The Market Vectors® Vietnam ETF (VNM) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Market Vectors Vietnam Index (MVVNMTR), a rules-based, modified capitalization-weighted, float-adjusted index intended to give investors exposure to Vietnam.
So, what does this mean?
As Vietnam does not have a well known index of of the market, Market Vectors has used an index created by a consulting firm called 4asset and licensed to Van Eck Global, which owns Market Vectors. It is only in Nov 2011 that Market Vectors took over the management of this set of indexes from 4asset.
From the prospectus, this index seems to be very narrow in my mind. Companies are included in the index only if they fulfill the following criteria:
- Generate at least 50% of their revenues from Vietnam, expected to generate at least 50% of their revenues from Vietnam, or demonstrate a strong market position in Vietnam;
- Market capitalization of $150 million and above and if market capitalization falls below $75 million, it will be removed from the index;
- Average 3 month daily turnover of $1 million;
- Only shares that trade on recognized exchanges will qualify;
After investing in the Vietnamese market for some time, I believe that while there are quite a few companies that have a capitalization of $150 million and above (point 2), it is still considered restrictive, because after the prolonged depression in the stock market currently, many large companies’ capitalization have fallen below this threshold even though their scale of business would easily exceed any company listed in the US, Singapore or any other exchanges with market cap of $150 million.
However, the most problematic I believe is the restriction on trading liquidity of the company concerned (point 3). Very few companies have a daily liquidity of $1 million and above.
Not surprisingly, there are only 31 companies that fit the criteria set by 4asset as described in the prospectus. As a result of this, I believe that the Market Vectors Vietnam ETF fund will have a very difficult job … How do you match (let alone outperform) an index with only 31 securities? In fact, the ETF fund IS the index. Adding frictional costs like buy and sell, commissions and rebalancing; Not least the fact that their AUM is large compared to the total market cap of these 31 companies, it almost guarantees the ETF will underperform the index despite the best efforts of its managers.
I can also think of other problems:
- Due to their restrictive criteria of only 31 stocks, it is plainly no secret which stocks this ETF is currently buying/selling. Local market players (brokerage houses, hedge funds or even retail investors) are likely to know this information way before the fund makes its move. As a result, it is pretty easy to front run the ETF and I bet this is a big problem for them.
- When the ETF for whatever reason has to liquidate, e.g. investor withdrawals etc, you can bet what kind of stampede it would cause for the 31 or so stocks that it owns. This has happened before. In 2009/10, several closed end funds focused in Vietnam were trading at very steep discounts to their NAV and hedge funds swopped in, acquiring a significant shareholding of these funds and threatened to liquidate these closed end funds. As can be expected, share prices of companies that they owned crashed in value. The fact that the Vietnam ETF is not a closed end fund may make it worse. Van Eck Global can create and remove units of the ETF at will depending on the demands of investors. Imagine if for some reason people want to liquidate their holdings of Vietnam, the ETF would have to sell and the value of their holdings can go from very overvalued to very depressed. What this means for investors is that unless you time your exit perfectly, your returns will be much less than what a typical investor who owns Vietnamese stocks (excluding those held by the ETF) would have.
- Looking at the index created by 4asset and its components, I find that out of the top 10 holdings, 5 are listed in stock exchanges other than in Vietnamese exchanges. I am sure if you own a stock listed in any country, its share price will be affected by the general market sentiment of that country as well, even if more than 50% of the company’s revenues is derived from Vietnam.
- 31 stocks is really far fewer than most other ETFs’ investing universe. The concentrated nature of the portfolio would definitely exacerbate the volatility.
In fact, knowing the problems listed above, if one is a long term investor interested in Vietnam, one should actually avoid these stocks owned by the Vietnam ETF because the fundamentals of the company may ultimately be overshadowed by the liquidity needs of this ETF. Indeed, this is actually manifesting itself in the market price of the securities owned by the ETF. Typically, the securities owned by this ETF is very out of line with the Vietnamese market in general.
The holdings (at least those listed in Vietnam) of the ETF are among the most expensive in the Vietnam stock market right now. I am thinking that perhaps it was the ETF buying that made them this expensive in the first place. For example (reported fund holdings as of 4 Feb 2012), the fund owns these stocks:
- Largest holding (nearly 10% of the fund), is that of insurance company Baoviet. Currently Baoviet trades for 46 times (this is not a typo error) price to earnings and 4.6 times price to book. It is an insurance company. Other insurance companies in Vietnam, e.g. second largest, Baominh, trades for only a price to earnings of 5 and a price to book of 0.4; BIDV insurance is only price to earnings of 6 and price to book of 0.6 and there are more examples …
- The 2nd, 4th, 5th are all banks. Obviously, I don’t think any fund should put so much in financials (e.g. Baoviet is also a financial). But these banks are among the most expensive Vietnamese banks by most common measures of value, e.g., Vietinbank (2nd largest holding) trades for a price to earnings of P/E of 11 and P/B of 2.1; Vietcombank (4th largest holding), P/E of 15, P/B of 2.4; Sacombank (5th largest holding), P/E of 10, P/B of 1.8. This compares with Military bank, P/E of 7, P/B of 1.5; Habubank, P/E of 10, P/B of just 0.6. There are many other examples but I think you get the idea.
- The 3rd largest holding is Vincom. This is a property company, the only non financial in the top 5. However, this company uses lots of leverage. If there is something wrong with the financial sector of Vietnam, I very much doubt this company will remain unscathed. In Vietnam, few property companies trade above 1x of book value as currently the sector is out of favor. However, Vincom is at a mind-boggling P/E of 63 times price to earnings and P/B of 12.7 (again not typo errors!). As you can see, the valuation is way out of line with other property companies.
In my opinion, only Petrovietnam Fertilizer (4.76% of holdings of the ETF), trades at a reasonable valuation that is in line with the rest of the Vietnamese market in general.
For me, I am a believer in value investing. While I don’t discount the merits of momentum and I think buying the biggest companies of any sector has its merits (assuming the biggest companies are the best run); I just can’t imagine how you can get above average results owning the most expensive companies of every sector.
This market distortion was likely caused by the ETF buying the shares that it currently owned. But this works both ways. When the ETF buys, it pushed up the price, making the ETF look really good. But when it sells … well, I don’t think we even want to know what will happen!
While I don’t propose everyone buy Vietnamese stocks directly (the market is too small for big funds for example), I believe that any serious investor who likes Vietnam, this is the way to go. I will address the issue of how to open a stock account in Vietnam to buy locally listed stocks directly in a followup post. Stay tuned!
P.S. In this post, I have not focused on the funds’ expense ratio (which is high compared to other ETFs), turnover ratio etc. as I believe this is information easily found on their prospectus/fact sheet. You can find this information on the ETF’s website.