Asia Frontier Capital (AFC) - September 2015 Newsletter
"The stock market is a device for transferring wealth
In September 2015, the AFC Asia Frontier Fund returned -1.4%, outperforming the MSCI Frontier Markets Asia Index (-7.5%), the MSCI World Index (-3.9%), and the MSCI Frontier Index (-2.6%), which all dropped significantly. The year to date performance of the AFC Asia Frontier Fund USD A-shares stands now at -0.8% versus the MSCI Frontier Asia Index, which is down -14.3% during the same period. The AFC Asia Frontier Fund has now returned +37.0% since inception.
The AFC Iraq Fund returned -2.2% in September 2015, outperforming the Rabee Securities USD Index which dropped by –3.9% in September. Though oil prices have continued their downward slide and global markets, including Iraq, have been under strain in recent months, the AFC Iraq Fund has performed in line with the Rabee USD Index since inception.
The AFC Vietnam Fund gained +1.2% in September bringing the net returns since inception to +34.9%, which is a significant outperformance of the Ho Chi Minh City VN Index and the Hanoi VH Index, which were -0.8% and +1.4% respectively in the same period in USD. The year to date performance of the AFC Vietnam Fund stands at –0.6% versus the VN Index and VH Index which have returned -1.8% and -10.4% respectively, in USD terms, over the same period.
Not many investors had expected the revelation of Volkswagen’s deceptive behaviour of avoiding emission regulations rather than properly addressing them. In fact, to many people Volkswagen was a well-respected and trustworthy leader in its field. This scandal that had a devastating impact on the company’s share price costing shareholders to the tune of €30bn was probably impossible to foresee. In stock selection one needs to do his homework, develop a substantive view of the promising nature of a company and weight the associated risks. But there always remain risks that cannot be quantified. This is the case in developed markets just as well as in the frontier markets. Therefore we diversify our funds across a number of positions, which means that even if a stock were to be impacted by a negative surprise, which we hope won’t happen, the impact on the overall portfolio would be minor. By the same token, due to the lower valuations of companies in frontier markets, in the case of a negative surprise the financial impact is likely significantly less, in absolute as well as relative terms.
The US Federal Reserve has once again decided to leave interest rates untouched. Though this action is designed to support the economy, this is not directly translating into a bullish momentum for share prices. Instead the markets seem to be affected by continued uncertainty about global economic growth. For some frontier markets that have a largely export driven economy, this could delay or slow down export growth. Most of our investments are in companies that benefit from local economic growth and will therefore be less affected by any uncertainty about the global economy.
Peter de Vries to Take Over Responsibilities from Stephen Friel
We would like to announce that AFC’s Marketing Director, Stephen Friel, has left AFC as of the end of September 2015 and is moving on to take up another opportunity outside of the frontier markets space. Steve has helped to grow our company since its inception in June 2013 and we would like to thank him for his hard work and wish him all the best for his future endeavours. As you can see in the Press section of the newsletter, Steve has gone out with a bang!
We look forward to continuing to bring our clients excellent service under the new direction of Peter de Vries working alongside with the rest of the AFC team. Peter has over 25 years’ experience in finance of which 20 have been in Hong Kong. He is a former Director and Senior Relationship Manager at Leopard Capital. Prior to that, he was an Executive Vice President at Upbest Financial Services where he was involved with fund raising and deal structuring for real estate investment and development projects in Macau. Previously he worked as Executive Vice President at ViewTrade Securities in Hong Kong as head of the business development for the Asia Pacific region. Peter has also held the position of Assistant Vice President at Merrill Lynch Asia Pacific. He holds an MBA in finance from Calstate Hayward, and a Masters of Science in Electrical Engineering from Twente University in the Netherlands. Peter is fluent in Dutch, English, and German.
