Frontier Markets, an interesting option for investors

Frontier markets are markets considered less advanced, smaller and somewhat riskier than other more established markets, however, they are considered a good investment for those investors looking for substantial long-term returns, since these markets have a huge growing potential compared with other more established countries.

We wanted to bring you some of the most interesting funds to invest in frontier markets, and we have put together four investment funds from T.Rowe Price, Franklin Templeton, FIM and Fiera Capital to understand their strategies, asset allocations and management style.

Frontier Markets Equity Fund

Johannes Loefstrand, Portfolio Manager T. Rowe Price Funds SICAV

The economies within our universe are at varying stages of development and many individual stories are at play in terms of macroeconomic environments, geopolitics, and the key sources of growth. Specific market considerations also apply, such as currency issues and the level of efficiency, liquidity, and regulation. Our strategy tends to focus on frontier countries with underdeveloped, yet fast-growing economies and large populations.

We define the universe as markets that are either in the MSCI Frontier Markets Index, the MSCI Frontier Emerging Markets Index, or are not included in the MSCI World and MSCI Emerging Market indices. It does not matter where the listing for a particular company is, provided they offer more than 50% Frontier country exposure. This results in an opportunity set which is larger and more liquid than the core index and includes many strong companies. We take a long-term view and maintain a portfolio of 50-80 quality companies.

Whilst we are style agnostic, we are more likely to tilt towards growth. We tend to look for companies in industries likely to experience structural tailwinds, examples of which include private healthcare, private education and fintech disruptors. Our approach is designed to identify the best opportunities, in rising industries in the right country that we can buy at an attractive price. Meeting with company management and evaluating management credibility is a key part of the process.

This is particularly pertinent in frontier equity markets given the scarcity of information and lack of wider analyst coverage. We look for quality management teams with a proven track record, a strategic vision, and the ability to execute. We also place a lot of importance on corporate governance. I have dedicated my professional career to frontier markets investing, and I am supported by a core frontier markets team, as well as the wider emerging markets equity team, and the emerging markets fixed income team, who provide invaluable top-down input into our frontier research. T. Rowe Price’s culture promotes information sharing, resulting in comprehensive insights and global context for all investments. 

We believe frontier markets have a place in an investor’s global portfolio considering the strong long-term fundamentals and attractive valuations, as well as uncorrelated nature of the returns compared to developed and emerging markets. The macro fundamentals and demographics in many frontier markets today are favorable and these economies have the potential to grow much faster than those in the developed and emerging markets universes. While the current global crisis brings investment opportunities, and the long-term growth outlook of many companies remains underpriced, we acknowledge that there will be individual winners and losers. Careful stock picking is therefore key, and we continue to focus on the long-term fundamentals of individual companies.

Franklin Templeton Emerging Markets Equity

Bassel Khatoun, Senior Managing Director, Frontier and MENA

For investors, frontier markets offer regional diversity across the Latin American, Middle Eastern, African, Asian and Eastern European regions. We’ve seen frontier economies push idiosyncratic reforms to support macro development. A highlight here has been Vietnam, which has recently unveiled a set of business reforms aimed at simplifying business procedures, with a focus on digitization. The MENA region has also seen a strong liberalization drive through social, economic and capital markets reform.Although the global economic outlook is likely to remain uncertain until the virus is effectively suppressed, we are cautiously optimistic that the worst is behind us.

Markets largely expect the world’s economies to bounce back this year following sharp contractions in 2020, with frontier markets such as the Philippines, Peru and Colombia[1] potentially leading the growth acceleration. For Frontier Markets, on an aggregate basis 2021 is forecasted by the IMF to be the fastest year for economic growth throughout the last nine years increasing to 4.7% from -6.7% in 2020 (market cap weighted). 

The recovery of demand and consumption after the sharp pullback in 2020 should support market performance through earnings recovery. Over the long term, we believe domestic dynamics that are geared toward favourable demographics and under-penetrated sector stories will drive frontier markets. Vietnam’s economy, in particular, could continue to expand after emerging as a rare spot of growth in 2020. We are monitoring the pandemic and policy responses in individual countries to properly assess investment opportunities. In some economies, like those within the MENA and Latin American regions, supportive commodity prices driven by global reflation should also underpin growth of cyclical sectors. 

On top of reviving economic prospects, the asset class also appears attractively valued relative to developed markets. As visibility on corporate earnings improves, investor flows into frontier markets could increase. Against this backdrop, we continue to favour high-quality businesses with sustainable earnings power and strong competitive advantages, trading at discounts to our assessment of their intrinsic worth. 

Amongst the portfolio’s key holdings are market-leading banks that we think offer exposure to the structural growth potential of frontier economies. We also see longer-term investment opportunities from growing consumer penetration and a “premiumisation” of buying patterns in frontier markets. Technology-related companies form another area of interest for us as the pandemic speeds up technology adoption globally.  We’ve seen an acceleration in the move towards organized retail, non-cash payments, online retailing and online education, at the expense of more traditional/old-economy models.

