Barron's June 14, 2019

Vietnam is an ascendant nation. Economic growth is cruising at 6% to 7% annually, powered by an export sector ranging from T-shirts to smartphones. (Samsung makes most of its handsets there.) The population of 97 million is young (median age 31), cheap to hire, and offers “the best-positioned workforce in Southeast Asia from an educational perspective,” says Sriyan Pietersz, an investment strategist at Matthews Asia.

 “The investment thesis is simple,” he adds. “This is a classic emerging markets story.” And oh, yeah, multinationals spooked by the trade war on China can move production to Vietnam, hopefully out of harm’s way.

Making money on Vietnamese stocks isn’t so simple, however. For one thing, the country is not yet an official emerging market, according to global index umpire MSCI. That exclusion prevents many funds from investing. The main holdup is regulations that limit most companies to 25% foreign ownership. Neighbors like Thailand and Malaysia finesse this question with nonvoting depositary receipts, raising the liquidity of their listed stocks. But Vietnam’s rulers seem in no hurry to follow suit. MSCI graduation will come no sooner than 2022, predicts Bill Stoops, chief investment officer for Dragon Capital in Ho Chi Minh City.

Given those restrictions, global investors have crowded into a few marquee names, driving up valuations to prohibitive levels. The top stock in the index, real estate/retail conglomerate Vingroup (ticker: VIC.Vietnam), trades north of 90 times earnings. No. 2 Vietnam Dairy Products (VNM.Vietnam) is at 25 times. “The Vietnamese market as a whole is reasonably to fully valued,” says Alison Graham, chief investment officer at frontier-markets specialist Voltan Capital Management. “We need to do some stock-picking among mid-cap companies.”

One she likes is Thien Long Group (TLG.Vietnam), a school-supplies manufacturer with a price/earnings ratio of 15. Dragon is also shunning the biggest stocks for the likes of Mobile World (MWG.Vietnam), Vietnam’s would-be Amazon.com at 12 times earnings, and Asia Commercial Bank(ACB.Vietnam), with a P/E below seven. Armchair investors can buy theVanEck Vectors Vietnam exchange-traded fund (VNM), but it will steer them toward pricier blue chips.

China’s problems cut two ways for Vietnam. The country may steal some business bound for its biggest customer, the U.S. But China itself is a close No. 2. And as a classic export-driven emerging market—trade is nearly twice gross domestic product—Vietnam stands to suffer in the short term if the trade war damages global demand.

Nor is relocating factories an easy process. Teresa Barger, CEO of Cartica Management, says it took an unnamed multinational more than three years to raise productivity at a new Vietnamese plant to the level of the old one in Shenzhen. Land is scarce and getting scarcer in Vietnam, which is about as large as New England, and infrastructure is at least a generation behind China’s. “They don’t have the deep seaports and multilane highways to just pick up where China leaves off,” Stoops says. “They will only benefit incrementally from the trade war.”

Classic emerging market energy also comes with classic disadvantages for outside shareholders. The state or homegrown oligarchs with vague notions of corporate governance control many companies. “Transfer pricing is absolutely rife,” says Graham, meaning siphoning profit from a listed entity to nonpublic subsidiaries controlled by the same owner. “It’s considered a normal thing in Vietnam.”

Investors looking for a quick return there from a trade-war dividend should think again.