AFC Asia Frontier Fund (AAFF) USD A-shares returned -1.4% in September 2015, outperforming the MSCI Frontier Markets Asia Index (-7.5%), the MSCI World Index (-3.9%), and the MSCI Frontier Index (-2.6%) which all dropped significantly. The year to date performance of the AFC Asia Frontier Fund A-shares stands now at -0.8% versus the MSCI Frontier Asia Index which is down -14.3% during the same period.
This month saw a continuation of nervousness across the globe which rippled across global markets, also impacting both frontier and emerging markets. Though the U.S. Federal Reserve decided to hold back on raising rates, worries over the impending rate hike as well the economic slowdown in China continued to impact investor sentiment in global markets. Sri Lanka was the latest country which allowed its currency to depreciate by about -4.8% during the month. Though Sri Lanka does not export as much as Vietnam or Bangladesh, the currency depreciation was allowed due to a huge increase in vehicle imports due to a drop in fuel prices and this increase in imports was impacting the foreign currency reserves. Vehicle imports in Sri Lanka increased by 101% in the first half of 2015 in USD value terms.
As discussed in the previous month’s manager comment, though currency depreciation is a worry in investors’ minds, the fundamentals of the fund’s larger markets are in relatively better shape compared to 12-18 months ago as countries such as Bangladesh, Pakistan, and Sri Lanka have benefitted hugely from the drop in oil prices and this has helped them manage their balance of payments and also improve their foreign exchange reserves. Consumer companies in Sri Lanka have shown good numbers for the June quarter due to rising disposable income and Pakistani companies dependent on imported commodities have continued to show good profit growth as they continue to benefit from low commodity prices. Though Vietnam may not benefit fully on a macro level from the drop in crude oil prices as it is a crude oil exporter, on the consumer level it has had an impact. Retail sales have grown by +9.8% so far this year and the cyclical upturn in Vietnam continues. This is reflected in the quarterly numbers of some of the cyclical companies the fund holds, as well as in broader economic data, with overall GDP growing by +6.5%, industrial production by +9.8%, and exports by +9.6% in the first nine months of 2015.
At the time of preparing the manager comment an important development took place in the form of the Trans Pacific Partnership (TPP) being agreed upon between all the member countries. The TPP is a free trade agreement between 12 countries: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the U.S. and Vietnam. A big beneficiary of the TPP from the fund universe is obviously Vietnam. The TPP will remove import duties to Vietnam’s biggest export market which is the U.S. and this will have a big impact on the country’s exports going forward. Further, due to this duty free access to the U.S. market, it is possible to see increased foreign investment into the country as manufacturers from the region look to set up operations in Vietnam to take advantage of the TPP. One of the bigger beneficiaries of the agreement is the textile and garment sector in Vietnam, as the country is becoming a leading garment and textile exporter due to its lower wages compared to China. Further access to the key market of US can provide even a bigger boost to the Vietnamese textile and garment sector. However, though the TPP has been agreed upon between all participating countries it still needs to be ratified in each country and the next hurdle to cross is passing the TPP in the U.S. Congress in early 2016. If the TPP does go through, it is a big positive for Vietnam’s long term GDP growth.
With respect to fund outperformance, this was primarily due to positive moves in some of the cyclical and consumer related stocks the fund holds in Vietnam. There was also stable performance in Bangladesh as consumer stocks for the fund held up well, and a positive move in a Mongolian junior mining company. The drags on performance were Sri Lanka and Pakistan, as the currency depreciation in Sri Lanka impacted market sentiment. Even though Pakistan pulled down fund performance this month, the fund did better than the overall KSE-100 index due to a +10% move in a consumer beverage company which is one of the fund’s larger holdings in Pakistan. In addition, the fund has a much lower weight to Pakistan compared to the MSCI Frontier Markets Asia Index and this also led to outperformance over the benchmark.
