Vietnam currently accounts for 30% of the MSCI Frontier Market Index, making it the largest and most developed constituent of it, so when can we expect the country to step up to the Emerging Market Index?
The rapid rise of the retail investor in Vietnam has transformed the country’s capital markets. Two and a half million new trading accounts were opened in the past year alone, with the overall market value surpassing US$ 300 billion since the stock market opened two decades ago. Daily liquidity now averages close to US$1 billion, and more than 80% of this activity comes from domestic investors, whose investment into the stock market replaced US $2 billion or so of foreign capital that was pulled out of Vietnam during the pandemic years.
Yet despite greater local interest and this increasing size and liquidity of the stock market, Vietnam is still classified as a ‘Frontier’ country by leading global equity index providers. It is the largest and arguably most developed constituent of the MSCI Frontier Markets Index (MSCI FM), with Vietnamese companies accounting for 30% of the US$88 billion represented in the index, but the curveball of a year that was 2022 has inevitably delayed its inclusion in the much larger – US$6 Trillion – MSCI Emerging Market (MSCI EM).
Indices, such as the MSCI FM and the much larger MSCI EM, are widely used as a benchmark for active and passive global institutional investors and fund managers. The MSCI FM comprises 99 companies from 29 countries and six Vietnamese listed companies are already in the top ten stocks. When a country’s stocks are included in the index, there is typically an increased allocation from investors who use that benchmark.
The high stakes and potential growing aches
To be eligible for inclusion in the MSCI EM, a company must have a market capitalisation of at least US$ 1 billion, as well as a minimum level of trading activity and liquidity. The country must also have regulations in place that allow foreign investors access to its stock market, along with a sufficiently developed infrastructure for trading and settlement. Interestingly, other Asian countries, including China, India, Indonesia, Korea, Malaysia, Philippines, Thailand, and Taiwan already represent a third of the 24 constituents of the MSCI EM.
It goes without saying that when and if Vietnam was to be included, the country would attract significantly more foreign capital and potentially see a re-rating in the valuation of several of the companies listed on its stock markets. Some studies have also suggested that such an upgrade would also reduce market risk, lower the cost of capital, and make the equity market more suitable as a source of domestic financing.
Today Vietnam does not fully meet the 18 criteria for inclusion set by MSCI and falls short on the key aspects of openness and equal treatment for foreign investors. As MSCI’s evaluation is based on feedback from institutional investors, brokers, and custodians, there would need to be a visible and demonstrable improvement in areas such as the amount of ‘free float’ available to foreigners after taking into consideration foreign ownership restrictions. Currently more than 10% of Vietnam’s market is impacted by such ownership restrictions, and more than 1% of the Vietnam Index suffers from lack of room for investors as a result.
Although progress has been made, there are short-term and mid-term impediments to improving the perception in investors’ minds. Exchange infrastructure needs to be enhanced with a facilitating central counterparty clearing system that reduces trade settlement periods and removes the current requirement to ‘pre-fund’ investor accounts. Theoretically, much of this can be addressed when the stock market system is upgraded. The good news is that the Vietnam Securities Depository and Clearing Corporation (VSDC) was established in December 2022, and this should allow the new ‘KRX’ trading platform to go live midway this year. However, we still have mid-term issues, which are primarily about easing capital flows and opening more of the addressable market to foreign investors.
MSCI conducts its reviews of countries annually and usually announces its findings every June. The review process for Vietnam as with all countries would be done in stages, not overnight. First, if enough progress is identified, Vietnam would be added to the watchlist ‘for potential upgrade’. One year later, if all went to plan, there would be an announcement made stating that the country would be included. Then, assuming all is well another year on, it would receive actual inclusion. It had been hoped that the first phase could be completed by June 2023, leading to inclusion by June 2025, but given the roller-coaster ride of 2022, this timeframe has probably slipped by at least one year.
Moving forward
The most important point is that these incremental steps needed for eventual inclusion would benefit everyone investing in Vietnam in the long-term. Although the actual amount of inflow to the market might be modest, maybe US$5 to US $10 billion initially, the prestige would also be welcomed by the government. Indeed, over the last twelve months or so, the focus of the general secretary of the Communist Party, Nguyen Phu Trong, has been on cleaning up misconduct in the system by pursuing private and public corruption and refining some of the rules related to bond issuance. Last year, the heads of the stock market and the regulator were removed, and there have been some short-term delays in implementing upgraded market infrastructure. A new chairwoman has been appointed to the State Securities Commission and she has just reaffirmed the launch of the new exchange trading platform and additional capital market developments.
Sadly, as we saw, sentiment among the six million or so domestic investors weakened for much of 2022 as global markets declined and local anti-corruption cases rattled local real estate stocks. Vietnam’s market fell by more than 35% and became one of the world’s laggards despite it being its champion only one year before. Thus, the market certainly could do with some positive news, as the eyes of investors likely stay on global events, such as the war and fear of recession and trajectory of US interest rates and inflation. Closer to home, investors will be watching signs of greater stability in the bond and real-estate markets.
Nevertheless, there is no urgency for Emerging Market inclusion amongst domestic investors and for foreign investors who wish to invest in Vietnam they can already do so through specialised funds, such as London-listed Vietnam Holding managed by Dynam Capital. Eventual inclusion would be a significant step for Vietnam, putting it more firmly on investors’ radars, but looking down the road there will be many opportunities to reap even before that happens.
The market is appealingly cheap, with stocks trading at around 10 times earnings and companies forecast to grow their earnings by an average of 10% in 2023. Resilient growth combined with weak local sentiment has started to attract foreign investors’ interest once again and in 2022 foreign net inflows were recorded for first time since 2019.
Growth at a reasonable price has been one of the mantras for Vietnam Holding over the past five years when it comes to its concentrated portfolio of public companies listed on the Vietnam stock exchanges. Whether you view Vietnam as the largest Frontier Market, or one of the smallest Emerging Markets, it is a country that could add some sensible diversification to your portfolio in 2023.
This article has been written by Craig Martin, Chairman of Dynam Capital. Dynam is the Fund manager for LSE listed Vietnam Holding (VNH).