Vietnam is regarded as the next Asian tiger in the making. In some circles, it is seen as the most exciting investment alternative to China. And even though its market is relatively small and expensive, the consensus opinion is that Vietnam offers tremendous opportunity for first movers who are willing to take the high-risk/high-reward road to investing.

Optimism about Vietnam is based on sound fundamentals. Its economy and stock market are booming on the back of more than two decades of reconstruction and reform following the devastating war between North and South Vietnam that ended in 1976. Animosity toward the U.S., which backed South Vietnam in the war, is now water under the bridge in the wake of the dramatically improved relationship between the two countries, providing the catalyst for a flood of investment into the rapidly emerging economy.

“Rising domestic income levels, a large, cheap and hungry work force, the improving regulatory environment and rising foreign investments are among the factors driving the economy,” says Mark Mobius, portfolio manager of Templeton Emerging Markets Fund at Franklin Templeton Investments Inc. in Singapore.

Vietnam’s GDP has grown by a cumulative average rate of 7% over the past decade, peaking at 8.4% in 2005, making it the second-fastest growing economy in Asia, behind China. And growth is expected to remain strong in the foreseeable future, according to Hong Kong-based brokerage CLSA Asia-Pacific Markets’ January research report, On the Road in Vietnam: Sizing up the next Asian tiger.

“Unlike other tigers in the Association of Southeast Asian Nations, Vietnam’s economic expansion has been remarkably resilient,” the report states. “Growth has accelerated each year since the late 1990s and is now past 8%, a level the government hopes to sustain for at least the next five years.”

Vietnam is at the beginning of a multi-year macroeconomic boom, predicated on a steady shift from agriculture to industry and services — enhanced by being one of the “youngest and most balanced countries in the region,” the report says. Agriculture’s share of the GDP declined to 21% at the end of 2005 from 39% in 1990, while the share of industry has grown to 41% from 23% over the same period, with services remaining almost flat, at 38% of GDP in 2005.

The boom in the former agrarian economy — which is abandoning central planning in favour of a market-based economy — is being fuelled by increasing domestic and foreign investment, rising exports, strong domestic demand, and high levels of domestic savings. The private sector — domestic as well as foreign — is becoming increasingly dominant as it currently makes up two-thirds of the overall economy and employs 90% of the total workforce.

Domestic savings, rising foreign direct investment and high levels of remittances from Vietnamese living overseas currently account for one-third of GDP and are expected to reach more than 40% over the next five years.

Although inflation remains high, at about 7.5%, government finances are healthy and public indebtedness is low. And the government is committed to boosting the country’s social infrastructure to buttress the macroeconomic foundation.

Vietnam is also expected to benefit significantly from its Nov. 7, 2006, entry into the World Trade Organization, says Patricia Perez-Coutts, vice president of AGF Funds Inc. in Toronto and portfolio manager of AGF Emerging Markets Fund.

The WTO entry is expected to be a catalyst for foreign investment by companies seeking to take advantage of Vietnam’s strategic location as an export hub. Over the past decade, Vietnamese exports have risen to 66% of GDP from 40%, with growth in exports of soft commodities — such as pepper, coffee, rubber, tea and rice — making Vietnam a key player in global commodities. In fact, Vietnam is ramping up its exports of everything from shrimps to ships to shoes, with more than one-fifth of all exports headed to the U.S., which signed a bilateral trade agreement with Vietnam in 2001.

As a result of all this, far more attention is being paid to the country’s soaring stock market, which rose 143% in U.S. dollars last year, making it the best-performing emerging market. Comparatively, the MSCI Far East price index gained 27.6% in 2006. Since 2004, the Ho Chi Minh stock index has risen by an average of almost 71%, following three previous years of negative growth between 2001 and 2003, during which it experienced an average annual loss of 14.5%.

@page_break@The entire market has done well, especially consumer-related stocks such as dairy, banking and oil and gas, says Mobius. However, Perez-Coutts notes that while the market is very promising, it is still very small and illiquid.

The Ho Chi Minh City Securities Trading Center and the Hanoi Securities Trading Center list just about 200 companies, with a total capitalization of about US$17 billion. However, more than 6,500 unlisted companies trade on the over-the-counter market, which is more liquid, but opaque, and has a capitalization of only US$6 billion. In order to reduce daily volatility, daily fluctuations of listed stocks on the Ho Chi Minh STC and the Hanoi STC are limited to +/- 5% and +/- 10%, respectively.

