Vietnam is one of the best-performing stock markets this year and has seen a huge inflow of foreign investment through passive exchange-traded funds [ETFs].
Many investors see ETFs as a cheap way to gain access to high-growth markets, but our performance data suggests this is problematic, with the funds producing disappointing returns compared with the massive gains made by active funds.
Furthermore, those who invest this way are exposing themselves to extra risks and potentially destabilising the markets they invest in, according to Gyentsen Zatul, associate director of investor relations on investment trust Vietnam Holding.
Zatul explains that ETFs are forced to buy the biggest stocks on the Vietnamese index – 20 companies make up 80 per cent of the market – and that this has stretched valuations.
This is compounded by rules limiting the amount of shares that can be held by foreigners, which means that investors end up paying a large premium to the market price to persuade holders to part with their securities.
Active managers can profit from this by selling their large cap stocks on a premium and concentrating on the less well-known mid cap area of the market, Zatul explains.
"It’s a story of two markets," he said. "There’s a lot of upside at the moment thanks to ETF inflows which mostly go into large caps."
The Vietnamese stock market is up 15.37 per cent this year, while Vietnam Holding has made 44.84 per cent, helped by a narrowing discount.
The stock market’s good run began in early December, and initially it outpaced the trust, although the latter has now overtaken the former.
"Our NAV did not keep up with the index at the start as we buy companies that aren’t in the ETFs," Zatul said.
Data from FE Analytics shows that the trust has made 23.8 per cent over the past year while the two main ETFs, from Deutsche Bank and Market Vectors, have both lost money.
Performance of funds over 1yr
Source: FE Analytics
Zatul says any market pull-back is likely to be worse for holders of passive funds as the whole concept of using an ETF for such a market is flawed.
"We believe it is almost impossible to run an ETF on a country like Vietnam on a one-to-one basis."
"They have to make a lot of compromises. Some ETFs will not invest in real Vietnam stocks but those in countries like Thailand, for example, which have operations in Vietnam."
The $448m Market Vectors Vietnam ETF holds 27.6 per cent of its funds offshore, with 9 per cent in Thailand, 8.5 per cent in the UK – including a large stake in Premier Oil – 5.7 per cent in Malaysia and 4.4 per cent in India.
The $377m Db X-Trackers FTSE Vietnam fund limits its holdings to those members of the stock market with larger free floats available to foreign ownership.
Tom Tuite Dalton, analyst at Oriel Securities, says that the approach of Vietnam Holding is likely to bear fruit in the longer term, even if it misses out on some of the temporary surge.
"As VNH is reluctant to play the momentum game or adopt what the less charitable might term 'the greater fool' theory, VNH’s manager has spent the last 18 months trimming its larger holdings and building positions in mid and small caps," Tuite Dalton said.
"Whilst in the short-term this position could work against VNH, as continuing ETF inflows favour the expensive stocks, we share VNH’s confidence that at some point rational investors will rotate into the smaller, more attractively valued stocks."
"VNH’s focus away from ETF-owned stocks should make it prove more defensive in a market downturn, which would likely result in ETF outflows."
Zatul says that the growing presence of ETFs in the country is for the most part negative for the market.
"We don’t think for the development of the market it’s very sustainable. We would rather see more funds that look at value like ours come to the market."
"However, ETFs do create liquidity, which is good for the market."
Thailand is another south-east Asian country that is pulling away from the pack.
The stock exchange of Thailand [SET] is up 52.42 per cent over the past year.
However, Aberdeen New Thai, managed by FE Alpha Manager Hugh Young, has made 68.81 per cent, according to data from FE Analytics.
Rather than following the domestic index, many of the passive options available follow the MSCI indices and have produced far inferior results.
Db X-Trackers MSCI Thailand has made 31.36 per cent over the past year, while the iShares MSCI Thailand Capped Investable Market Index has made 38.22 per cent, according to data from FE Analytics.
Performance of funds over 1yr
Source: FE Analytics
Thailand is more developed than Vietnam and is on the major emerging markets and Asian indices.
It has made investors a lot of money over the last decade, with the index up 818.89 per cent over 10 years and 221.08 per cent over five.
Vietnam is at a far earlier stage of development, and the market still has far to go before it is fully liberalised.
However, the government has committed to increasing the amount of foreign ownership allowed in order to encourage inward investment.
The country is also seeing a growth in investment by technology firms such as Samsung, as its cheaper labour makes it attractive in the light of rising wages in China.
Tuite Dalton says the country looks more stable than it has for years, and it could be an interesting area for an adventurous investor.
"The improving macro environment in Vietnam is gaining increasing and well warranted recognition among investors," he said.
"Inflation has come down from over 20 per cent in 2011 to average around 8 per cent in 2012, as financial reforms intended to temper growth rates and improve sustainability were implemented."
"These positive changes, the prospect of which prompted us to turn positive on VNH in November 2011, resulted in the Vietnamese currency strengthening in 2012 relative to the US dollar."
"Finally, Vietnam has fast moved up the quality spectrum in terms of its exports, with handset exports overtaking oil in 2012, and with Samsung now a key FDI provider."