MSCI Frontier Markets index delivered 24% in sterling terms in 2013, compared with MSCI Emerging Markets’ fall of 4.1%. So far, it looks like both regions will continue this pattern into 2014, with EM down a further 5.1% and FM up 2.9% year to date.
Concerns over the Fed’s tapering, uncertainty over China’s growth and persistent earnings downgrades have plagued the sector with no signs of the headwinds abating. Further, the ‘Fragile Five’ of Brazil, Indonesia, India, South Africa and Turkey all face elections this year.
Frontier currencies appear more stable and remain largely unaffected by flows that poured out of the more mainstream EMs.
The case for frontier markets is well known. They come from a base of representing just 0.3% of the global market capitalisation and 4% of GDP, but represent 12% of the global population with annual population growth of 1.5%.
Frontier markets tend to have positive demographics – a younger, more urban population with rising incomes suggest domestic consumption will grow favourably.
There is a huge amount of foreign investment ploughing into frontier markets, such as Japan investing in Vietnam, for example.
Numis added that the relatively low debt levels – when compared with developed markets – and fewer side effects from the Fed’s tapering than in the more liquid debt markets. Emerging markets were hit by capital outflows, pushing up valuations and exchange rates.
While frontier markets come with additional risks, such as a lack of available information on the companies based there, for investors with the resources to scrutinise the investment opportunity, there are distinct advantages.
That said, coverage has picked up, with several large institutions now publishing data on the regions.
“As market inefficiencies begin to erode, investor interest in FM equities can be expected to pick up. An example is Vietnam, which has benefitted from a strong equity market this year to-date, partly in anticipation of a relaxation of foreign ownership limits – at present around 35% of the universe by market cap is inaccessible to new foreign investors.”
Correlated FUM and performance
Numis has suggested that funds under management and performance of MSCI EM are closely correlated.
A recent report by Citi estimates that frontier markets currently have roughly $18bn – only half of which is through dedicated frontier market vehicles, compared with $990bn in EM and $8.6trn in developed markets.
In valuation terms, frontier markets are no longer trading at a discount to EMs, but they are offering a dividend yield of 3.6%, with stronger earnings growth.
Numis suggests investors should resist the temptation of selling out of frontier holdings too early, given their strong (relative) rally last year.
Numis has cited Dr Slim Feriani, chief investment officer at Advance Emerging Capital, who said fund flows looked set to grow further and equity valuations would remain attractive, even in the face of an EM recovery rally.
