Frontier markets remain a rich hunting ground for investors in search of attractive growth and alpha generation opportunities, according to the top-rated managers focused on the sector. 
Emerging markets have seen a resurgence this year as investors worry about the state of developed markets but some fund managers argue little-known frontier markets could also be worth a look for those seeking off-the-radar opportunities.
Brexit has caused uncertainty in the UK and Europe while in the US the general election looms over markets and the Federal Reserve remains undecided on whether to raise interest rate despite the economy continuing to improve.
This has also boosted non-US companies, as their dollar denominated debt remains cheaper in other currencies while US interest rates remain low.
Oliver Bell, manager of Frontier Markets Equity Strategy at T. Rowe Price, said: “Given that frontier markets are in the early stages of their economic development they are less tied to the global market cycle and driven more by their own domestic demand.”
“For this reason, frontier markets demonstrate lower correlations versus global markets and tend to experience lower volatility during periods of high global risk, hence providing attractive risk-adjusted returns.”
Sam Vecht, portfolio manager of the BlackRock Frontiers Investment Trust, adds that these markets have also been somewhat immune to the earnings downgrades that have plagued the emerging markets in the past.
Over the last five years frontier markets have provided attractive risk-adjusted returns relative to their emerging market counterparts, as the below graph shows.
Performance of indices over 5yrs
Source: FE Analytics
Many, including the BlackRock Investment Institute, have suggested emerging markets as an area for investors to consider if worried about developed markets but over the last five years frontier markets have outperformed by 28 percentage points.
Vecht said: “These markets are one of the remaining areas within equity land where you are able to get substantial portfolio diversification.”
Surprisingly, they have also been less volatile, posting 5.5 percentage points less annualised volatility compared to emerging markets. They have also had a significantly lower maximum drawdown – the amount an investor could have lost if buying and selling at the worst possible times – though this may also be down to the illiquid nature of the companies within the sector and the (usually) longer reporting periods.
This risk/reward profile is due to a number of factors in recent years that have made the asset class less risky, according to the fund managers.
David Park co-manager of the Carmignac Emerging Discovery and Carmignac Emergents funds, said: “Frontier regions have made large economic strides in recent years as economies and capital markets have liberalised."
“The asset class remains undercapitalised and under owned, with strong growth potential. The potential magnitude of their economies and growth prospects are not reflected in the scale of their stock market capitalisation.”
However, he caveats, they can come with political instability, higher volatility and poor liquidity, and so investors should be prudent – like with any investment – when making a decision on which fund to buy.
Park focuses on three key points when deciding on whether to invest in a company – countries with healthy macroeconomic fundamentals, underpenetrated sectors and rigorous screening of business models, including cash flow and (ideally) low debt.
This approach seems to have worked well, as the Carmignac Emerging Discovery fund has outperformed its IA Global Emerging Markets sector and MSCI EM Mid Cap benchmark over recent years, as the below graph shows.
Performance vs sector and benchmark over 5yrs
Source: FE Analytics
The five-crown rated fund, which Park runs with Xavier Hovasse, is the least volatile in its sector over five years, with 11.91 per cent, and is second for maximum drawdown.
Park highlights Argentina as an up-and-coming economy following the recent election of Mauricio Macri last year.
At the end of last year, his government lowered duties on agricultural exports and this led the fund to up its stakes in IRSA, a real estate company focused mainly on commercial real estate, and Cresud, a property firm with extensive agricultural land holdings.
But the €177m fund has also added Banco Supervielle, as “loans to the private sector account for a mere 16 per cent of GDP, putting Argentina among the frontier markets with the lowest stock of private credit in the emerging world,” Park said.
“It follows that acquiring a stake in an Argentine bank is fully in line with our philosophy of investing in underpenetrated market segments.”
Another keen on Argentina is T. Rowe Price’s Bell, who runs the group’s $12m Frontier Markets Equity fund.
“From a country perspective, Argentina typifies the investment case for frontier markets – namely improving politics, leading to better macro management which in turn leads to attracting investment and results in growth,” he said.
“An improving macroeconomic backdrop and continued reforms have been supportive of well-positioned, high-quality businesses in the country, and we increasingly see good bottom-up opportunities here.”
Performance of fund vs MSCI Frontier Markets since launch
Source: FE Analytics
The fund has performed well compared to the MSCI Frontier Markets since launch, outperforming by 17.51 percentage points.
He says the fund focuses on management track record and he and his team travel to visit companies as many time as possible to learn more about them, as well as looking at the fundamentals