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Episode Summary:
On this episode of Pyramids and Pagodas, we meet Scott Osheroff, CIO of the Asia Frontier Capital Uzbekistan Fund, a long-only absolute return equity fund that invests in the promising Uzbek market. With the fund returning an exceptional 59% in dollar terms since 2019 (as of 31 March 2024), we wanted to lift the hood on their investment strategy and learn about how even the humble retail investor can get a piece of the action.
Uzbekistan’s often underreported yet remarkable reform story since the death of authoritarian President Islam Karimov in 2016 has ushered in average GDP growth of 5.3%. Scott paints a picture of a country breaking out of obscurity and joining the ranks of the world’s export powerhouses with a focus on value-added manufacturing. A boom in stock market valuations is driven by rapid population growth, fiscal reforms, increasing ease of doing business, and streamlined brokerage infrastructure.
With 12 years of experience working in emerging and frontier markets in Asia, Scott draws parallels between Uzbekistan and Vietnam's early growth stories. The Tashkent Stock Exchange features some companies experiencing annual growth rates of 5-600% and trading at PE ratios of 1.5x. Foreign and domestic investors are only just starting to realize the potential of streamlined trading regulations and infrastructure, and increasing inflows are expected to drive valuations in the coming years. Last year, the Tashkent Stock Exchange witnessed a five-fold increase in the number of transactions, surpassing 412,000 (equivalent to approximately USD 229 million in volume). The exchange has already established its own stock index, namely the Uzbekistan Composite Index, and hosted three IPOs on its platform. It is noteworthy that the funds raised from these IPOs last year did not exceed USD 10 million, which is relatively modest for the size of the economy. However, these are encouraging signposts of what lies ahead.
As a landlocked country, Uzbekistan seeks to carve out a niche not by competing on cost with the likes of China and Vietnam, but rather through value-added goods and services. With a relatively developed manufacturing base thanks to a long-standing policy of import substitution, opportunities in consumer goods, petrochemicals, and construction materials beckon to foreign investors. For those looking for broad exposure to the macro growth story, its hard to go wrong with Uzbekistan’s financial services blue chips.
As with any frontier market, Uzbekistan is not without its complexities. A continually depreciating currency, similar to many export-driven economies, means one should be wary of currency risk. However, with the Uzbek Som being floated in line with the market, dollar availability and capital controls no longer pose a barrier to investment. The cost of capital remains prohibitively high for many companies, but this means balance sheets are often healthy. The current (but hopefully temporary) low liquidity in the market requires patience when entering and exiting positions.
Setting up an online brokerage account in Uzbekistan is surprisingly easy and can be done in one day with a passport copy and no notarization required. Screening stocks is relatively straightforward with quarterly financials posted online and many of the financial services companies audited by the Big 4 accounting firms. Scott doesn’t see fraud and poor corporate governance as any more problematic than other developing or even developed markets. His approach is simple – dividends don’t lie and an Uzbek company that is professionally run by quality people is no riskier from a governance perspective than a similar company in the US or Europe.
Audio Stamps:
00:52 Intro to Scott Osheroff.
01:47 How Scott got started in Asia, what piqued his interest in this region and what attracted his focus to the Uzbek market.
04:10 Scott’s investment research and process leading to his fund’s outperformance.
10:04 Uzbekistan’s reform story, including the impetus for change and the progress made so far, and how the international community responded to these reforms.
18:01 Competitive advantages of Uzbekistan and reforms in the education system leading to upscaling of labor force and increased value-added activities.
23:45 Difference between Uzbekistan’s young demographic relative to ageing populations in Russia and other CIS states.
26:15 Staffing of factories, value-added exports and key strategic priorities by the government
31:20 Uzbekistan’s inflation and interest rate.
36:33 Investing in the Tashkent Stock Exchange and re-rating catalysts, and looking at Kazakhstan as a bellwether, the AIX (Astana Stock Exchange).
40:54 Appropriate stock selection approach in Uzbekistan.
48:30 Uzbekistan's market regulations and quality of disclosure with international standards today.
53:14 Question on dividend tax for foreigners investing in Uzbekistan.
53:46 Managing currency risk in Uzbekistan.
57:51 Process of setting up a brokerage account in-country, and challenges of liquidating positions and capital controls.
59:31 Investment opportunities in the Uzbek market.
1:01:24 Concluding remarks.
Additional Resources:
Asia Frontier Capital Uzbekistan Fund
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Ep 7. Uzbekistan – Emerging from the shadows of obscurity and onto investors' radars