Chuck Bastyr, portfolio manager and chief investment officer of Toronto-based Meadowbank Asset Management Inc., cautions that the “market has gotten ahead of itself and is currently overvalued.” He argues that foreign–invested funds have been the main driver of market growth, resulting in the “largest-cap securities getting a huge lift.”

Mobius also contends that “the market is quite overvalued at the moment” but expects it to “grow rapidly,” while enduring “corrections along the way.” Stocks are currently trading at 20 times 2008 P/E multiples, which, although high, is “not stupid” according to the CLSA report, given that many of the better Vietnam companies are achieving top-line growth of 20% or better.

It is anticipated that privatization of state-owned enterprises would lead to an increase in the number of listed companies in “another year or two,” according to Perez-Coutts. Between 1990 and 2005, the number of state enterprises declined to 4,000 from 14,000 and is expected to fall to about only 300 over the next few years. New listings are expected in sectors such as telecom, oil and gas, financial services, airlines and banking.

The success of privatization would be largely underpinned by an influx of foreign investment. The Vietnamese government is willing to take a minority interest in privatized companies, unlike countries such as China, in which the government tends to have a majority interest. Last year, foreign ownership of listed companies was increased to 49% from 30%, with the exception of banks, which remain at 30%. Foreign ownership in unlisted securities is also capped at 30%.

Political stability, low labour costs, fiscal incentives and concessions, and a growing domestic market will make it easier for foreign capital to tap into Vietnam’s advantage as an investment destination, according to the CLSA report.

Vietnam’s economic revolution is paralleled by its social revolution. Although poverty remains entrenched, the standard of living is improving — the current per capita annual income of US$631 has almost tripled since 1990. Investment in infrastructure, which is at almost 10% of GDP, is among the highest in the region, but investment remains inadequate in areas such as transport, power and telecommunications. Life expectancy is rising rapidly, infant mortality is falling and the level of education is improving, contributing to a -vibrant workforce.

Incidentally, Vietnam is one of the few countries in the world that are net exporters of food and energy. However, it has no refining capacity and, as a result, is one of the largest importers of oil products in the Asia-Pacific region. However, plans are afoot to construct two refineries by 2010, which will supply about 70% of the country’s energy needs.

In spite of its improving stature on the global scene, Vietnam remains one of the most politically corrupt countries in the world. Its legislative and regulatory system is weak; and there is a lack of transparency, uniformity and consistency in government policies and decisions. The Heritage Foundation’s 2007 Index of Economic Freedom ranks Vietnam 138 out of 157 countries, while Transparency International’s 2006 Corruption Perceptions Index ranks it 111 out of 163 countries.

Nevertheless, the CLSA report says it makes sense to start building a core position in Vietnam, either directly or semi-directly. Perez-Coutts says that AGF Emerging Markets Fund has a marginal indirect exposure through a Malaysian company, while Templeton Emerging Markets Fund has a small direct exposure.

Investors seeking to capitalize in a larger way on the Vietnamese opportunity could invest in offshore country funds such as Dragon Capital Management Co.’s Vietnam Enterprise Investment Ltd. Fund, Korea Investment Trust Management Co.’s Vietnam Growth Fund and Prudential Vietnam Securities Investment Fund Management Co.’s Vietnam Segregated Portfolio Fund — all closed-end funds listed on the Irish Stock Exchange.

As Vietnam emerges to become the next Asian tiger, investors would have to stomach corruption, bureaucracy and a weak legal framework, says Bastyr. On the other hand, Mobius sees changing government regulation, poor corporate governance, lack of transparency and low liquidity as the main risks of investing in Vietnam.

Mobius argues that “like China, we could see high economic growth rates for several years, but a global slowdown or draconian government regulations to cool the stock market would be bad for the country.” Although Perez-Coutts is “keeping an eye” on Vietnam, she believes that there are “very few areas for future growth” in a market “that remains very fragmented.”

Despite the fact that Vietnam still has a long way to go, it is rapidly becoming a bigger image on the radar screens of emerging-markets investors. The CLSA report says its stock market is uncorrelated to the rest of the world and traded sideways while the rest of Asia recently collapsed. Therein lies the first-mover advantage. IE