The following article first appeared in the December 2007/January 2008 edition of AsianInvestor magazine. The delays in IPOs announced after our publication date seem to justify our sceptism! Each month we offer a feature from the magazine. To subscribe, please email us at [email protected]

On the surface it is easy to justify the current hype surrounding Vietnam as AsiaÆs next big economic growth story. The country joined the World Trade Organization this year and is working double time to open up the economy and implement international best practices.

The government is targeting an average GDP growth of 8.0-8.5% annually from this year to 2010 and plans to raise $150 billion over the same period to meet that goal. Add the countryÆs rising productivity and low labour costs, and viola, youÆve got a super-duper investment theme.

But while VietnamÆs economy appears to be fertile ground for robust growth, the same cannot be said just yet for its financial markets and its fund management industry.

ôVietnam is like a fine bottle of wine without a corkscrew,ö says Brad Durham, co-founder and managing director of Emerging Portfolio Fund Research (EPFR) Global, a US-based firm that tracks fund flows and allocations of around 15,000 portfolios worldwide with around $10 trillion in combined assets. ôWhile the buzz suggests that Vietnam is the poster child of the emerging frontier markets, only a handful of mainstream emerging-market equity funds actually have exposure.ö

There are around 25 funds focusing on Vietnam equities managing over $10 billion of assets, according to EPFR data.

ThatÆs miniscule compared with the estimated $1 trillion in assets held by fund managers focused on emerging markets generally.

Out of the 100 global emerging market equity funds tracked by EPFR Global, only three have holdings in Vietnam.

Among those three, the New Star World Invest Emerging Markets Fund has the highest allocation, but it is a mere 1.1% of total assets. The average Vietnam weighting of the three funds is 0.03%.

Asia ex-Japan equity funds have a slightly higher allocation to Vietnam, but the figure is still nothing to crow about. The average Vietnam weighting among such funds is 0.05%, placing it at the second lowest position in the region next to Bangladesh in terms of allocations.

The two largest positions are held by the Baille Gifford Pacific Fund and the Baille Gifford Pacific Horizon Investment Trust Fund, which have a 2% exposure in the market.

VietnamÆs ôbit-player statusö, as EPFRÆs Durham describes it, is the same in the arena for emerging market bond funds, where it makes up a mere 0.2% average weighting among the portfolios that have exposure to the market.

The largest allocation is the 1.6% position held by the T. Rowe Price Sicav Global Emerging Markets Bond Fund.

Missing the surge

Foreign investors have been limited in their participation in VietnamÆs surging stock market, due in large part to delays in the countryÆs privatization program. Their gains from the stock marketÆs 140% rise in 2006 and its 42% increase in the first 10 months of this year has been marginal at best in relation to their overall assets under management across various markets.

EPFRÆs Durham estimates that 26 initial public offerings that were supposed to take off in the second half of this year have been delayed.

Investors are still waiting for the chance to buy shares in Vietcombank, the largest state-owned bank in Vietnam; Vietnam Airlines; and telecommunications providers Vinaphone and Mobiphone.

When listed, those four stocks are expected to increase VietnamÆs market capitalization by 50% from the current level of around $26 billion.

To be fair, the young stock market has experienced tremendous growth. Market cap was only $2 billion by the end of 2005. It quintupled to $10 billion by late 2006, and then more than doubled again.

So being æonlyÆ $26 billion today represents a real accomplishment û but much of that is due to high valuations due to lack of demand as much as new listings.

Vietnam Holding Asset Management (VHAM) notes that 2006 was a particularly strong year for the Ho Chi Minh City and Hanoi stock exchanges, with 155 new listings in total, because companies could enjoy a corporate income tax holiday that closed this year.

There were 11 new listings in 2005 and 20 so far this year, according to VHAM deputy managing director Nick Freeman, with 2006 an exceptional year. The slow pace of IPOs highlights the ongoing problem of lack of things that foreigners can buy on VietnamÆs stock market.

There are only around 200 stocks listed in the Ho Chi Minh City and Hanoi stock exchanges, plus around 3,000 stocks in the over-the-counter market.

In total, only around 25% of these shares are liquid enough to be considered by foreign investors, and many of these are already nearing their foreign investment limits. Foreign investors are entitled to hold up to 49% in aggregate of a listed company. For banks, the limit is lower at 30% in aggregate, with a 10% cap per investor.

Out of VietnamÆs total market capitalisation, the state still holds around 32%, foreign investors hold around 26%, and local investors own the rest.

ôForeigners are restricted by the liquidity filters,ö says Mark Canizares, Ho Chi Minh City-based investment director at Manulife Vietnam Fund Management Company. ôThey would normally go for the most liquid stocks, and even then, they can only trade so much.ö

Canizares, who manages the VND215 billion ($13.6 million) Manulife Progressive Fund, notes that investors û whether foreign or local û should look at the stock market as a long-term investment.

Manulife Vietnam is among the latest to try and gain a foothold in VietnamÆs fund management industry, which is still at a very early stage. VietnamÆs stock market was set up in 2000. So far, there are only three retail mutual funds in Vietnam û the first fund was launched in 2004 and the latest of which was launched by Manulife Vietnam.