The best performing indices within the AAFF universe in September were Mongolia (+1.9%), followed by Bangladesh (+1.7%) and Vietnam (+1.4%). The poorest performing markets were Pakistan with (-7.0%) and Sri Lanka (-3.5%). The top-performing portfolio stocks were a Mongolian junior gold mining company (+25%), followed by a Bangladeshi personal health care company (+19.7%), a Mongolian property developer (+19.1%),
In September we added to existing positions in Mongolia and Vietnam. We completely exited a food processing company in Sri Lanka and a holding company in Myanmar. Additionally we continued to reduce further our holding in two companies in Vietnam.
As of 30th September 2015, the portfolio was invested in 113 shares, 1 fund and held 4.8% in cash. The two biggest stock positions are a pharmaceutical company in Bangladesh (5.2%) and a Pakistani pharmaceutical company (5.1%). The countries with the largest asset allocation include Vietnam (28.2%), Pakistan (20.0%) and Bangladesh (14.7%). The sectors with the largest allocation of assets are consumer goods (40.3%) and materials (14.4%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 14.55x, the estimated weighted average P/B ratio was 1.49x and the estimated portfolio dividend yield was 3.57%.
For more information about Asia Frontier Capital’s Asia Frontier Fund please click the following links:
AFC Iraq Fund Class D shares returned -2.2% in September 2015, which was an outperformance against the Rabee USD Index (RSISUSD) which returned -3.9% in USD terms. The fund has outperformed the RSISUSD by +0.1% since inception.
In September the AFC Iraq Fund continued to build positions in several Iraqi companies including insurance companies and banks, as well as other sectors including pharmaceuticals, telecommunications, and real estate. It made no changes to current foreign listed holdings, which derive the majority of their business from Iraq, in the energy and oil sectors. The fund has only undertaken buying activities and has not yet made any full or partial exits.
The RSISUSD index’s -3.9% decline in September masks a rise from a -8.8% decline in the first half of the month. Notable index underperformers included Iraq Middle East Bank (-12.2%), Investment Bank of Iraq (-12.1%), and Gulf Commercial Bank (-4.3%), which collectively account for a 33% weighting in the index. The major outperformer was Mamora Real Estate (+15.5%) on the back of a +6.95% upward move in August which in the process increased its index weighting to about 6%. The index is down -15.1% YTD, down -17.1% from the June high but still up +29.5% since the recent bottom in March 2015. The volatility of monthly returns on both the upside and downside are an inevitable part of the Iraq investment story as it is both a nascent frontier market and an illiquid one, and hence the focus of the long term is an essential part of the investment thesis of this fund.
The continued poor performance of the market since the June peak, as noted last month, is mostly related to strains on local liquidity from lower oil prices and the short-term dislocations from the recent political reform package. The double whammy of the cost of war and lower oil prices has strained government spending with the result that the non-oil economy is seen by the IMF to decline by -11.2% in 2015 on the back of a -8.8% decline in 2014. This has manifested itself on the ISX in the form of distressed selling combined with anaemic local buying, resulting in meaningful declines on low volumes. This however, seems to have eased somewhat allowing the index to bounce +5.2% from the September lows to end the month with a -3.9% decline for the month.
Net foreign inflows, as seen through proxy portfolio flows, continue to build on the strength noted in August. However, the Eid holidays resulted in a shorter month with preliminary data at almost two thirds of the levels of August but still higher than recent months indicating a downtrend has been halted (see the chart below). However, this recovery in flows is still in its infancy and much lower than the levels seen in 2013, which implies a continued recovery in inflows will go hand in hand with a recovery in the market. Increasing confidence in the end of conflict in Iraq spurred by positive implications of the Iran nuclear accord will likely be a driver of continued inflows.
*Outside chart: Oct 13: + $14m inflow into IBSD, Source:
Looking at the portfolio, as of 30th September 2015, the AFC Iraq Fund was invested in 14 shares and held 1.0% in cash. As the fund invests in both local and foreign listed companies that have the majority of their business activities in Iraq, the countries with the largest asset allocation were Iraq (88.8%), Norway (6.1%) and the UK (4.0%). The sectors with the largest allocation of assets were financials (50.3%) and consumer staples (19.5%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 14.13x, the estimated weighted average P/B ratio was 1.17x, and the estimated portfolio dividend yield was 2.71%.
