Strategy: Of FOLs and Money — Is the market FOL-efficient?

Of FOLs and money (July 17, 2019)

Full-FOL stocks continued to underperform YTD, underscoring a possible unintended consequence of the FOL cap. Our theory is that the implied lack of future foreign net buying negatively impacts domestic investor sentiment for full-FOL stocks. However, the evidence on individual names is mixed. Among the VN30 components, most of the open FOL outperformance is due to just five large cap stocks, and attribution for the laggard status of the full-FOL group is even more highly concentrated in just one name.

Themes and catalysts

• Stocks with no foreign ownership limit (FOL) room underperformed open-FOL stocks YTD by 7ppt.
• But full-FOL stocks have been marginal outperformers QoQ (i.e., during the weak market).
• Does this represent a structural feature? Maybe not, but it continues to merits observation.

Risks

• Stocks typically achieve full-FOL on solid fundamentals.
• But FOL premiums, settlement issues, and weak domestic sentiment for such names are downside.
• Eventually, NVDRs might happen, but what will that mean for FOL premiums?

Updating our VN30 screen for Full-FOL vs Open-FOL components as outlined in our “FOLs and money” report of April 9. Based on free float market cap weightings, the 20 full-FOL stocks in the VN30 underperformed the 10 open-FOL stocks by 7ppt YTD. The full-FOL cohort made up some relative ground in the weak market of the past 3 months, but only outperformed by 2ppt QoQ.

Is there such a thing as an FOL-efficient market? We want to argue that full-FOL stocks should underperform in bull markets but outperform in downturns. After all, institutional investors think long term and are less prone to dumping stocks on cyclical market weakness. By contrast, during periods of cyclical strength, domestic investors (who are keenly aware of foreign market activity) tend to avoid full-FOL stocks because that status implies zero future net buying by foreigners.

Maybe not. The problem with such broad conclusions is that just five names account for over 100% of the open-FOL group’s +8% YTD weighted return: VIC, VCB, VRE, VHM, and VNM. Indeed, 10 members of the open-FOL group have delivered negative returns YTD. Similarly, the full-FOL group’s underperformance is mostly attributable to TCB, which has both that group’s highest weighting and weakest YTD performance. Of the 10 full-FOL stocks, 8 tickers have increased YTD.

We remain cautious on full-FOL names given our concerns about structural underperformance (albeit this may not exist broadly) and settlement issues. In addition, investors in full-FOL shares should at least consider the possible impact on FOL premiums from the eventual adoption of NVDRs (perhaps in 2021). Our top picks are all open-FOL stocks: VHM (BUY), VCB (BUY), and STB (BUY).