CEO and Fund Manager Asia Frontier Capital

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24th February 2014

CEO and Fund Manager, Asia Frontier Capital Thomas Hugger has spent 27 years in private banking where he specialised in managing portfolios of listed and unlisted equities. He has been investing in Asian and African Frontier Markets since 1993. He is the former Managing Partner, CFO and COO of Leopard Capital and was previously a Managing Director and Head of Portfolio Management at LGT Bank in Hong Kong. He also held senior investment positions at Bank Julius Baer in Zurich and Hong Kong. Mr. Hugger was the founding shareholder of one of the largest brokerage companies in Bangladesh. He is also a Certified Financial Investment Analyst (CFIA) and Investment Adviser (Switzerland) and a Certified European Federation of Financial Analysts Societies (EFFAS) Financial Analyst.

Since its inception in March 2012, Asia Frontier Capital’s focus on the frontier markets of Asia has proven successful, what factors have accounted for the growing interest in these markets?

Thomas Hugger: “Frontier markets in Asia are going to be the growth story of the next two decades and investors are interested in getting in ahead of the crowd. Frontier markets in Asia offer the opportunity to invest in the ‘next China’ before stock and asset prices get pushed up. We invest in countries like Bangladesh, Cambodia, Iraq, Laos, Mongolia, Pakistan, Papua New Guinea, Sri Lanka and Vietnam because they are all at a similar stage of economic development as China 25 years ago or Thailand 40 years ago. Today it might sound crazy to invest in a place like Bangladesh in anticipation of the country becoming a major industrial hub. But their markets are developing quickly and the country is strategically located between China, India and Myanmar. Just look back — 25 years ago people were saying it was crazy and risky to invest in China but their economy grew by around 10% per year for more than 20 years making China now the second largest economy in the world!

Every day in China you see entrepreneurs shutting down their factories in Guangdong province between Shenzhen and Guangzhou and moving them to Vietnam, Myanmar and Bangladesh. To me it seems strange that investors look for returns in China without paying attention to where the Chinese are putting their money. If anyone is going to be able to find the ‘next China’ it makes sense to me that the people that built China would have a good idea what to look for.

The reason the AFC Asia Frontier Fund has been successful is that we have invested in financially sound companies at attractive valuations in markets that have been overlooked by other (mainly foreign) investors. When we allocate capital we have a distinct advantage as we have done the research and found opportunities that others have not even been looking for. With the niche strategy we employ we are also able to find small and mid cap opportunities that large fund management companies are forced to screen out due to their liquidity constraints. The fact that Asian frontier markets are now attracting attention from international investors reinforces the confidence we have in our strategy as well as the countries we invest in.”

Asia Frontier Capital has identified particular value in Vietnam, can you elaborate on this?

TH: “The Ho Chi Minh Index is currently at 560 points which is still less than half of the index level reached during its peak in March 2007! Since then many companies in the non-financial sectors have been growing organically and as a result of this these companies are trading today at a huge discount to comparable emerging and frontier companies in Asia and globally.

Looking beyond typical large cap index stocks you can find incredible opportunities in small to midsized companies that have simply been overlooked. For example, we were able to invest in a debt free fast moving consumer good (FMCG) producer when the market capitalization of this company was smaller than the cash on its balance sheet! These kinds of valuations are only found at the end of year long bear markets as we have seen it in Vietnam from 2007 to 2012. To take advantage of this type of opportunity you need to be doing your research constantly and be able to move fast to put your money in. However, sometimes you need to accumulate a position in small amounts over time which is where my trading background comes in handy. This approach is one way Asia Frontier Capital differs from the big fund houses.

