Some 80 per cent of frontier market funds in the Investment Association universe have lost money over the past three years and all are down over one year, with all but one clocking up double-digit losses, according to research by FE Trustnet.
Frontier markets – which include the likes of Kuwait, Kazakhstan, Pakistan, Nigeria and Kenya –delivered strong gains for investors up until the tail-end of 2014 but have been hard hit since.
The string of fund launches into the frontier market space in the period after the financial crisis have mostly failed to live up to the excitement around the investment case for these high growth countries on the edge of investable world, as they have significantly underperformed developed market equities.
As far as the data goes back, just under eight years, the MSCI Frontier Markets index has fallen 18.5 per cent compared with a 12.47 per cent gain from the MSCI Emerging Markets index. The MSCI World index, by comparison, has soared 79.06 per cent.
Performance of indices since 2008
Source: FE Analytics
In 2015 no fund investing primarily in frontier market stocks made a positive return. The best performer – the £11.9m Charlemagne Magna New Frontiers fund, managed by Stefan Bottcher and Dominic Bokor-Ingram – was the standout relative performer with a fall of 0.04 per cent.
According to FE Analytics, it is also the best performer of any open or closed-ended frontier markets portfolio over three years with a return of 22.14 per cent against a fall in the index of 14.52 per cent.
Performance of funds in 2015
Source: FE Analytics
Baring ASEAN Frontiers, Baring Frontier Markets, Templeton Frontier Markets and T. Rowe Price Frontier Markets Equity lost more last year, meaning their three-year numbers were also in negative territory.
In the closed-ended space, the BlackRock Frontiers Investment Trust, which is managed by Sam Vecht and Emily Fletcher, has done much better than its peers with a return of 19.97 per cent over three years but these were essentially front-loaded, taking place in 2013.
Performance of trust and index over 3yrs
Source: FE Analytics
The only other investment trust to invest in the space, Advance Emerging Capital Advance Frontier Markets, has made a marginal 1.03 per cent gain over three years.
Ben Willis (pictured), head of research at Whitechurch Securities, says the effect of quantitative easing’s withdrawal has been a big factor on many of these markets as well as capital flight from these areas as the global outlook has become more risk averse.
He says the case for holding frontier market funds is currently quite weak and in strong contrast to a few years back, making them a highly contrarian portfolio position.
“Back then everybody was loving it and talking it up. It was the same with emerging markets. They had a good a run, it is all animal spirits and people get very bullish. These are the new markets that are going to give you the burgeoning returns and then it just evaporates with quite fragile global growth,” he said.
“We are quite happy to have some exposure as part of a broader emerging market funds where they maybe allocating a small amount to frontier markets but we don't have enough conviction to go in wholeheartedly.”
He says now because of the market's expectation of US rate rises and slowing commodity demand from China the outlook for frontier markets is poor.
“These two things are the major threats that have derailed that very bullish optimism on those frontier markets and that is not going to go away and that is why we have seen the appetite wane for exposure to these types of markets.”
George Birch-Reynardson, manager of the Somerset Capital Frontier Markets fund, concedes that it was “a weak year” for frontier markets in 2015, mainly due to currency pressures.
“Frontier markets were flat in December, holding up slightly better than their emerging market peers as the announcement of a rate hike by the Federal Reserve precipitated a sell‐off in some major EM currencies. That is not to say that frontier currencies are any less vulnerable; it is only that more of them are pegged.”
Pressure on frontier currencies looks likely to persist in 2016, he adds, due to an expectation of further rises in interest rates as developed markets edge higher.
“There is further downside risk for currencies in oil exporting countries if the slump in oil continues. We remain focused on bottom‐up analysis but will look to avoid countries where currencies are most obviously at risk,” Birch-Reynardson said.
AXA Wealth head of investing Adrian Lowcock says he is avoiding frontier markets for some time.
“As an investment they were always risky and likely to be volatile. Investors therefore need a very long-term perspective on these kind of investments,” he said.
“Concerns over China’s economy, global growth and the US raising rates has delivered a strong dose of risk aversion amongst investors. Frontier markets are also subject to political upheaval and the last few years have had their fair share of that.”
“The demographics are good in many frontier markets with young populations whilst technology means that some of the structural issues holding back investment in these countries can be more easily overcome.”
However, Lowcock says, given the current outlook for the strength of the global recovery, frontier markets are a pure contrarian play and only for investors considering the very long term – 20 years plus.
“These markets are likely to be very volatile, subject to regulatory risks ell and investors should view them as an asset class where you could lose your initial investment. I would only suggest having a small amount in this, 1 to 2 per cent at most and even then only for adventurous investors with larger portfolios.”