Last year in an article, ‘A new frontier in Vietnam’, we noted how Vietnam accounted for 30% of the MSCI Frontier Market Index and highlighted the challenges to being upgraded to the MSCI Emerging Market Index. There is another chance of an upgrade but on a different index, the FTSE Russell Secondary Emerging Market Index. So, what are the prospects for Vietnam now?
Vietnam was added to the FTSE Russell’s Watch List in September 2018 for a possible reclassification from Frontier to Secondary Emerging market status. However, progress towards such an upgrade has been painfully slow, in part due to Covid-19, but also because Vietnam falls short of satisfying the criteria used by FTSE Russell.
Unlike MSCI’s three categories, Developed, Emerging and Frontier, FTSE has four that a country’s stocks can be classified as: Developed, Advanced Emerging, Secondary Emerging and Frontier. Eligibility for a given status is determined by six main criteria (MSCI uses five) and a total of 24 sub-criteria (MSCI has 18).
FTSE developed the criteria with consultation from the international institutional investor community and it publishes an annual review of all markets against these criteria each September. If a country is under consideration for a status change, either up or down, it is included in the Watch List. Vietnam is currently on this list for an upgrade, while Pakistan is on the list for a downgrade.
When and if an upgrade happens, Vietnam will leave the likes of Bangladesh, Mongolia and Sri Lanka and join the same league as Indonesia and the Philippines. Vietnam, Indonesia, and the Philippines already share the ‘lower middle’ GNI per capita ratings by the World Bank.
The countries only differ on 11 out of 24 criteria:
| Category | Indonesia | Philippines | Vietnam |
| Credit Worthiness | Investment | Investment | Speculative |
| Market monitored by regulatory authority | Restricted | Pass | Pass |
| No or simple registration process for foreign investors | Pass | Pass | Restricted |
| Reasonable Transaction Costs | Pass | Not Met | Pass |
| Short Sales Permitted | Restricted | Restricted* | Not Met |
| Developed Derivatives Market | Not Met | Not Met | Restricted |
| Off Exchange transactions permitted | Pass | Pass | Not Met |
| Efficient Trading Mechanism | Pass | Pass | Restricted |
| Central Counterparty Clearing | Pass | Pass | Not Met |
| Settlement (free delivery) | Restricted | Restricted | Not Met |
| Account structure operating at the Custodian level | Restricted | Restricted | Not Met |
Source: FTSE Russell, September 2023 *The Philippines introduced short selling in October 2023
Vietnam does not meet the ‘Settlement’ criterion because of the need for pre-funding of stock accounts and pre-trading check to ensure availability of funds prior to trade execution. Nevertheless, it will remain on the Watch List as a Frontier market and reviewed for possible reclassification in 2025.
“Although progress on the planned market reforms has remained slow, a recommitment to the work required has been made by senior levels of government. In addition, the State Securities Commission (SSC) has demonstrated renewed energy in seeking a workable solution that would remove the need for pre-funding”, a leading brokerage in Vietnam said.
Viva Vietnam
The rapid rise of the retail investor in Vietnam has transformed the country’s capital markets. There are an estimated 7.6 million trading accounts in Vietnam, which is equivalent to 8% of the population. This is comparable to the European average of 7.9% (according to euronerd.com). However, unlike Europe, where institutional investors account for most of the stock market activity, domestic retail investors dominate Vietnam’s market. Furthermore, daily liquidity in Vietnam now averages close to US$1 billion, with more than 80% of this activity coming from domestic investors.
Despite increasing local interest and the growth in size and liquidity of its stock market, leading global equity index providers continue to classify Vietnam as a ‘Frontier’ country. It is the largest and arguably most developed constituent of the FTSE Russell Frontier Index, with Vietnamese companies accounting for 37% of the indices’ US$93 billion. Additionally, five Vietnam companies are in the top-ten of the index.