Last month we mentioned the weak second quarter earnings for telecom operators while in our June newsletter we reviewed Telecom IPO’s and as such a short review of the telecom sector is appropriate.
Iraq’s fixed line network, like much of Iraq’s infrastructure, was mostly destroyed during the 35 years of conflict and what wasn’t destroyed has suffered from lack of upkeep and maintenance. Currently fixed line penetration stands at 7%, while mobile penetration stands at over 86% from almost zero in 2003, since mobiles were forbidden prior to then. Iraq is served by 3 GSM operators with country-wide licenses, which each paid about USD 1.25 billion for in 2007 for a 15-year license. The pre-paid segment accounts for 97% of all subscribers due the security situation and 3G wasn’t introduced until early 2015.
Internet access as a result of this is slow, tortuous, and expensive as the country relies on the northern Kurdish region for internet access, supplying over 75% of networks and over 90% of personal IP addresses, making access expensive. There are no reliable or consistent figures for countrywide internet usage with the industry quoting penetration rates of less than 15%. A Gallup survey of a telephone poll of 2,050 phone users, both mobile and fixed, conducted in December 2014, showed that 50% of Iraqis have internet access but that only 40% have used the internet recently and 52% have never used the internet.
These dynamics underpin our positive long-term stance on the space as internet usage and associated growth industries take hold with the roll-out of 3G on its own right and as an enabler of internet access. This seems to be echoed by the mobile operators with each agreeing to a USD307 million fee in November 2014 for 3G spectrum for the reminder of their 15-year license.
The difficult operating environment for the operators, normally characterized by high operating costs, was exacerbated by the ISIS occupation of a third of the country with the associated loss of customers, equipment, and coverage. The ensuing conflict added to the challenges of network shutdowns, associated with much higher operating costs, the displacement of over 3.2 million people (9% of the population), and escalating price competition to attract and keep users.
Second half 2015 results of the two public operators demonstrate the devastating effect on revenues: -21% for Asiacell and -32% for Zain while net profit was -90% for Asiacell and -65% for Zain. The final effect on net income was made much worse by the high amortization/depreciation charges to cover the 3G spectrum fee. Zain is the operating name in Iraq for Al Khatem Telecom.
However, the silver lining within this perfect storm is the quick adoption of 3G, with up to 20% of subscribers moving to 3G since its introduction in early 2015. The higher associated data revenues and the moderating price competition should lay the foundation for profit recovery. The path, however, will be rocky as the introduction of a 20% VAT on pre-paid cards and internet services in the summer and conflict related headwinds will exert their negative effects.
The disparity of the valuations in the table below is due to the different route taken by each company to list its shares on the Iraq Stock Exchange (ISX) which was discussed at length in our June newsletter.
Comparison Iraqi Telecom Companies as of 30th September 2015
For more information about Asia Frontier Capital’s Iraq Fund please click the following links:
The AFC Vietnam Fund returned +1.2% in September, bringing the net returns since inception to +34.9%. By comparison, the performances of the Ho Chi Minh City VN Index and the Hanoi VH Index were -0.2% and +1.4% respectively (in USD terms). Since inception the AFC Vietnam Fund has outperformed the VN and VH Indices by +31.0% and +27.6% respectively, in USD terms.
