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The Asia Frontier Fund USD A-shares declined −1.4% in September 2018. The fund underperformed the MSCI Frontier Markets Asia Net Total Return USD Index (+0.4%), the MSCI Frontier Markets Net Total Return USD Index (−0.1%), the AFC Frontier Asia Adjusted Index (−1.1%) and the MSCI World Net Total Return USD Index (+0.6%). The performance of the AFC Asia Frontier Fund A-shares since inception on 31st March 2012 now stands at +47.8% versus the AFC Frontier Asia Adjusted Index, which is up +27.2% during the same time period. The fund’s annualized performance since inception is +6.2% p.a., while its YTD performance stands at −13.4%. The broad diversification of the fund’s portfolio has resulted in lower risk with an annualised volatility of 9.07%, a Sharpe ratio of 0.63 and a correlation of the fund versus the MSCI World Net Total Return USD Index of 0.32, all based on monthly observations since inception.

Though global indices saw a slight recovery in returns this month, investor sentiment in general remained subdued as worries over the trade war between China and the U.S. continued to take up investor attention with an additional USD 200 billion of Chinese exports to the U.S. being imposed with 10% tariffs but this was expected as these measures were announced in June 2018. Which way the trade war goes and when a compromise may be reached is anybody’s guess, but it appears that in the long run certain economies such as Vietnam could benefit from this as it offers a low-cost manufacturing base, has improving infrastructure and is geographically well positioned into the supply chains of North and South East Asia. The trend of Vietnam becoming a manufacturing hub in the region has not been occurring for the past few quarters but this has already been a long-term trend which is reflected in foreign direct investment (FDI) inflows over the past few years with USD 13 billion being received so far this year. Samsung now manufactures a majority of its mobile phones in Vietnam while most well-established Hong Kong-listed textile companies have moved a large part of their production to Vietnam from China or are putting up any new production capacity in Vietnam.
Given the strong FDI and increasing exports, economic growth remains robust with 3Q18 GDP growth reported at 6.9% led mainly by manufacturing growth of 12.0% while export growth remained strong at 13.9% YoY. Tourist arrivals also remained healthy and picked up in September after a soft patch in August to close 3Q18 with 14.9% YoY growth. Market sentiment was also boosted by the announcement by FTSE Russell that Vietnam would be put on its watch list for an upgrade to Emerging Market status. However, being put on the watch list does not guarantee an upgrade but this is a positive signal as it would probably push the authorities to take steps to transition from watch list to actual upgrade.

As a result, the Ho Chi Minh VN-Index gained 2.8% this month and the fund’s Vietnamese holdings were the main drivers of performance which was led by an industrial park operator which is strategically located next to Ho Chi Minh City, has a new industrial park coming online this year and has 63% of its market cap as net cash, while trading at a trailing twelve-month P/E of 3.9x. The fund’s other holdings which led performance in Vietnam were a commodity transportation company which trades at a trailing twelve month P/E of 8.7x and is expected to benefit as new crude oil and coal transportation contracts kick in from 2018/2019, while the fund’s automotive holding company did well for a second month in a row due to good quarterly results on the back of rising sales at Honda Vietnam, in which it has a 30% stake.

The Bangladeshi market witnessed a correction this month as sentiment remains subdued due to the upcoming elections and this affected fund performance while the recent quarterly season of results has been fairly stable with no major negative surprises. On a macro level, remittances have begun to accelerate again with the financial year ending June 2018 witnessing a 17.3% increase to USD 14.9 billion and the July-September quarter seeing a growth of 13.8% YoY. The current account deficit remains a concern as it has crossed 3% of GDP but the country is in a relatively better position to manage this with foreign exchange reserves of close to USD 33 billion, covering around 6 months of imports, while total government debt and external debt at 32% and 18% of GDP are relatively better and much lower than some of its peers in the frontier universe. (More on these topics and on the country in next month’s travel report).

