Vietnam is already rapidly industrializing and reducing barriers to trade. However, it is still a frontier market with low prices and abundant opportunities for value investors.
Vietnam’s GDP increased by 7.1% in 2018 and The Asian Development Bank forecasts continued strong growth of 6.8% in 2019 and 6.7% in 2020. We believe that the significant gains generated by industrialization elsewhere (in Asia) are only beginning in Vietnam.
Vietnam is successfully following the classic Asian development model of export-led manufacturing growth. Light manufacturing is thriving. Nike and Adidas shifted much of their footwear production from China to Vietnam between 2007 and 2017. Apple is now considering moving 15% to 30% of production out of China, with Vietnam and India the most likely destinations.
The growth of manufacturing in Vietnam is fueled in part by trade liberalization. Vietnam already has operational trade agreements with China, India, Japan, South Korea, and Australia. Perhaps more importantly, the EU signed free trade and investment protection agreements with Vietnam in 2019.
Prices Remain Low
Despite Vietnam’s strong and consistent growth, prices remain low enough to attract value investors. Vietnam’s stock market capitalization was only 52% of GDP in 2017, compared to 71% for China and 165% for the United States. Furthermore, prices remain relatively low in Vietnam. According to IMA Asia, Chinese manufacturing pay nearly doubled to four dollars per hour between 2010 and 2016. JLL Research reports that Vietnamese factory wages ranged from $1.00 to $1.40 per hour during that time.
Lower wages go far in explaining the continuing movement of labor-intensive manufacturing to Vietnam. Industrial land prices in Vietnam are also comparatively low at below 140 US dollars per square meter. While most assets in Vietnam are undervalued, smaller companies are likely to offer the best returns.
We Expect Small Caps to Outperform
In the emerging markets, Lazard found that small-cap outperformed large-cap by approximately 100 basis points per year between 2007 and 2017. There are not any major small-cap value index funds yet for frontier markets, which underlines the potential for generating alpha. Lazard also showed that emerging market small caps offer greater exposure to real estate and industrials, which have more potential in Vietnam.
The Private Equity Advantage
Private equity also has several significant advantages in the Vietnamese market. Barriers to entry are low in the high-growth real estate and light manufacturing sectors, so there are more opportunities for private capital.
The very fact that labor and land are relatively inexpensive in Vietnam implies that there is a capital shortage. It follows that capital will produce higher returns. 71% of private equity fund managers require an expected rate of return of 20% or more for investments in Vietnam.
There is also greater potential for capital appreciation in the long-term. Businesses that buy land at today’s low prices and build using low-cost labor increase in value as input prices rise. Greater appreciation leads to higher exit multiples for investors. About 74% of private equity decision makers surveyed by Grant Thornton Vietnam expect an exit multiple of 5x or higher.
Getting in on the Ground Floor
Vietnam is just starting on the path of export-led growth that produced decades of high returns in Japan and China. The IMF estimates that developed Japan has a nominal GDP of $41,021 per person, while per capita income is $10,153 in emerging China. Vietnam is a frontier market where the average annual income is only about $2,726. The significant gains generated by industrialization elsewhere are only beginning in Vietnam.
Frontier markets can be more difficult to access, but overcoming these challenges creates additional alpha for our investors. The Ashton Global International Small Cap Fund seeks to produce higher returns by investing in undervalued small companies outside of developed markets.
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