Along with the rest of the world Vietnam faced some difficulties during the global financial crisis, but many of these have been worked through. We believe the recent actions taken by the Vietnamese government will help to solve the remaining problems and offer a solution to non-performing loans in the financial sector and the sluggish real estate market. The economy is stabilising as GDP growth has picked up in the last quarter of 2013 and Vietnam’s credit rating has also been notched up which reflects the improving economic conditions. On a macro basis the fundamentals are also very strong. The country has close to 90 million people, a median age of 29 and a literacy rate of 93% yet the economy is half the size of Thailand which has a population of only 67 million. With greater emphasis on reforms in the state run sector as well as the growth of private enterprise in Vietnam we expect to see the country reach to where Thailand is today.”

Which sectors in Vietnam hold the most potential for investment?

TH: “In Vietnam many sectors offer great potential to investors but we expect some sectors to outperform others. Since Vietnam has a large, well educated workforce the increasing foreign investment will create more job opportunities for workers and this will lead to an increasing amount of money in their pockets at the end of each month. For this reason we like the consumer, agriculture and industrial sectors. Vietnam is also seeing increasing attention from investors and individuals around the world so we want to own the things they will want to buy. For this reason we also like securities trading businesses and the tourism sector. Company valuations and fundamentals in these sectors are also very attractive.”

You have a wealth of experience across the emerging markets of South and East Asia, what is your view on the potential of these markets?

TH: “When you have been investing in Asia for as long as I have (over 20 years) you can see the difference between a great trading opportunity and the underlying drivers that give markets long run potential. Right now these markets offer both!

As I was saying earlier, there are great opportunities available right now, but these countries also have a young, fast growing population that have better education outcomes than any time in history. The young people in these markets are switched on, hard working and tech savvy. When you look at the numbers they are staggering — the median age in Laos is 21, in Cambodia it is below 25 and in Vietnam it is 29. These favorable demographics support domestic consumption and a fast growing GDP from a low base. This means increasing consumption of basic goods due to the developing population and higher growth means that consumers will buy more discretionary goods like motorbikes, cars, mobile phones, white goods and air conditioning to name a few.

AFC believes that the big story for the next couple of years will be the shift of light manufacturing from China to places like Bangladesh, Cambodia, Myanmar and Vietnam. Global technology companies such as Intel and Samsung have already started to build hi-tech production factories in Vietnam. Samsung will manufacture about 40% if its mobile phones in Vietnam by 2015. Within various other countries also there are interesting developments taking place. Pakistan is expected to see further growth in its textile industry as it is one of the countries which has received favorable trade terms from the EU. Sri Lanka and Cambodia are seeing a massive growth in tourism, Iraq is rebuilding its economy and sitting on huge oil reserves, Bangladesh and Pakistan have one of the largest populations in the world and even the slightest increase in per capita income will lead to a dramatic shift in consumption.

Looking at Mongolia they have huge untapped natural resources and it is difficult to put a shovel in the ground there without discovering something valuable. Myanmar was formally the ‘rice bowl of Asia’ and has been attracting international attention as their economy opens up. The Asian frontier countries we invest in have a combined GDP of U.S. $ 831 billion and a population of 572 million. Some people may not look deep enough to see the long term potential in these markets, but when you have done your research it is difficult to miss it.”

How will the U.S. Fed tapering policy impact these markets?

TH: “I believe that Asian frontier markets will be less affected by tapering than the rest of the world as they are less correlated to global markets. When you look at the numbers, Emerging Markets will move in step with global markets, nine times out of 10 as the MSCI Emerging Markets Index and the MSCI World Index have a correlation of 0.91! When you look at Asian frontier markets this is simply not the case as the MSCI Frontier Asia Index and the MSCI World Index have a correlation of only 0.35. So, if investors are concerned about upcoming developments in the U.S. And Europe, then Asian frontier markets offer a way to diversify portfolio risk whilst still offering great value and performance.