Indices are widely used as a benchmark for active and passive global institutional investors and fund managers. When a country’s stocks are included in the index, there is typically an increased allocation from investors who use that benchmark. So, to be in line with the index, a Frontier market investor may allocate 37% to Vietnamese stocks. If Vietnam is upgraded to Secondary Emerging market, it might be expected to have an allocation of 1% to 2%. That looks small, but the FTSE Emerging Market capitalisation is US$6.6 trillion dollars (seventy times bigger than the Frontier Market), so Vietnam will see a much smaller share of a much larger pie.
The stakes are high
It goes without saying that when and if Vietnam is classified as an emerging market, the country would attract significantly more foreign capital and potentially see a re-rating in the valuation of several 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.
The benefits for the Vietnamese government in pursuing this upgrade include the following:
1. Enhanced Global Investment and Economic Growth: Achieving emerging market status would significantly increase foreign investment inflows, providing capital for infrastructure, technology, and various sectors. This influx of investment would accelerate economic growth, creating more jobs and enhancing the overall standard of living.
2. International Recognition and Credibility: Being classified as an emerging market would affirm Vietnam’s economic stability and progress on the global stage. This recognition would improve trade relations, open new partnership opportunities, and potentially lead to more favourable international agreements.
3. Market and Economic Resilience: The process of upgrading would necessitate and encourage the implementation of robust financial regulations and practices. This would not only attract more investors but also ensure a more resilient and diversified economy, better equipped to handle global economic fluctuations.
Vietnamese authorities could assist the stock market in achieving an upgraded status in the following ways:
1. Regulatory Reforms and Transparency: Implementing and enforcing stricter regulatory standards, particularly those related to corporate governance, financial disclosures, and transparency. Aligning with international best practices will build investor confidence and meet the criteria set by global market classification entities.
2. Market Infrastructure and Accessibility Improvements: Enhancing the stock market infrastructure to ensure efficient trading, clearing, and settlement processes. Additionally, easing restrictions on foreign ownership and investment, and simplifying the process for foreign investors to participate in the market.
3. Economic Diversification and Stability Measures: Encouraging diversification in the economy, which in turn diversifies the stock market, reducing reliance on a few sectors. Implementing policies that promote economic stability, such as controlling inflation and maintaining fiscal discipline, will further bolster investor confidence.
Moving forward
The most important point is that taking these incremental steps towards inclusion will benefit everyone investing in Vietnam in the long run. Although the initial influx to the market may be modest, ranging between US$3 and US $5 billion, the government would greatly appreciate the prestige.
Eventual inclusion would be a huge move for Vietnam, putting it more firmly on investors’ radars, and there will be plenty of opportunities to reap even before that happens.
The market is appealingly cheap, with stocks trading at around 10 times earnings and companies forecasting an average of 20% growth in earnings in 2024. Weak global growth and domestic sentiment depressed the stock market in much of 2023, but with a better second half, funds like Vietnam Holding (VNH) managed to generate strong overall returns (up 23% on the year). Although foreigners were net sellers of Vietnamese equities in 2023, perhaps as we enter the Year of the Dragon the prospects of a possible upgrade next year by one of the key index producers would shine more light on the market again and attract greater foreign investor inflows.
Growth at a reasonable price has been one of VNH’s mantras during the past six years for its concentrated portfolio of public companies listed on the Vietnam stock exchanges. Whether you view Vietnam as the biggest Frontier Market, or one of the smaller Emerging Markets, it is a country that could add sensible diversification to your portfolio in 2024.
This article has been written by Craig Martin, Chairman of Dynam Capital. Dynam is the Fund manager for LSE-listed VNH.
Vietnam Holding (VNH) is an award-winning, nimble fund focused on the exciting market in Vietnam. The Fund’s outperformance was recognised by both Citywire and UK Investor Magazine, who both awarded the Fund the title of ‘top emerging market single country fund’ at the of end of 2023. For over a decade VNH has been at the forefront of responsible investing in Vietnam, using an active and engaged approach to drive outperformance. The Fund received top scores for its PRI Transparency report over the years.