Although on paper Vietnam looks to be one of the most attractive emerging countries, the Southeast Asian nation has never quite lived up to its billing as an investment opportunity. But with a steady stream of policy reforms, solid economic fundamentals, and improving physical infrastructure, Vietnam may finally be in position to catch the bouquets thrown over China’s shoulder. Investors who take the plunge early may even get a kiss from the new bride.

 The Search for a Suitor

It is hard to argue with Vietnam’s country fundamentals. Following the Thai floods last autumn, it has surpassed its regional competitor as the world’s largest exporter of rice. It is the second largest exporter of coffee and exports large amounts of seafood, sugar cane and casava. Of the latter, 99% goes to Japan to be turned into ethanol.

 Similar to Indonesia, but with fewer resources already exploited, there are significant deposits of gold, tungsten and copper. It boasts 3,000 kilometres of coastline, making it a good logistics centre for trade in Southeast Asia. The population is 90 million and growing, 60% of whom are under 30 years old, meaning the demographic dividend has yet to be redeemed. Vietnam is ideally placed to benefit both from the regional trade opportunities presented by China’s re-emergence and the displacement of capital as costs in its northern neighbour steadily rise.

 But despite these allures, Vietnam remains off the radar of most investors, and those who do follow it have been reluctant to make a proposition so far.

 A credit blow out, with debt-to-GDP rocketing from 70% to a peak of 135% (although it has now receded to 116%) and several currency revaluations in recent years have spooked many, while economic policy makers found have themselves behind the curve on inflation and growth risks at various points.

 Jason Pidcock, manager of the Newton Asian Income fund at BNY Mellon, outlines the sceptic’s case. “It looks good on paper, with good demographics and a low per capita GDP, and there would seem to be plenty of low-hanging fruit. But when I started focusing on Asia nearly 15 years ago I thought ‘Vietnam is five years away from being investable’. I still think it’s about five years away, so in this sense it has been a perennial disappointment.”

“It really is Wild West and extremely volatile. It will be some time before we see a properly functioning government and market driven economy. This also means any good Vietnamese company that emerges will probably list overseas in order to get proper attention.”

 Indications of a Courtship

To make matters worse, 2011 was not a good year for the Vietnamese economy. Like others in the region, it suffered as global export demand flagged and capital pulled out of emerging markets generally. Inflation ran at 19.8%, while growth slowed to 5.89% in the fourth quarter.

 But there are signs the situation is stabilising, both from a macroeconomic and investment environment perspective. Dan Svensson, fixed income and debt funds manager at Dragon Capital, points to tentative reasons to be hopeful. “We remain cautiously optimistic on both the currency and the macroeconomic stability although external factors may thwart any scenario. Vietnam’s monetary conditions are now very tight which may lead inflation towards 10% or less by the second or third quarter.”

 “We are also cautiously positive on the development of external balances and the government’s determination to control fiscal spending. Although the real economy will need time to pick up speed, we believe that lighter monetary conditions during the second half of the year will allow for lower government yields and also lending rates, which will give some support to asset prices.”

 On a wider level, conditions may also be becoming more conducive to institutional investment. It is now five years since Vietnam joined the WTO, and the country ranks highly on political stability indicators. It was recently ranked as the number one “frontier market” in an annual Thomson Reuters survey, suggesting it may be one of the most desirable débutantes in terms of post-BRIC high-growth plays.

Andy, Ho, Managing Director and Head of Investment of VinaCapital, Vietnam’s largest fund house, says: “The Thomson Reuters ranking is good news on one level, but it’s bad news that we are not yet part of the emerging markets group yet.”

 “From a governance point of view, things are improving. The structures are coming into place for investors to find an entry point. On top of that, there is the physical infrastructure investment, which is allowing growth and reducing friction costs in the economy, which ultimately benefit shareholders.”

 Beautifying the Bride

In the most recent developments, the government in Hanoi has embarked upon various reforms and policy initiatives designed to improve its credibility among institutional investors. These include consolidating the banking sector, deepening fixed incomes markets, and increasing cooperation with foreign market actors.

In December, Vietnam signed an agreement with the Australian government to cooperate on sovereign bond market development. There is a drive to improve bond transparency and documentation for corporate or SOE bonds, Hanoi having recently invited Fitch, Moody’s and S&P’s to examine these instruments.

 The government recently initiated banking sector reform earlier than most analysts thought with the consolidation of three troubled banks into one new entity, although there are at least a dozen more in need of consolidation. There has been a tightening of capital and risk controls for the sector generally, and moves are also afoot to reduce excessive competition in the securities and insurance spaces, including imposing higher CAR on securities companies from April 2012.

 For Svensson, these reforms present risks and opportunities. “In the next one or two years Vietnam’s banking sector will offer the best chance in the last 10 years to buy a large stake in a bank at a deep discount. The story is similar to Indonesia’s banking reform in early 2000. It also indicates this or maybe next year should be an excellent time to look at Vietnam’s equity market.”

 Vina’s Ho agrees: “In the short-term, there may be some volatility, but we’re bullish on the long-term and view the volatility as opportunities to deploy capital.”

 Happily ever after?

But despite Vietnam’s undoubted promise and indications the country may be becoming a more viable option for institutional exposure, it may still be too early for many to make a commitment. The government bond market remains relatively illiquid, and with the exception of some 15-year paper available to life insurance companies, tenors are normally under five years.

 On the short-term, banking sector reforms could disrupt the corporate bond space, keeping liquidity tight and dissuading new market participants who would broaden the investor base from entering. As a result, investment opportunities remain concentrated in high capital growth plays such as direct investment or participation in private equity funds.

 “From a portfolio management perspective, Vietnam is clearly not a place to put the bulk of your investment,” concludes Vina Capital’s Ho. “But a lot of investors are increasing exposure to India and China, and these markets will move more and more in tandem. Smaller countries like Vietnam are a diversification play. We recognise that it is an economy to diversify into for returns and would say, come in and put a little money to work and see how it goes.”

 So, while Vietnam may not quite be ready to walk up the aisle, to the right investor it might represent an attractive bit on the side.

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