FIM EM Frontier Fund

Matthew Vogel, Head Strategist and Portfolio Manager

While the indices use static, capital markets metrics to define frontier markets, it is clear that being focused on the dynamic markets and companies under-represented in the indices delivers less correlated, higher returns.  Using socioeconomic factors to define the frontier universe leads the manager to focus on reform-oriented economies with high growth in health and education, changing consumption habits and formalization of the economy, infrastructure, financial inclusion, and fintech. Geographically, that means the markets of South and Southeast Asia, the Middle East, and to a lesser degree, Africa and Latin America.

With a forensic bottom-up analysis more akin to private equity, FIM has generated 112% returns since inception in 2013, while the benchmark has delivered -10.8%. Since the drawdowns of the pandemic last March/April, the fund has returned 56.8%, and 17.9% year-to-date vs -0.39% for the benchmark MSCI Frontier EM Index.

This significant alpha is a function of not looking at the large cap, static index companies and instead investing in change.  To discover and analyze these opportunities requires an on-the-ground presence and frequent contact with companies and other stakeholders.  The proximity of Dubai to the target markets facilitates this.  Clearly, there is no value for passive investment in these markets.

Further aiding alpha generation in these markets are our quantitative and qualitative ESG frameworks for companies and countries.  Fully integrated into the investment process, they contribute to alpha via risk mitigation and level of conviction in our investment theses.  ESG risk factors are greater in frontier markets, so having capacities to assess these makes an important difference.

With respect to the investment outlook, our target markets, such as Vietnam, the Philippines, Pakistan and Bangladesh are expected to growth at close to 6.5% per year in 2022-2024, well above average growth rates in developed markets (2%) and emerging markets (5%).  Historically, periods of global recovery are very positive for returns in emerging and frontier markets, and we believe that the opening growth differential for frontier markets will attract capital flows with the post-pandemic normalization.

The pandemic has increased focus on increased spending needs in health and education, digitalization/e-commerce and fintech – and this is clearly the case for frontier markets which have underspent in relative terms.  We see tremendous new opportunities in these sectors at interesting valuations.  In the portfolio, tech and fintech is growing from exposure to listed players and new market entrants.  In the portfolio, we have high growth fintech companies from markets such as Egypt, Kazakhstan and Pakistan, while also playing the digitalization and logistics themes across almost all the markets.

At the macro and company level, it is an exciting time to be investing in frontier markets.

Magna New Frontiers Fund

Dominic Bokor-Ingram, Senior Portfolio Manager, Magna New Frontiers Fund

The greater the number of market participants focussing on any publicly traded financial asset, on average the greater the chance of that asset being priced correctly. We view this frontier and smaller emerging market opportunity set as a huge source of potential alpha which we can apply our bottom up investment process to.

The Fiera Frontier Markets team’s research and financial modelling process, will often come to a very different conclusion of the fair value of a company than that attributed by “the market”. Combined with our country risk analysis we seek to construct a portfolio of companies in countries that have the strongest economic, political and stock market reforms, which we believe creates the optimal environment for seeking out companies that can compound their earnings over many years, and where we can buy these companies at attractive valuations.

The biggest country weighting in our portfolio currently is Vietnam, where a top down reform process that is following the Chinese state sponsored capitalism model with a few year lag, is leaving us with many markers and much evidence of how their economic sectors and private companies will develop. The retail sector is a great example of learning from the history of more developed nations and applying these lessons to today’s new emerging economies.

In the early 1990’s, the percentage of formal retail (as represented by shops at the time although online retail would now be included) in countries like China, Korea and Taiwan was just 5%. This has grown to over 65% today. In Vietnam the number today is just 8%. With very similar political and economic systems to its North Asian neighbours, but only starting its economic reform journey in around 2007, we can forecast with some certainty the growth and transformation path this sector will take. The final piece of the jigsaw is to find companies with strong management that can take advantage of this huge growth opportunity in a corporate governance structure where we, as minority shareholders, can share fully in the upside. And finally, the lack of focus from international investors, and the still nascent development of domestic financial institutions means that we can buy these companies at attractive prices.

There are many other examples in our portfolio of situations where changes in political or economic direction create a window of opportunity, sometimes many years in length, for our experienced team to find companies with substantial growth opportunities that are largely ignored by the global investment community. These can range from ECB policy changes creating restructuring opportunities in the Greek banking sector, language barriers in Kazakhstan giving local technology companies freedom from competing with the global tech giants, massive reform bills being passed in Indonesia creating the environment for a surge in foreign direct investment and The National Transformation Plan and Vision 2030 in Saudi Arabia focussing capital and investment on the growth of the non-oil economy.

The Magna New Frontiers Fund has been researching and investing in these opportunities for the last 10 years and has developed an extremely successful and consistent performance record. The Fund has produced a positive return of +23.7% (EUR net composite) year to date, with its 1 year annualised performance being +60.0%, 5 year annualised performances of +11.7% and 10 year annualised performance of +9.6%. This long only equity Fund invests in the public markets of frontier markets regions. All data EUR net as at 28 May 2021.