The nature of emerging market investment has changed in recent years. To a large extent, the idea of backing fast-growing countries and investing as they develop has been replaced with a significant bet on the fortunes of behemoths such as China and India. For a more ‘traditional’ emerging market approach, investors have to think smaller.
And, if they do, they will end up where Emily Fletcher, co-manager on the BlackRock Frontiers investment trust, focuses her attention. She invests alongside Sam Vecht, her co-manager on the trust, while also contributing to the wider global emerging markets team with Gordon Fraser, her co-manager on the Emerging Markets Frontier hedge fund, and Stephen Andrews, on the Emerging Markets Income and Emerging Markets Sustainable funds.
At heart, she is tasked with exploring the world’s smallest economies and markets to uncover nuggets of growth in these complex but fast-growing countries.
The team focuses on emerging and frontier markets excluding the eight largest – China, India, Taiwan, Korea, Russia, Mexico, South Africa and Brazil. The result is a portfolio very different to the MSCI Emerging Market Index, where these larger countries account for more than 90% of market cap.
This is by no means an easy option. Many of the group’s rivals have pulled away from this part of the market – Abrdn closed its Frontiers trust in 2020, followed by Jupiter in 2022. It takes a big team, who are willing to roll up their sleeves in some tough and difficult-to-access areas, alongside a robust risk-management function that can operate globally.
“Researching 20 stocks in 20 countries is exponentially more difficult than researching 20 stocks in one country,” says Fletcher. “For each holding, we need to understand the economy and political landscape, as well as the stock itself. There are no economies of scale for this part of the market. You can only do it as part of a large and well-resourced team.”
Such an approach is also time-consuming and requires on-the-ground research. “We spend a lot of time in the countries themselves, understanding local politics, meeting CEOs, suppliers, NGOs, development banks, doing a lot of due diligence and gathering as much information as we can,” she explains.
Information is often scarce. Fletcher points out that while US investors can obtain inflation data with a lag of just a few weeks, for some of their markets, this can take months. “Egypt has just released its current account data from September,” she says. “When we are analysing the reasons for the 60% fall in the currency, we need to take that into consideration. It is an art as much as a science.”
Why not focus on ‘easier’ markets then? Fletcher believes these unloved regions bring something new and interesting to a portfolio: “Very few investors are looking at these countries. Going where no-one is looking presents a huge opportunity for alpha. These markets are very uncorrelated, have lower volatility and are largely unexplored.” This can bring real diversification, she says – and, perhaps more surprisingly, they can also deliver income. The trust currently has a yield of 4.4% – not a target, but a natural by-product of companies in these markets.
The team has built up a considerable body of expertise in its 13 years of working together. As Fletcher points out, IPOs are generally a feature of areas where capital is abundant, which has not been true for this part of the market. This means the team rarely meet companies they have not seen before. They have existing relationships across all the countries they invest in and, importantly, she says, have built up trust.
“We wouldn’t invest in a company that did not have fully audited accounts and we like to meet a company five or six times before we invest,” she adds. “We also want to meet their suppliers, their competitors and the ecosystem around them.”
The team work on the basis that all countries are cyclical and so a buy-and-hold strategy is not appropriate. “It is really important to move in and out,” says Fletcher. “It means we are buying when others aren’t, which helps in markets that are less liquid.” The team are always looking for countries where the cycle is turning – and thus may be about to see a welcome mix of an improving currency, improving asset flows and better sentiment.
This means there is no typical geographic allocation for the trust. “The current top-three countries in the trust have all been zero-weighted at some point in the past decade,” notes Fletcher. “The number of countries that have featured in that top three would be as high as 10 or 12. It is all about being in the right place at the right time. Equally, there will always be a time when we don’t want to own a particular country. Vietnam, for example, has been a strong performer, but it is still cyclical.”
