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This article first appeared in Personal Wealth, The Edge Malaysia Weekly on November 4, 2019 - November 10, 2019

Located in the heart of Central Asia, the Republic of Uzbekistan has seen significant reforms since the death of its former president and longtime dictator Islam Karimov in 2016. The country, which is now opening up its market to international investors, presents a lot of investment opportunities in both its public and private sectors, say international fund managers.

Scott Osheroff, chief investment officer of Asia Frontier Capital Ltd’s AFC Uzbekistan Fund, says that within Central Asia, Uzbekistan offers the best potential for investors. He explains that the country’s current president, Shavkat Mirziyoyev, has been very vocal about transforming the country into a more investment-friendly destination, accelerating the liberalisation of the economy. Since he took over as president in 2016, he has also been announcing measures to enhance the strength of the country’s judiciary and ensure protection for minority investors.

The government’s efforts to attract foreign direct investment (FDI) include lifting its currency controls, floating the som (the Uzbek currency), allowing citizens to purchase foreign cash for the first time and privatising the country’s many state-owned companies, says Osheroff.

“The country is trying to remedy the brain drain that resulted from its years in isolation and address the issue of underemployment by encouraging FDI. More foreign investments mean more businesses opening up and hiring locals. These are some of the overlying aspects as to why the country has moved so quickly over the past three years,” he adds.

The underemployment issue was highlighted by International Monetary Fund (IMF) managing director Christine Lagarde in her speech in May last year. Half of Uzbekistan’s 33 million people are under the age of 30 and annually, over 600,000 of them join the workforce. Despite this, the number of formal sector jobs has hardly increased over the past several years.

Due to the reforms and other factors, Uzbekistan’s economy is on an upward trajectory. It grew 6% last year and the IMF forecasts annual growth of 8% in the next few years.

“On the investment side, what attracted me to the market is that the assets are generationally cheap as valuations, in the equity and real estate markets, are compressed. For example, there are stocks on the market paying 25% dividend yields that are growing several hundred per cent year on year. I don’t think the type of broad value on offer in Uzbekistan exists anywhere else in the world,” says Osheroff.

Launched on March 29, the AFC Uzbekistan Fund focuses on the 603 companies listed on the Tashkent Stock Exchange and over-the-counter market, offering a portfolio that has a low correlation with global equity markets. The company decided to launch the equity fund following the anticipation of a massive re-rating in the prices of equities on the stock exchange. This is occurring as a result of the government’s gradual move to privatise its non-core assets, which is expected to lead to an inflow of foreign equity investors and thus enhanced liquidity.

To illustrate his point, Osheroff notes that one of the listed companies on the Tashkent Stock Exchange is the largest steel company in Central Asia. The company, which is currently government-owned, is undergoing a capacity expansion to be able to satisfy the country’s needs for steel and enable Uzbekistan to become a net exporter.

“The stock, which is trading at a price-earnings ratio of four times, has gone up over 300% in the past six months with a 6% dividend yield. Moving forward, the government is going to divest its investments in the company and prepare it for a dual-listing in the early 2020s. The dynamics of the market are truly exciting and the value that you can get there, combined with the growth, is exceptionally rare in an age of zero interest rates globally,” says Osheroff.

Though he agrees that there are still liquidity challenges and risks that the country might be facing from reform fatigue due to the number of decrees passed over the past few months, Osheroff believes the situation is improving. The market capitalisation of the Tashkent Stock Exchange, for example, has increased to US$4.1 billion (from around US$2 billion mid-2018). The government is also managing expectations well by announcing any delays to reform executions if it is not ready.

Osheroff says the industries he is most excited about are the ones that will be well leveraged to economic growth and rising discretionary spending. They include food and beverage, industrial material production and financial services.

There are opportunities in the private markets too. One company that is trying to tap this opportunity is Sturgeon Capital Ltd, which has invested in the Silk Road region via public markets for 12 years. The company currently manages a UCITS IV-compliant equity fund called the Sturgeon Central Asia Fund and is planning to launch Uzbekistan’s first dedicated private equity fund by the end of the year.

Kiyan Zandiyeh, CEO of Sturgeon Capital and portfolio manager for Sturgeon Capital’s Alternative Strategies, describes Uzbekistan as the region’s most attractive market.

“However, under the previous administration, it was very difficult to invest there on a meaningful level. When the administration changed, we started to see the country move from a closed socialist state to an open free-market economy. Today, it is possible to deploy meaningful capital there,” he says.

Limited liquidity in the public market is one of the reasons the firm decided to look at Uzbekistan’s private market, says Zandiyeh. He also thinks there are more interesting and diverse opportunities in the private market where valuations are just as attractive as the ones on the public market. Sturgeon Capital has invested in the country for more than eight years.

Like Osheroff, Zandiyeh says the firm likes the country’s financial sector. “This is based on the GDP per capita perspective, which is coming from a very low base. It was about US$1,260 last year. By comparison, in its peer country Georgia, which has a fifth of its population and no natural resources, it is around US$4,000 while Kazakhstan’s is around US$9,000. On a broad level, we believe Uzbekistan’s GDP per capita has a long way to catch up and the benefactor to that is usually the financial sector.

“The added leverage we have of that is that a large number of Uzbeks are not formally banked — wages are historically paid in cash. Now that the government is urging the population to be paid through their bank accounts, the deposit and lending base is increasing, benefiting the financial sector players.”

Uzbekistan’s GDP per capita currently stands at about US$1,500. The World Bank recently increased its GDP forecast for 2020 to 5.7% from 5.5% previously.

The other area Sturgeon Capital likes is agriculture. According to a July 3 market overview and trade data report by the US Department of Commerce, agriculture accounts for about 17.3% of Uzbekistan’s GDP and employs about 26% of its labour force.

“The agricultural sector is benefiting from the country’s low cost of labour, which is on average about US$240 per month. This offers a significant competitive advantage when it comes to the cost of production. Agricultural companies are also mainly exporting their produce. This means that the companies get hard currency revenue, allowing them to enjoy hedging benefits. To us, that is very attractive,” says Zandiyeh.

Apart from the financial and agricultural sectors, Zandiyeh also likes early-stage online businesses. The country, which has a high percentage of youths, enjoys a relatively high internet penetration rate. A growing number of online businesses are taking proven business models of other countries to Uzbekistan. As the overheads are low, companies do not need much capital to capture market share and they would be able to break even much earlier than their peers in more developed countries, says Zandiyeh.

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