Data from FE Analytics shows that the MSCI Frontier Markets index has made 24.32 per cent in the year-to-date, while the MSCI Emerging Markets index has lost 1.31 per cent.
Performance of indices in 2013
Source: FE Analytics
Sam Vecht, manager of the BlackRock Frontiers investment trust, says that this took most experts by surprise.
"If I had said at the beginning of the year that frontier markets would be up 20 per cent and emerging markets would be down, people would have said that was impossible," he said.
Vecht says that good fundamentals support the strong performance of the asset class, listing good cashflow from the companies he buys, higher dividend yields and better quality.
"Even in the recent sell-off, frontier markets have done better," he added.
While the dip in emerging markets is so far a short-term phenomenon, many commentators have pointed to serious structural issues in the sector, which could cause problems for some time to come.
Vecht says that the decline of a number of currencies against the dollar has been the major factor, and with the US authorities considering bringing their quantitative easing [QE] programme to an end, this could be a strong theme over the coming years.
Another reason why investors are turning to frontier markets is the diversification benefits they bring.
Data from FE Analytics shows that the MSCI Frontier Markets index has a significantly lower correlation to the MSCI Emerging Markets and FTSE All Share indices than the latter two do to each other.
Correlation of indices over 3yrs
| Name | FTSE All Share | MSCI EM (EMERGING MARKETS) | MSCI FM (FRONTIER MARKETS) |
|---|---|---|---|
| FTSE All Share |
N/A | 0.77 | 0.44 |
| MSCI EM (Emerging Markets) | 0.77 | N/A | 0.46 |
| MSCI FM (Frontier Markets) | 0.44 | 0.46 | N/A |
Source: FE Analytics
Our data shows that the correlation between the frontier markets index and the emerging markets index over three years is 0.64, and to the FTSE All Share is 0.68 – a level regarded as low – while the UK index displays a correlation of 0.77 to the emerging markets index, indicating a strong positive relationship.
Investors who are considering introducing frontier markets to their portfolio have few options.
The major open-ended fund in the field – five crown-rated Templeton Frontier Markets – soft-closed in June.
The $2.26bn fund has marginally lagged the index over three years, however, returning 20.35 per cent compared with 25.13 per cent from the MSCI Frontier Markets benchmark.
Performance of fund vs index over 3yrs
Source: FE Analytics
The only other open-ended option is Ewan Thompson’s Neptune Frontier Emerging Markets fund, but this has a short track record.
It was only launched in December 2012 and has just £1.9m in assets under management. Ongoing charges are higher in smaller funds as running costs are spread among fewer investors, and the fund’s figure of 2.58 per cent is likely to be a tough sell.
The fund has also performed disappointingly so far, making just 9.6 per cent while the index has risen 23.97 per cent.
Many commentators have suggested that a closed-ended structure offers the best way to get access to frontier markets.
Liquidity is a big issue for managers in this area of the market, who can find it hard to sell out of stock at short notice.
Open-ended managers have to sell their stock when investors want to withdraw from a fund, giving them a disadvantage compared with managers of investment trusts.
Vecht’s £107.1m BlackRock Frontiers trust is the standout option at the current time, although it is expensive.
Data from FE Analytics shows that Vecht has produced better NAV returns (on a total return basis) than any other emerging markets or frontier markets manager in the closed- or open-ended space.
The trust has made 46.8 per cent in NAV terms over 12 months compared with 30.41 per cent from the MSCI FM index.
Charlemagne Magna Emerging Markets Dividend, the best-performing open-ended emerging markets fund, has made just 21.9 per cent over this time.
In share price terms, the trust has performed even better, making 59.26 per cent, according to data from FE Analytics, and pushing the trust onto a 6.6 per cent premium.
Performance of trust vs indices over 1yr
Source: FE Analytics
The premium makes the trust expensive, which is why it has conducted a C-share issue to offer investors access at a price close to NAV.
Vecht says that his fund is well-positioned to continue its strong run, with valuations in frontier markets still low and 80 to 85 per cent of companies drawing their growth domestically.
He points to Iraqi oil stocks as one area he finds particularly exciting, saying he has 6 per cent in that sector.
The other closed-ended option is the £89.8m Advance Frontier Markets trust, which is sitting on a discount of 12.5 per cent.
The fund has more closely tracked the index in recent months, returning 28.88 per cent over one year while the benchmark has made 30.41 per cent.
Vecht is highly rated by analysts, but Advance Frontier Markets has a respectable record, beating its benchmark over three and five years.
While the index has lost 10.55 per cent over five years, the trust has made 1.73 per cent, quite substantial outperformance.
Advance Frontier markets has ongoing charges of 1.54 per cent and BlackRock Frontiers 2.14 per cent, according to the AIC.
However, both trusts have performance fees, and the BlackRock trust will have taken more in this regard thanks to greater outperformance. It charges 1.57 per cent before the performance charge. The FE Anlaytics performance data in this article is all net of fees.
Investors may soon have a third closed-ended option, according to Oliver Crawley, partner at Somerset Capital Management.
Crawley says Somerset is thinking of launching a frontier markets investment trust, with a limit of £200m, highlighting the lack of choice in the space.
He says that such a portfolio should only ever be a tiny part of a well-diversified portfolio.
"Anyone thinking of investing in these countries needs to have a long investment horizon, maybe 10 years, and to invest only a small part of their portfolio," he said.
He also says that investors should be wary of selling out of emerging markets because of a short period of underperformance.
"If you have a three-year horizon or more, emerging markets are still the place to be," he said.