At present, Saudi Arabia and Indonesia are the two largest holdings in the portfolio – at 18% and 17%, respectively – followed by Vietnam, Kazakhstan and Thailand. According to Fletcher, Saudi Arabia has seen huge social change in recent years, which is creating a lot of opportunities – for example, the team have invested in a female-only gym. The country has also received a boost from higher commodities prices that is helping increase tax revenues and spread wealth.
The Indonesian weighting in the trust is largely formed of Bank Central Asia – at 5%, the trust’s largest holding – and Astra International, its second largest. “There is an expectation of huge growth in nickel demand to support the energy transition,” says Fletcher. “Indonesia has the second-largest nickel reserves in the world. This is changing the macroeconomic environment. We are investing in clothing retailers and companies selling cars and motorbikes.”
The cliche with developing economies is they are all focused on areas such as banks and brewers but, in reality, the sector mix is far more diverse, with consumer discretionary stocks, materials, industrials and even technology represented in the portfolio.
See also: What are the drivers behind India’s ‘sizeable runway’ for growth
“We have property companies, alongside software outsourcing companies, lithium producers and nickel companies,” says Fletcher. Investors should not forget these markets are beneficiaries of many of the same trends seen elsewhere, including digitalisation, the energy transition and financial inclusion.
In terms of their criteria for individual stocks, the team want companies that can do much better than the market expects – in short, where there is an element of surprise. Potential holdings need the same good fundamentals as might be expected elsewhere – capable management team, sound cashflow, strong balance sheet – alongside openness and transparency.
Eastern Europe’s time in the sun
Fletcher identifies opportunities ahead in eastern Europe. The region has suffered from its proximity to Ukraine but a lack of investor interest has left valuations looking attractive. “The Polish market is at the lowest valuation level we have seen,” says Fletcher. “The economy is looking stronger and there are opportunities emerging across banks, retailers and industrial companies.”
According to AIC figures, the trust’s share price is up 84.3% in total return terms over the three years to 31 March 2023, which puts it first-quartile in the IT Global Emerging Markets sector, significantly ahead of the sector average of 26.6%. In net asset value (NAV) terms, performance has been even stronger, rising 91.6%.
A good chunk of this performance came between March and September 2022, as it bounced back strongly after a tougher period in the latter stages of the pandemic.
Investors need to be prepared for volatility – while the operational performance of the companies themselves is not particularly volatile, sentiment towards the sector bounces about, which can lead to variations in the share price.
The trust has traded from a premium of 6.5% down to a discount of 13.7%. At the time of writing, it is 6.7%. There are signs sentiment is improving, with the share price outpacing the NAV since the start of the year.
Nevertheless, this is a segment of the market that rewards patience. While many companies within these markets look cheap, are potentially high-growth and offer a diversifying source of income, there are not a lot of natural buyers and it can take time for the wider market to ‘discover’ the opportunity.
“We saw a huge boom post-Covid,” says Fletcher. “Since then, with energy-price and food-price rises and inflationary pressures, we have seen central banks be very early to hike rates – much earlier than in the west. We saw economies slow down after that and markets and economies do badly, but it means they are now presenting some really interesting opportunities.
“These markets offer growth in a growth-starved world and yield in a yield-starved world. Valuations look attractive – the average is around 10x earnings. Over the past 10 years, investors have not had to do much except own a Nasdaq ETF – but we believe in cyclicality everywhere, so most areas get their time in the sun.
What we see looks very compelling on a bottom-up basis. I have no good answer to the ‘when’ or the potential catalyst, except to say that once investors realise it has happened, it may well be too late.”
Emily Fletcher is a portfolio manager and research analyst on the global emerging markets equities team within BlackRock’s Fundamental Equity Group. She is responsible for co-managing the BlackRock Frontier investment trust, Emerging Frontier hedge fund, Emerging Markets Sustainable Equity and Emerging Market Equity Income strategies. Fletcher joined BlackRock as an analyst in 2006 and, prior to moving to her current role in 2008, was a member of the company’s multi-asset portfolio strategies group and the UK equity team.
This article first appeared in the April edition of Portfolio Adviser Magazine