The government in Bangladesh this month also revised minimum wages for workers in the garment and textile industry which is the leading exporting industry for the country. From December 2018 onwards, minimum wages will move from USD 63/month to USD 96/month. These wage levels are still very competitive and lower than China, Cambodia, India, Pakistan, and Vietnam while it could be positive for consumption as the Bangladeshi garment and textile industry employs 4 million workers.

Despite significantly reduced exposure to Pakistan, the country was a drag on the fund’s performance as macro concerns continue to take up investor attention, even though the government announced measures to contain the inflated fiscal deficit by increasing natural gas prices which will help reduce the deficit by around 30 basis points. The government also announced an interim budget which is expected to reduce the fiscal deficit by 50 basis points through revenue raising measures such as higher import duties and higher taxes on tobacco products as well as on individuals over a certain income bracket and more controlled development expenditure. Further, as expected, the State Bank of Pakistan raised benchmark interest rates by 100 basis points taking the cumulative increase so far this year to 275 basis points. As of writing, it was also announced that the government will approach the IMF for a loan to help overcome the country’s problems related to its wide current account deficit and low foreign exchange reserves. A potential IMF loan would possibly bring with it further measures linked to currency depreciation, higher interest rates, and further price reform in the power and utility sectors. These developments are not surprising and were expected over the past few months which you can read about here in our previous note.

Sri Lanka also hurt performance this month despite a low exposure to the country as the currency saw a sudden drop on the back of certain research publications regarding the macro health of the economy in light of a stronger USD and rising USD interest rates. The depreciation of the Sri Lankan Rupee by 4.7% during the month hurt performance by 20 basis points while the fund’s Sri Lankan bank holding, despite trading at a price to book ratio of 0.8x at the start of the month, faced a correction of 14.2% due to rising loan loss provision expenses, a trend being faced by the entire banking sector as slower agricultural and construction related growth in 2017 begins to have an effect on non-performing loans. This bank, however, is well capitalised and the current non-performing loan issues facing the sector as a whole should not significantly hurt its capital adequacy position or dividend payment abilities.

Given Sri Lanka’s external debt position as a % of GDP as well as USD repayments/refinancing due in 2019, the government has recently taken measures to control imports by increasing import duties on passenger cars so that the country’s current account deficit and balance of payments does not get out of hand.

The best performing indexes in the AAFF universe in September were Cambodia (+8.0%), Kyrgyzstan (+5.6%), and Vietnam (+2.8%). The poorest performing markets were Iraq (-4.8%) and Bangladesh (-4.1%). The top-performing portfolio stocks this month were: a steel producer from Uzbekistan (+37.5%), a junior mining company from Mongolia (+33.3%), a power distributor from Kyrgyzstan (+29.3%), an engineering company from Uzbekistan (+26%), and a Mongolian real estate developer (+20.0%).

In September, we added to existing positions in Mongolia, Uzbekistan, and Vietnam. We added an airport operator in Kyrgyzstan, and two engineering companies and two cement companies in Uzbekistan to the portfolio. We exited one conglomerate and one cement company from Pakistan, a pharmaceutical company in Vietnam and one department store operator in Mongolia in September. We partially sold one automobile company in Pakistan and four companies in Mongolia.

As of 30th September 2018, the portfolio was invested in 114 companies, 1 fund and held 3.9% in cash. The two biggest stock positions were a pharmaceutical company in Bangladesh (7.4%) and a cashmere producer from Mongolia (4.3%). The countries with the largest asset allocation include Vietnam (25.5%), Bangladesh (19.9%), and Mongolia (19.0%). The sectors with the largest allocations of assets are consumer goods (30.5%) and industrials (20.0%). The estimated weighted average trailing portfolio P/E ratio (only companies with profit) was 13.24x, the estimated weighted average P/B ratio was 2.47x, and the estimated portfolio dividend yield was 3.90%.

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