Tapering is really just a blip in the long run growth story of these markets. That being said the impact of this event will depend on how fast or slow the Federal Reserve will reduce their bond repurchases. We expect a slow reduction of repurchases, followed by a long period of low interest rates without rate hikes and this should not impact our markets a great deal as tapering has been generally expected by investors for the past six-eight months. Also, just a handful foreign investors are active in Asian frontier markets as yet so the huge swings in capital flows, we saw in emerging markets like India, Indonesia and Brazil the last time the Fed announced it would begin tapering is much less likely. In fact, the currency in countries like Vietnam and Bangladesh have been quite stable since the Fed tapering talk began. Further, if someone is looking to invest in frontier markets based on a single decision by a foreign central bank, they have generally missed the point and need to look closer at what is driving the long term opportunities in these markets.”

You are the founding shareholder of one of the largest stock brokerage companies in Bangladesh, what was your experience of working in the South Asian capital markets?

TH: “When we started the brokerage company in Bangladesh early 2000 there was no written research reports available on any company in Bangladesh, the stock prices were not available on Bloomberg and hardly any foreigners were investing there. It was a great experience to put the country on the radar screen of international investors. Thanks to our international experienced staff, we were greatly involved in shaping the capital market in Bangladesh and advising government institutions how do develop it. As frontier markets are still developing it is incredibly important to know how things really get done on the ground. I mean, how could you properly value a company if you do not know how they get business done on a day to day basis? I would be wary of anyone claiming they understand frontier markets just sitting behind a trading desk in London or New York.”

What are your views on the regulatory frameworks in frontier markets?

TH: “They are widely different from country to country and the focus on regulation is very different in each country. Some countries focus regulation on investors — others on companies. It is also very important to look forward to see how upcoming regulatory changes could impact our portfolio. For this reason we regularly speak to regulators, brokers and other investors to put the pieces together.

More specifically the entry barrier for foreign investors in countries like Bangladesh, Mongolia and Vietnam is very high. For example, in order to start trading in Cambodia, Mongolia and Vietnam we had to get a mountain of documents legally certified and they had to be sent around the globe for this purpose. At the moment, however this has actually worked to the advantage of our fund as this barrier has been the stumbling block preventing others from buying undervalued companies. In other markets, however it was quite simple to start trading such as in Iraq and Papua New Guinea.

Each market has unique conditions. Smaller listed companies need to report in Mongolia only once a year – by 30th June – and less than 80% of the companies submitted their annual report last year. However, the companies listed in Iraq need to file their quarterly reports on time otherwise they get suspended from trading indefinitely. In Vietnam, Pakistan, Sri Lanka, Bangladesh and Iraq, there are disclosure every quarter and it is easy to get hold of annual reports and quarterly reports from the company website or exchange filings. Speaking to company management also is not that big of an issue as many companies are willing to speak and share more information about their businesses.”

After an extensive career in private banking, what led you to set up Asia Frontier Capital?

TH: “It was always my dream to run my own investment company especially after spending so long climbing up the corporate ladder. The higher I got the more time I spent on internal non-productive meetings instead of looking after my client’s investment portfolio which was incredibly frustrating.

I was always interested in investing in emerging and frontier markets especially in Asia, Middle East and Africa and when I got the chance to acquire the fund management company I am running now I did not have to think twice. I also now have complete freedom to run the company the way that I think is best interest for my investors and my team.

When people trust you to invest their own money it is an incredible responsibility and I do not take that responsibility lightly. I also think more generally that the investment world has lost some of its quiet charm in the past decade. Today it seems as though people want to work in the ‘finance’ industry rather than the ‘financial services’ industry. When I took over the company I was determined to bring back the level of service to rekindle that charm. This approach has been quite successful in attracting the kind of clientele I like to work with. The vast majority of my current investors are individuals and family offices who see, like us, the investment opportunities in Asian frontier markets. We have a more personal style so if there is anything my investors want to know about our markets all they need to do is pick up the phone or send me an email.

With this in mind, we will have to stop accepting new investors at some stage in the future as I am planning to keep the fund at a boutique size to maximise the returns on our investment strategy. I can then focus on generating great returns whilst working with a core group of investors over the coming years.”