Various free trade agreements have been signed in recent months or are near completion. Even the TPP has finally been signed after 5 years of negotiations, but still requires ratification by all its member countries. Inflation came down further from an already moderate level in the previous year and will probably be well under 3% in 2015. Foreign direct investments continue to grow together with foreign remittances from overseas Vietnamese, which are responsible for a positive balance of payments, although there is a small trade deficit of around USD 4 billion (as of September), due to increased imports (mainly machinery and equipment). As a positive exception within Asia and probably the world, the Asian Development Bank recently raised Vietnam’s GDP growth forecast to 6.5%. This upward revision however should already be obsolete after preliminary growth figures for the first 9 months show a growth of 6.5%, beating all expectations. Thus, the growth rate this year is now expected to come in between 6.7% and 6.8%, after achieving 6% last year and 5.4% in 2013. In only 3 months’ time there will be the official start of the ASEAN Economic Community but the press seems to have completely forgotten about it, especially its positive impact on regional trade. With such a positive macroeconomic environment combined with low equity valuations, it shouldn’t be surprising if the index starts a new uptrend.
Even more surprising is the reality that shares are still on the same level as in recent years.
VN30 Index since 2012
The above chart of the VN30 Index (2012-2015) includes shares of both exchanges and will probably gain in importance after the merger of the two stock exchanges in the coming years. Foreign investors were pro-cyclical and therefore sellers for the past several weeks, given the weakness in emerging markets. For the whole year however they were neutral and the low share of trade turnover with only 5-10% in recent days shows once again that local investors are inactive and certainly not buyers.
However, we continue to see a stabilization in market breadth (advance / decline ratio) and a relative strength of smaller stocks and we also noticed an increased interest in many of our fund holdings. While global major markets are still looking for a technical support at around the lows of August, we already see the beginning of a rebound and a good start for the historically positive fourth quarter. With a very low volatility of equities and the Vietnamese currency over the last month, the indices were more or less unchanged.
For more information about Asia Frontier Capital’s Vietnam Fund please click the following links:
Since Sri Lanka's three decade long civil war ended in 2009, the government has pursued ambitious economic policies in attempts to spur growth on the island. Sri Lanka's economy expanded by 8% in 2011, and after a slight lull in growth due to weak external demand, is expected to grow at an average of 7.7% a year through 2016. Economic growth will be concentrated among investment in reconstruction efforts (particularly in the north and east), large infrastructure projects, real-estate development, and assorted business investment as companies seek to capture market share amid rapid economic expansion. Private consumption, fuelled by rising incomes and consistent flows of remittances, is also driving economic expansion. Sri Lanka's 91% literacy rate and life expectancy of 75 years rank well above those in the region (including India, Bangladesh, and Pakistan), making the labor force attractive for both manufacturing and service jobs, which already compose 57 % of GDP.
The CSE has a market capitalization of USD 23.0 billion and a P/E ratio of 13.4x as of September 2015.
In line with our process of being on the ground in the countries we invest in, Ruchir Desai, Senior Investment Analyst of the AFC Asia Frontier Fund, travelled to Sri Lanka to attend an investor conference in Colombo.
It was good to be going back to Sri Lanka for another visit, especially after the new government came to power earlier this year. The past 8-10 months have seen lots of changes in Sri Lankan politics, which has led to a change in the direction the new government would like to give to the country. Similar to last year, the meetings were all held in Colombo at the Cinnamon Grand, but this time I also got a chance to visit Galle, a seafacing picturesque city which is located around 120 km south of Colombo and is a big tourist attraction. Getting to Galle has now been made quite efficient with the opening of the Southern Expressway which connects Colombo and Galle and has reduced travel time from around 3-4 hours to 1.5-2 hours. The Southern Expressway has been further extended to the South to Matara and this is expected to be further extended to Hambantota, on which work has begun.
Besides being known for its scenic views of the Indian Ocean, one of the main tourist attractions in Galle is the Galle Fort, first built by the Portuguese and then further built up by the Dutch. The city has done very well to maintain the architecture and feel of its colonial past and this is reflected in most buildings in and around the Galle Fort area.
Galle Lighthouse and Dutch Hospital Complex - Galle
During my last visit to Sri Lanka there was a lot more confidence amongst the policy makers and corporates but since the new government has come to power there is a sort of cautious optimism on the ground and there is a lot of expectation from the new government to deliver as most people I spoke to wanted change from the previous government. The upcoming budget in November will probably be a good indicator of which direction the new government is going to take and it would not be surprising to see the new government take measures to increase tax revenues, as the fiscal deficit is around 5.9% of GDP and needs to addressed.
