Hovasse, manager of the €364m Carmignac Emerging Discovery fund, has roughly a third of his portfolio in frontier markets in a bid to take advantage of low valuations before they attract the attention of more mainstream investors.
"Whether you look at the banking sector, consumption, investments, we’re seeing a lot of under-penetration," he said.
"The loan-to-deposit ratio in the banks is lower, the total credit as a percentage to GDP is lower. Household debt as a percentage of personal income is lower than anywhere else in the world."
He adds that government debt in many frontier markets is very low – a stark contrast to the debt-strapped developed world.
While many investors would have been wary of frontier markets due to their history of high volatility and illiquidity, Hovasse says they have in fact been less volatile than other "classic" emerging markets.
"Things have changed," he said. "In fact they’re not only less volatile but they are also less correlated to their local markets, so what the frontier markets are doing to a portfolio today is offering alpha opportunities."
"There’s more growth so there’s going to be good performance, but also de-correlation from the mainstream developed markets, which is what the emerging markets were doing in the 90s, but not anymore."
Over the last five years, the MSCI Frontier Markets index has a correlation to the FTSE All Share and S&P 500 of 0.67 and 0.65, respectively, a relatively low figure. This compares with a correlation of 0.84 between the All Share and the MSCI EM index over the same period, and 0.75 between the S&P 500 and the MSCI EM index.
However, frontier markets as a whole have underperformed both developed market indices over the period, as well as the MSCI EM index.
They have had a strong start to the year though, with the index up 23.77 per cent, compared with 21.35 per cent from the S&P and just 11.34 per cent from the FTSE All Share, according to FE Analytics.
Performance of indices in 2013
Source: FE Analytics
Hovasse thinks this is a trend that will continue, particularly as developed nations are still suffering from economic problems caused by their financial sectors.
"The financial systems of frontier markets are much less interconnected to developed markets’ financial markets," he said.
He points out that banks have their own funding, rather than getting support from governments, such as is the case in the developed world.
Hovasse admits there are some issues with liquidity in frontier markets, but he says many of the markets he is invested in don’t face those issues, particularly because there is a lot of domestic liquidity in them.
He commented: "Some countries are more vulnerable because they have been going up a lot on hype or hope or overconfidence, so we try to avoid those countries."
"Places like sub-Saharan Africa have been very fashionable so we need to be wary of valuations. We invest in Kenya and Nigeria but we want to make sure that we invest in companies that have good cash-flow generation."
"Companies with good cash-flow generation can always buy back their shares if there’s a liquidity crunch, so that’s also supportive of the share price."
"The frontier markets blew up at the time of the Lehmans crisis because there was a lot of those markets, like Eastern Europe, where the macro fundamentals were very weak."
However, he says many countries, such as the Philippines and Peru, have strong fundamentals with lots of liquidity, and these are areas he is exposed to in the fund.
As part of Carmignac Gestion’s three-strong emerging markets product range, the Carmignac Emerging Discovery fund invests towards the smallest end of the market cap spectrum.
Over the last year, the fund has returned 11.65 per cent compared with 11.27 per cent from the IMA Global Emerging Markets sector.
Although the fund has no benchmark, as a basis of comparison, the MSCI Emerging Markets index has gained 10.83 per cent over this time.
Performance of fund vs sector and index over 1yr
Source: FE Analytics
The manager says the fund’s small cap remit sets it apart from other funds in the space and in the Carmignac range.
"What’s different is the investment universe. Carmignac Emerging Discovery is a fund which invests in small and mid caps. The specificity of this fund is that it also has in its mandate the ability to invest in frontier markets."
The fund’s highest sector bet is in consumer products, at 42.25 per cent of the portfolio. Financials make up the next highest weighting, with companies such as Bank Negara Indonesia in the top 10-holdings.
The number-one holding is Chilean beverage company Embotelladora Andina.
The fund requires a minimum investment of £1,000 and has an ongoing charges figure of 1.21 per cent.
This article was written in collaboration with and is sponsored by Carmignac Gestion.
