In this Issue
In June, AFC Asia Frontier Fund (AFC) USD A-shares outperformed the MSCI Frontier Markets Asia Index(-6.9%), the MSCI Frontier Markets Index (-5.8%) and the MSCI World Index (-2.6%) with a return of -2.3%. With strong returns on a 1 year (+19.02%), YTD (+10.56%) and 3 month (+6.92%) basis, AFC has been ranked by Bloomberg in the 95th, 97th and 99th percentile within its category, which consists of 2,254 peer funds.
Not content to rest on our laurels, our analytical team identified some great news for the Asia Frontier asset class by identifying the low correlation to the MSCI World Index in comparison to more renowned emerging market indices. Whilst there is no such thing as a free lunch in the portfolio management world, the closest you can get to it is by taking advantage of diversification opportunities. It is good to know that global investors can access the low correlations which the Asian Frontier markets offer through the AFC Asia Frontier Fund. Asia Frontier Capital's exceptional uncorrelated returns are still available to new investors looking to come online. With our past performance, lunch is on us.
Moving forward with the AFC universe there were only two indices that had positive returns in June which were Bangladesh (+7.0%) and Mongolia (+3.8%). Bangladesh's Dhaka Stock Exchange (DSE) rallied thanks to improved confidence in the country's political stability with the DSE receiving the largest inflow of foreign capital in the last fiscal year. Bangladesh's growing remittance inflows and an increase in foreign exchange reserves also helped boost foreign investment. Mongolia's stock market gained due to improved foreign investor sentiment thanks to the recent developments with Rio Tinto's mining project in Oyu Tolgoi and the reelection of President Elbegdorj. For more information on Mongolia be sure to read our country snapshot at the end of the newsletter.
With Vietnam as AFC's largest country allocation, the 7.2% decline of the VN Index in June that stemmed from a broad selloff in blue chip stocks was less than excellent news. However, due to the value-driven stock selection in our portfolio, AFC outperformed the VN index by 4.4%. This performance reflects the less volatile nature of our wider portfolio which has been more resilient to large negative index movements. Vietnam's stock exchanges also announced that starting on July 22nd, both of the country's exchanges will extend their trading hours, which should help increase liquidity and trading activity.
The top-performing portfolio stocks were four stocks from Mongolia which gained between 22.6% and 48%, followed by a Pakistani tobacco company (+20.6%) and a Bangladeshi oil and petroleum distributor (+20.3%). We will continue to hold these shares as they are still trading below our fair value or target price.
In June we added to existing positions in Mongolia, Sri Lanka and Vietnam. Additionally, we bought a small position in a Vietnamese country fund which is trading at 39% discount to NAV. Although most of the fund's holdings are Vietnamese blue-chip companies which have dipped we saw value as foreign registered shares are trading at a premium to local shares. In Bangladesh, we took profit in two stocks: a mobile phone operator and a consumer appliances company (68% profit in 6 months). We also added a new position in a Bangladeshi pharmaceutical company because of good growth prospects.
As of June 30, the portfolio was invested in 109 shares, 2 closed-end funds (with 32.5% and 39% discount to NAV), 1 GDR (with 61% discount) and held 7.75% in cash. The two biggest stock positions are a power producer from Laos (4.7%) and a pharmaceutical company from Bangladesh (4.6%). The countries with the largest asset allocation include Vietnam (18.6%), Bangladesh (13.9%) and Sri Lanka (13.4%). The sectors with the largest allocation of assets are consumer goods (43.0%) and materials (12.6%). The fund's weighted average Price/Earnings ratio was 14.2x, Price/Book ratio was 2.6x and dividend yield was 4.3%.
With all of the work going into the transition of fund ownership, the AFC team has not had time in June to get on the ground in our frontier markets to provide our travel notes for this month. Keep a look out for next month's newsletter when we will provide local insights as we put our finger on the pulse of Papua New Guinea.
Every month we highlight economic developments in one country within the Asia Frontier Capital Universe.