Though expectations are quite high for the new government, lower crude oil prices have been a major positive for the country as this has helped managed the balance of payments and current account deficit as Sri Lanka imports most of its oil. Lower fuel prices and lower inflation have trickled down to the consumer level and this was reflected in the June quarter numbers of most consumer related companies that presented in the conference. Also, another factor which was positive for consumer spending was the increase in salaries of government employees.
Though consumer companies showed good numbers in the first half of 2015, margins could come under some pressure as most consumer companies in Sri Lanka import their raw materials and the recent depreciation of the rupee is a negative factor for them. Besides this one off margin pressure that consumer companies could face, their fundamentals remain in order. Besides meeting companies the fund already holds, I got a chance to meet a few more names which look interesting, namely a company that runs private hospitals and a leasing finance company.
After two days of meeting companies, the last day was spent checking out facilities/factories of some of the companies. First off was South Asia Gateway Terminals (SAGT) at Colombo port. SAGT is currently one of three terminals in Colombo port that handle containers mainly for transhipment to India and other sub-continent countries. Not just SAGT, but Colombo port which includes the other two container terminals (one run by the government and the other run by Colombo International Container Terminals) has become a major transhipment hub for cargo headed to the subcontinent. The main reason for this is that India does not have a deep water port which can handle larger container vessels as compared to Colombo, which is a deep water port. The other reason for Colombo becoming an important transhipment hub is its strategic location between east and west sea routes.
The next visit was to the factories of Ceylon Cold Stores (CCS), the leading soft drinks and ice cream manufacturer in Sri Lanka. The Elephant House brand of soft drinks and ice cream is extremely well established in the country as well as within the overseas Sri Lankan diaspora. Elephant House and Coca-Cola together control about 80% of the domestic soft drinks market and this should probably not lead to unhealthy price competition. The plant is fully automated with not a lot of manpower required for most tasks.
The last factory visit was to the plant of Distilleries Co. of Sri Lanka (DIST). As the name suggests, DIST focuses on producing alcoholic beverages such as Arrack. Arrack is a local alcoholic beverage that is consumed across the country and is made from fermented sap of coconut palms or fermented ethanol which is then distilled into Arrack. Arrack makes up about 90-92% of the legal hard liquor market in Sri Lanka but hard liquor has been losing market share to lower priced alternatives such as beer, especially stronger beer which has higher alcohol content. Having said that, there is also a huge illicit hard liquor market in Sri Lanka and the government has taken some steps of late to crack down on this segment by shutting down a few illegal operations. The distilling plant we visited has been newly opened and is very impressive and fully automated with German machinery.
The site visits were a good end to the Sri Lanka trip and it was a great opportunity to get to speak with the management team of existing holdings and look at possible new ideas. I look forward to being on the ground once again next year.
I hope you enjoyed reading our monthly newsletter. If you would like any information about our funds or markets please let me know.
With kind regards,
Asia Frontier Capital Limited
This document does not constitute an offer to sell, or a solicitation of an offer to invest in AFC Asia Frontier Fund, AFC Asia Frontier Fund (non-US), AFC Iraq Fund, AFC Iraq Fund (non-US), AFC Vietnam Fund or any other funds sponsored by Asia Frontier Capital Ltd. or its affiliates. We will not make such offer or solicitation prior to the delivery of a definitive offering memorandum and other materials relating to the matters herein. Before making an investment decision with respect to our Funds, we advise potential investors to read carefully the respective offering memorandum, the limited partnership agreement or operating agreement, and the related subscription documents, and to consult with their tax, legal, and financial advisors. We have compiled this information from sources we believe to be reliable, but we cannot guarantee its correctness. We present our opinions without warranty. Past performance is no guarantee of future results. © Asia Frontier Capital Ltd. All rights reserved.
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