The fund manager’s view
Fergus Argyle, manager, New Capital Emerging Markets Future Leaders fund
Fifteen or 20 years ago, frontier markets were regarded as the new paradigm for equity investing. Underexplored, increasingly liquid and with dynamic macroeconomic backdrops, these markets offered opportunities you couldn’t find anywhere else.
The appeal was heightened after the global financial crisis. But after two decades, MSCI Frontier Aggregate has underperformed broad emerging markets by over 100% and world equities by more than 200%. Inflation and precarious trade have punished subordinate currency regimes and the very notion of frontier markets has become relatively meaningless, especially when three of the largest economies –Nigeria, Egypt and Argentina – are excluded.
We believe Vietnam dominates with exciting bottom-up opportunities. A major manufacturing hub for electronic hardware, it has moved up the value chain in recent decades. IT services providers are winning several contracts in Japan and effectively competing against larger international peers.
Kazakhstan also offers potential opportunity. It is home to one of the most dominant and best-run fintech companies in the world – Kaspi.kz. Recently listed on the Nasdaq, it has effectively overtaken Visa and Mastercard.
In Argentina, we await the pain of president Javier Milei ’s reforms to bite before passing judgement on whether this time is different. But Argentina, for once, has the crucial trifecta of reformist regime, domestic cohesion and international support in place, so staying the course could lead to material improvements in Argentines’ quality of life.
The country is also home to exciting companies. After a rocky first few years in public markets, one online travel agent is executing a strategy to lift margins and grow out of Covid having acquired key channel assets linking offline and online bookings.
The economist’s view
Paul Jackson, global head of asset allocation research, Invesco
Africa could well be the investment story of the 21st century. Although many of its 54 nations are impoverished or unstable, the upside is large and there are signs of improvement, making it an obvious target among frontier markets.
The primary advantages are geographic. Comprising 23% of the world’s landmass, Africa benefits from impressive resource endowments and potential for renewable power generation. It also has 24% of the world’s agricultural land and 65% of the world’s unutilised arable land, which will become critical as population growth and climate change test our ability to feed ourselves.
With Africa likely to suffer disproportionately from climate change, these advantages imply that much of inbound investment could, and should, take the form of agriscience, infrastructure and power generation projects.
There are demographic tailwinds, too. In 2020, Africa accounted for only 15% of the world’s working age (15-64) population, but the UN predicts this will rise to 41% by 2100. Crucially, this population growth should come as most other major regions experience shrinkage, suggesting Africa’s growth could outpace the rest of the world.
Politically, the formation and subsequent accession of the African Union to the G20, the creation of the African Continental Free Trade Area, and the addition of two more African nations to the Brics+ bloc are positive steps.
Progress is unlikely to be uniform, so we narrow our focus to large markets that are likely to attract overseas investment. Although South Africa is top of this list, it is no longer considered a frontier market. However, its neighbour Botswana is close behind, due to its relative stability and openness to investment, followed by Tanzania, Ghana and Algeria.
Zambia, Morocco and Egypt are also targets, while Mauritius and the Seychelles have many of the characteristics we seek, except scale.
The fund selector’s view
Darius McDermott, managing director, Chelsea Financial Services
Frontier markets are best suited to long-term investors rather than short or medium-term speculation, as while the growth potential is undeniable, the timeline is uncertain. There is also heightened risk, illustrated by recent events in the Middle East, Ukraine and north Africa. The major issue is a lack of liquidity – this can be brutal to shareholders as any rush to the door will send prices tumbling.
While economic development fuels success in frontier markets, the uneven pace across these nations creates an investment landscape with varying degrees of potential. Therefore, an active approach will likely prove more fruitful than a passive one, given the diverse composition and potentially rapid economic evolution of these markets.
To mitigate risk, it may also be prudent for investors seeking exposure to invest in a broader emerging market or Asia fund that also invests in frontier market companies. These markets typically exhibit low correlation with each other, and therefore including a small allocation within a broader strategy can enhance diversification.
Some of the frontier Asian economies look to have a particularly exciting growth trajectory – Vietnam, for example, is capitalising on the global trend of companies diversifying their supply chains away from China. Fuelled by recent trade tensions with the US and Covid-19 disruptions, multinationals are seeing the risks of having all of one’s eggs in the Chinese basket.
We favour the Schroder Asian Alpha Plus fund, managed by Richard Sennett. This fund comprises a best ideas portfolio of 50-70 stocks, with Sennett leveraging the extensive research team at his disposal for local market insights, quantitative screening and risk management. With over 8% of the portfolio invested in smaller markets such as Vietnam, Indonesia and Thailand, the fund is well-positioned to capitalise on the growth potential of Asia’s smaller economies.
The wealth manager’s view
Sarah Ruggins, head of investment specialists, St James’s Place
Frontier markets are incredibly nuanced, with complex drivers of risk, and present a unique set of challenges and opportunities. As part of our disciplined approach to identify attractive opportunities, valuations are the key input to our asset allocation views. We believe any signs of relative pricing extremes in emerging economies should be dampened as idiosyncratic risk factors are more prone to overwhelm fundamentals in these regions. This outsized idiosyncratic risk therefore makes us reticent to take a shorter-term view on frontier economies.
However, we understand that valuations are just one piece of the puzzle and must be moderated by a range of other factors. We also consider fundamentals, the economic environment, behavioural flags and tail risks when evaluating the relative positioning of our asset classes, and introduction of new asset classes into
our asset allocation framework.
Generally speaking, we believe frontier markets are positioned to benefit from stronger demographics, higher growth and regulatory liberalisation over the long term, creating interesting opportunities and use cases. As such, we are in the process of evaluating this asset class for use within our investment management approach as a meaningful diversifier to both equities and emerging markets.
While we remain constructive on emerging markets, we have recently moderated this overweight view slightly. Given that non-US developed markets also offer compelling valuations, we believe it prudent to diversify our active positioning across markets with similar characteristics and risks to the US market to complement our emerging market exposure.
This article first appeared in the May issue of Portfolio Adviser magazine