There are around 100 so-called member funds, but these are not widely available to the public and are mainly offered to private individuals or certain companies who may want to invest in these portfolios.

WhereÆs the demand?

Although there has clearly been a dearth of investment products offered in Vietnam prior to the last few years, demand for retail mutual funds hasnÆt been particularly strong. The Manulife Progressive Fund failed to meet its target fund size, generating only 85% of its target. Manulife Vietnam general manager David Wong attributes the lacklustre response to retail investorsÆ continued preference to directly invest in stocks.

ôThe demand for mutual funds is not yet strong,ö says Wong. ôRetail investors in Vietnam still need a lot of education. We need to explain to them the difference between investing in stocks and mutual funds and explain to them the benefits of investing in a mutual fund.ö

Investment consciousness is also hampered by the lack of international investment opportunities and the absence of a compulsory pension investment scheme.

Don Lam, CEO of local boutique VinaCapital, which manages around $1.9 billion, says having the scale asset-wise is going to be key to survival.

ôI donÆt believe it would be possible for a fund manager with less that $50 million to generate enough fees to pay your rent, pay your staff, have the scale to have your own research department and conduct an in-depth review of the market, the sectors, and specific companies.ö

In the case on VinaCapital, the company has a staff of 140, including 110 investment professionals that look after its four funds. Operational costs alone can be quite hefty, says Lam.

The new fund management companies in Vietnam that manage small portfolios will likely only survive for a few years, ôthree years topsö, after which they would have to either merge with another company or close down altogether, Lam says.

ôWith more fund managers coming in, thereÆs bound to be a shakeout, a consolidation in the market. It will be difficult for the smaller funds to survive, unless they are run by partners who donÆt mind waiting a long time before booking actual profits,ö Lam says.

Business Vietnam-style

The lack of high-quality research and the difficulty in finding and retaining good talent are the two common challenges facing fund managers in Vietnam.

ôWe have all made significant profits in the biggest bull market Vietnam has ever seen. We now need to be far more rigorous with our investment processes moving forward in order to sustain the progress and take full advantage of the opportunities here,ö says Alex Hambly, board member at Prudential Vietnam Fund Management, which manages around $1.5 billion in Vietnam.

Fund managers say most of the available research from brokers in Vietnam cover only facts and figures, and lack any kind of analysis that could help in making investment decisions. Information from the listed companies is even more scarce.

Phan Thi Tuong Tam, executive vice-president of the Ho Chi Minh Stock Exchange, says getting listed companies in Vietnam to comply with international corporate governance standards has been a top priority, but it hasnÆt been easy in the absence of fines or penalties that could serve as deterrents.

The exchange is in the process of considering imposing fines on companies that fail to comply with its corporate governance guidelines, she says.

ôMany of the listed companies donÆt give importance to corporate governance. Many donÆt even understand the concept and why it is for their own good,ö says Tam.

Meanwhile, Nguyen Than Long, deputy director of the State Securities Commission, says its supervisory department is ôoverloadedö with work and unable to fully monitor all the activities in the local stock market for now.

ôThere are some limitations at present. Previously, we were only in charge of listed companies. Now, we are also in charge of public companies, numbering in the thousands,ö Long says.

Under the Law on Securities, which was implemented in January this year, joint stock companies with over VND10 billion ($633,000) in charter capital and more than 100 shareholders must register with the commission to be a public company or face fines.

However, only around 700 joint stock companies have registered to be public companies and accept SSC regulations as of end-October.

On the human resources front, companies such as VinaCapital are easy targets for those on the lookout for fund management talent because they have been on the ground for several years.

ôMaintaining our staff is one of key challenges. ItÆs easy for newcomers to take our mid-managers and offer them a better position,ö VinaCapitalÆs Lam says.

A few months ago, VinaCapital lost its financial comptroller, who was hired to become the CEO of a fund management company that was about to be formed, which Lam declined to identify. Last year, the company had a 5% staff turnover, a number that is ônot as badö this year.

Lam says around two-thirds of VinaCapitalÆs staff are Vietnamese who studied overseas, mostly in Australia and the United States.

ItÆs difficult for fund management companies to lure investment professionals from financial centres such as Hong Kong and Singapore because of the hefty 40% income tax in Vietnam (itÆs 16% in Hong Kong, and capital gains arenÆt taxed).

A company needs to pay a huge premium on salary if it wants to poach staff from overseas or the person taking the job needs to be willing to move despite the tax issues.

When turkeys fly

At present the exciting story has lured huge portfolio investments from places like Japan and Korea, and many fund managers and service providers are keen to get a slice of the action. Vietnam represents the last big East Asian frontier. But the current sizzling pace of demand has sent stock market valuations soaring, which can obscure the difficulties on the ground û in particular, that thereÆs not much of a domestic funds or pension market to speak of.

ôWe have an expression here,ö notes PrudentialÆs Hambly. ôæIn strong winds, even turkeys can flyÆ.ö

The question is: who will be left flying when the strong winds stop blowing across Vietnam?