9%). The fund’s estimated weighted average trailing P/E ratio was 8.35x, the estimated weighted average P/B ratio was 1.35x and the estimated portfolio dividend yield was 8.08%.

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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