Emerging markets: invest now in the next China

Value investors look for out-of-favour sectors, businesses or markets with decent balance sheets, acceptable prospects, and something onthe horizon that might make other investors wake up to their full potential. Most work in big economies, such as the US.

But the pool of businesses trading at big discounts to their potential value (those with a wide "margin of safety", as Ben Graham, the "father of value investing", would put it) is looking increasingly shallow. So more and more value investors now look to emerging markets. One whom I follow closely is Greg Fisher at the Asian Prosperity Fund. He has been taking big positions in what could be the standout emerging market from a value point of view Vietnam.

The next big thing

But while Vietnam has promised much, it hasn't always delivered the local stockmarket has stagnated in recent years. But a major catalyst for change might be up ahead. On 26 June, the government announced a long-awaited lifting of curbs on foreign ownership of listed firms (with the exception of "strategic" sectors, such as banking and defence), government bonds, investment funds and other financial instruments.

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The changes take effect from September. This should boost liquidity Vietnam's market capitalisation is currently only $60bn, with daily trading volume averaging $100m. Vietnam might now benefit from even more sustained investment by the likes of South Korea and Japan, which could help withpromotion into the MSCI Emerging Markets index, which would attract more foreign direct investment. Foreign participation in the Vietnamese market is only around 10%, against South Korea's 35%.

Of course, we've been here before, which may explain investors' scepticism. Vietnam's benchmark index trades on a trailing price/earnings (p/e) ratio of around 13, 20%-30% below its peers, according to estimates by local investment firm VinaCapital. But if the reforms take off, equities could surge. The biggest driver for change could be the fact that the Vietnamese government needs to shake up its own version of China's state-owned enterprises (SOEs) through privatisation.

So we have a lowly valued market, with many decent local franchises that are selling into fast-growing, urbanising local consumer markets. There's also top-down government reform and the possibility of big inflows of capital. This is why Fisher has been upping his exposure to Vietnam it's now his second-biggest geographic holding (at 31%) behind Japan. While the market overall is fairly cheap, Fisher notes that many of the biggest names are quite expensive. So he's been fishing further down the index.

One example is energy to mobile phones to logistics group Petrosetco. It is no longer majority owned by the government, and margins have been rising as it gets out of some business lines and expands its relationships in Korea. Fisher has also been buying Vietnam's listed gas operators. They have high quality, often young management teams who "have a point to prove". These businesses are on p/es of six to eight, yields are above 8%, and they generate plenty of cash.

How to invest

Vietnam Opportunity fund (LSE: VOF)

Its top ten holdings include dairy producer Vinamilk, the Sofitel Legend Metropole hotel in Hanoi, and oil and gas group PetroVietnam. Andy Ho, the fund's managing director, reckons "this dramatic lifting of foreign ownership limits will immediately make Vietnam the most attractive Asian frontier market", boosting the amount global fund managers allocate to it.

There are some risks, not least the vulnerability of the Vietnamese dong, which, like the Chinese renminbi, isn't freely convertible and is subject to capital controls. The government has used devaluations to maintain the local economy in the past the central bank has devalued the dong twice this year, by 1% each time, in response to a stronger US dollar and to maintain export competitiveness. I wouldn't be surprised to see the dollar strengthen more, which might prompt more volatility. But the likes of VOF might be net beneficiaries of a weaker currency, and the growth boost it tends to imply.