With Successful Elections, Legislative Reform, and the Launch of Rio Tinto's Mega-Mine, Mongolia's Outlook Brightens
Mongolia, once the darling of foreign investors and mining corporations, has had a large question mark looming over it over the past few years as the government has backtracked on previously agreed upon mining profit shares, scaring off many investors and sending the country's stock exchange on a downward spiral. In recent months, however, Mongolia's outlook has brightened due to the country's recent election, the passage of a new Securities Law enacted to further safeguard investors' interests, and the first successful copper shipment from Oyu Tolgoi mine. Invigorated by this rekindled investor appetite, Mongolia's economy is projected to achieve 14% GDP growth this year and 11.6% growth in 2014.
On June 26, presidential elections were held and the Democratic Party incumbent, President Tsakhiagiin Elbegdorj, was reelected with 50.2% of the popular votes. Elbegdorj's victory was cheered by foreign investors and geopolitical analysts who underlined the immediate necessity for the Democratic Party to structure clear guidelines for dealing with the country's mineral wealth, infrastructure and environmental problems, and widespread corruption. All three Presidential candidates ran on a platform of "resource nationalism", but Elbegdorj was viewed by foreign investors as taking the most moderate stance on this issue, as mentioned by AFC Fund Manager Thomas Hugger in a CNBC interview on June 26th.
With the reelection of the Democratic Party, Mongolian lawmakers can move forward in clarifying many of the country's uncertain mining and investment regulations to improve the country's investment climate and sovereign credit rating. President Elbergdorj has signaled that he plans to unveil a new foreign-investment law soon which will bring further transparency and reassure investors that Mongolia is a trustworthy country in which to invest. With a population of under 3 million and an estimated US $1 trillion of untapped metals and minerals, attracting foreign investors will be vital for Mongolia to profitably extract the country's resources, while ensuring sustainable and equitable development. Avoiding the "Dutch Disease" that has plagued many other resource-rich countries is one of Mongolia's priorities as it decides how best to allocate rights to its resources and as it balances between foreign business interests and domestic pressure for "resource nationalization".
To appease perceptions of unfair distribution of wealth, President Elbegdorj announced plans to decentralize government spending and increase the budgetary allowance of province and county-level decision-makers - a move that was popular amongst Mongolia's rural population who have often felt left behind by the rapidly-modernizing political and commercial hub of Ulaanbaatar. The Democratic Party also acted on corruption by firing a deputy in the Government Secretariat accused of corruption and investigating the incumbent MP Sangajav Bayartsogt's offshore income account.
The June election results come on the heels of two improvements in legislation that also improved investor sentiment. In April, the Mongolian government passed an amendment to the controversial Sectors of Strategic Importance (SSI) section of the Foreign Investment Law. The amendment raised the foreign ownership limits in a number of sectors, including mining, and removed the previous requirement for parliamentary approval before purchasing equity in a company operating in an SSI.
In May, an amendment was made to the Securities Law that increased investor confidence by allowing multinational companies operating in Mongolia to participate in dual listings on overseas exchanges. This is particularly relevant for corporations involved in the country's mining sector, which will be able to list on the Mongolian Stock Exchange as well as an international bourse. This should allow domestic investors to maintain holdings in Mongolia's resources listed on a foreign exchange while also assuring foreign investors that their investments will be liquid through the dual listing on a larger, more stable exchange in London, Toronto, Hong Kong, or Sydney. The revamped Securities Law also introduced depositary receipts, custodian banks, and internationally-standardized disclosure requirements to Mongolia's capital markets.
Much of the concern regarding Mongolia's mining sector has hinged on Oyu Tolgoi ("OT"), one of the biggest open-pit mines in the world, containing an estimated 79 billion pounds of copper and 45 million ounces of gold. Oyu Tolgoi - Mongolian for "Turquoise Hill" - is a US $6.6 billion joint venture between Rio Tinto, Turquoise Hill Resources ( a subsidiary of Rio Tinto), and the Mongolian government. The Mongolian government has a 34% stake in the project.
