While industry professionals remain split on whether frontier markets deserve a dedicated place in an investors’ portfolio, those with greater risk appetite could reap the returns from the next generation of emerging countries.
However, with emerging markets having already gone through this, the MI Somerset Emerging Markets Dividend Growth manager said investors need to look to frontier markets for ‘wipe the floor’ returns over the next decade.
Indeed, while over 10 years the MSCI Emerging Markets has outperformed the MSCI Frontier Markets, this appears to be shifting, as over the past five years the frontier index has outperformed the emerging benchmark by 21.24 percentage points.
Performance of indices over 10yrs
Source: FE Analytics
Below, FE Trustnet asks other managers and asset allocators whether they would advise taking a dedicated frontier market positioning.
John Malloy, manager of the $938m RWC Global Emerging Markets fund, said while it is partially true that frontier markets could become the next emerging markets there are some caveats.
“If you look at India as an example, it has one billion-plus people and 5-10 per cent of those people are as wealthy as in the UK or in the US,” he explained.
“Then you have another segment of 20-30 per cent which are emerging market status with GDP per capita of $8,000-$12,000.
“But then you have literally hundreds of millions of people that are basically frontier level and their GDP per capita is $1,000-$2,000 per year.”
While there are certain countries such as Taiwan and Korea which have completely integrated with the developed world, he said there were other countries that have not within the emerging markets bucket.
“Korea and Taiwan would be unique examples of where emerging markets have emerged but even in China if you look at the fourth and fifth tier cities there is still a segment of that population which is very poor,” he said.
However, overall he agrees with the sentiment that over the next decade or two the frontier markets have the potential to offer higher returns.
Indeed, in Malloy’s own fund he has the potential to invest up to 20 per cent in frontier markets with exposure currently representing 18 per cent including stocks from Vietnam, Pakistan, Zambia, Ghana and Panama, as the below chart shows.
Source: RWC
The reason for this is not only the potential for more significant gains but also the lack of correlation the asset class has with other equity regions.
“The correlation between frontier markets and emerging markets is less than 0.5. The correlation between emerging markets and developed markets is 0.8 or higher,” he said.
“With frontier markets if you can add an investment to your portfolio that has a low correlation that is an interesting investment proposition.”
As such, for an investor with a more long-term time horizon, they offer an uncorrelated return as well as the potential for a “hockey stick” type of return.
Malloy said: “I think if somebody is thinking about a retirement in 15,20 or 30 years that sort of time horizon then most definitely [frontier markets should be a dedicated part of the portfolio].
“It is something that you want to buy a little bit in – anywhere from a couple of per cent and 6 per cent – obviously you don’t want 100 per cent.”
He added that picking the correct manager is also extremely important, as well as the ability to leave the position alone during difficult periods.
“Don’t read the headlines, don’t look at the volatility or the political changes. Just go with a good team and hopefully they can navigate through the geopolitical risk,” he said.
Gavin Haynes, managing director at Whitechurch Securities, agreed that long-term investors should be looking at smaller countries, but said that frontier markets as a whole are too niche for dedicated exposure.
“For investors prepared to take a long-term view some of the smaller, less developed emerging markets offer the potential to replicate the growth that has been achieved by some of the larger mature emerging markets over the past decade,” he said.
“I still believe that frontier markets are a niche area for most investors and we don’t hold any direct exposure to this area at present.”
However, Haynes noted that funds investing in broader emerging market mandates should include frontier markets in their remit to take advantage of opportunities and increase diversification.
Indeed, he agreed that investing early in the development of economies where growth levels are high can provide exciting returns, albeit with higher risk.
“Corporate governance, political instability and liquidity are all key risks to consider if investing in frontier markets,” Haynes added.
Anthony Rayner, multi-asset fund manager at Miton Group, said that he also does not have frontier market exposure for a number of reasons.
“By definition, frontier markets will have higher levels of risks in a number of areas, such as liquidity and governance,” he said.
“These are of course all relevant but liquidity, or illiquidity, is often underappreciated – in some cases wrongly indicating lower price volatility, and therefore suggesting lower risk.
“For us, as our approach is dominated by being pragmatic, we tend to avoid less liquid exposures, as it limits our ability to be nimble if the data changes, which really is our ‘bread and butter’.”
Indeed, Rayner noted that some frontier markets will even have lock-in periods where investors are unable to withdraw their allocations.
Overall, Whitechurch Securities’ Haynes said that if investors are looking at adding dedicated frontier market exposure, it is important to find the right manager.
Performance of sectors and markets within the catch-all term of frontier markets can deviate greatly so managers who can find opportunities through diversifying across these markets are key, he said.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
And for those wanting direct exposure to the asset class, he said Blackrock Frontiers Investment Trust would be “a fund worthy of consideration”.
Haynes added: “Under Sam Vecht and Emily Fletcher this trust has generated strong returns and provides well-diversified exposure.”
The £314.3m trust invests across the frontier markets space targets capital growth and its largest country exposure is to Argentina, which represents 17.3 per cent of the portfolio, followed by Kuwait (12.2 per cent) and Vietnam (9.9 per cent).
The largest holdings within the portfolio include National Bank of Kuwait, Argentinian energy company YPF and Kazakh stock Halyk Savings Bank.
The trust is currently trading at a premium of 4.4 per cent, is not geared, has a yield of 3.2 per cent and ongoing charges of 1.68 per cent, according to data from the Association of Investment Companies.