Once it reaches full capacity in 2020, OT will produce 450,000 tonnes of copper and 330,000 ounces of gold per year, accounting for one third of Mongolia's GDP and 3% of the world's overall copper production. OT's construction has been a major reason for the country's double-digit GDP growth rate in 2011 and 2012 and the mine is expected to operate for at least 50 years.
Rio Tinto had proclaimed since February that it would not begin exporting from OT until it resolved disagreements with the Mongolian government over costs, fees, and financing for the project. Rio has halted construction on multiple occasions due to the Mongolian government's persistent efforts to redraft its agreement with the company to receive a larger share of the mine's revenue.
Much progress has been made, however, and after multiple delays, Rio Tinto finally exported its inaugural shipment of copper to China on July 9th. Located just 80 km north of the Chinese border, the Oyu Tolgoi mine is attractive to Chinese manufacturers who have a growing demand for raw minerals and natural resources to drive their industrial production.
If OT can be successfully managed as a public-private partnership, it has the potential to transform Mongolia's economy by vastly improving the country's infrastructure and assuring foreign investors that the country is indeed a safe place to inject billions of dollars. OT has been called a 'litmus test' in that foreign investors and mining giants are keeping a close eye on the project to determine whether the Mongolian government is truly committed to attracting foreign direct investment (FDI) and whether the country is really a safe place in which to invest.
The successful launch of OT's exports will help Mongolia's macroeconomic situation and improve its balance of payments by contributing much-needed revenues to the government and bolstering additional FDI as investors regain confidence in the country.
The Mongolian Stock Exchange (MSE), which was the world's best-performing stock exchange in 2010 and second-best performing exchange in 2011, has been battered in 2012 and 2013 due to the government reneging on its agreements with mining companies and flip-flopping on foreign investment decisions. Earlier this year, the government briefly froze the accounts of Rio Tinto and SouthGobi Resources, which caused investor confidence in the country to plummet over concerns about the feasibility of repatriating earnings from the country.
But with the enactment of the revised Securities Law slated for the beginning of next year, the MSE should grow due to a number of planned initial public offerings (IPOs). Erdenes-Tavan Tolgoi, the country's largest coal producer, is planning a dual listing on the MSE and the London Stock Exchange, and may also list in Hong Kong. Increased investor confidence should soothe the MSE's volatility, and according to the bourse's CEO, market capitalization could balloon from its current US $1.3 billion to US $30-40 billion in the next decade as mining giants currently listed overseas pursue IPOs on the Mongolian Stock Exchange.
In addition to the obvious plays in mining and natural resources, a number of other sectors remain attractive to investors eyeing the MSE. As Mongolia's population experiences a windfall in wealth from resource revenues, the country's expanding middle class will spark growth in the consumer goods, financial services, and energy sectors. Auxiliary sectors that support the mining industry, such as logistics, construction/building materials, infrastructure, and power generation, will experience rapid growth as capital flows in to the country and the mining industry expands.
Although Mongolia is gradually regaining credibility, investors will continue to hold their breath and watch closely as further legislation is enacted and Oyu Tolgoi ramps up production. A lot is riding on how the Mongolian government chooses to manage its joint venture in OT, and the country's reputation as an investment destination will largely weigh on the success or failure of the public-private agreement in the OT project. Another potential concern for Mongolia is its overreliance on China and the possibility of Mongolia's economic expansion slowing as China's GDP growth and appetite for Mongolian resources cools down. Mongolia currently exports 80% of its resources to China, and a drop in Chinese demand for minerals or a decline in global commodity prices would severely hurt Mongolia's economy. With the coming surge in the country's income, the Mongolian government will face tough challenges in regards to income inequality, economic diversification, corruption, and environmental degradation.
Overall, Mongolia's growth potential is massive and the recent developments in the country's election, enactment of legislative reform, and the long-awaited exports of Oyu Tolgoi copper have brought a new sense of optimism that Mongolia will be able to safeguard investors' interests and sustainably extract its resources. For contrarian investors analyzing companies that are auxiliary to the country's mining industry or are poised to benefit from the persistent economic growth, Mongolia is a fascinating opportunity with serious potential.
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