Markets: Money from the leftovers
Investing in frontier markets, which are less established than emerging ones, was very profitable until recently
SA investors might be familiar with shares on our continent such as Safaricom in Kenya, Zenith Bank in Nigeria and Delta Corp in Zimbabwe. These are some of the better-quality names in what are now called the global frontier markets.
Across the world there are markets at a similar stage of development, with the same (il)liquidity and often similar GDP per capita.
Over the past 14 years the frontier markets have returned 450%, or 12.9% compounded annually, ahead of both emerging markets (310% or 10.5% annually) and developed markets (175% or just 7.4%). But, more recently, life has been tougher on the frontier. The Templeton Frontier Markets Fund, the most widely distributed fund in the sector, has lost 3.75%/year over the past three years.
Often managers have no choice but to live through the volatility. The daily trading across frontier markets is US$380m, which is just 0.1% of global trading and considerably less than the JSE alone trades.
Templeton Emerging Markets chairman Mark Mobius, who co-manages the fund, says that after the market fall since 2014 he believes most frontier markets are ready for a rebound as they should benefit from increased infrastructure and defence spending in the US.
There might even be a switch of US imports from China to Southeast Asia, helping Vietnam, one of the leading frontier markets, if new US president Donald Trump is sincere in his
Vietnam already has the largest weighting in the Templeton fund, and large holdings include Binh Minh Plastic and DHG Pharmaceutical. Mobius says there are some first-class businesses on the Vietnam exchange, and more are being privatised.
The first home-grown global frontier team has been set up by Coronation and is run by Peter Leger. He also runs the Africa team, so he has experience in operating in illiquid markets.
Leger’s frontiers fund, still an institutional fund and not yet a unit trust, has not attracted much business since it launched in December 2014, and has less than $20m. But he says it won’t be marketed aggressively until it has built up a three-year track record.
He invests in some of the scraps his colleagues in Coronation emerging markets consider too small or marginal.
Leger holds no shares in Vietnam, as they have remained expensive throughout the time the fund has been open. His largest exposure is to Sri Lanka, which, with an annual growth of 5% that is foreseen up to 2020, is expected to outpace most emerging markets comfortably. Just as significant for Leger, who runs the fund on a stock-led "bottom-up" basis, is that there are some companies in Sri Lanka with long-established records.
The next big name in frontier markets could be Iran, though the Trump victory might delay the easing of sanctions for a few years.
The country has already been included in the new Credit Suisse Frontier Markets index. It trades $52m/day, almost 15% of that entire frontier markets total, with no foreign ownership to speak of, and the economy is bigger than large frontier economies such as Pakistan or Egypt.
Templeton strides the frontier universe like a colossus, with $800m in its Luxembourg-based global frontiers fund alone and at least as much in its US-domiciled fund. It will battle to invest in quality shares if this asset base doubles in a short time. But it will probably be the default frontier markets fund for some time. With Mobius running the fund, Templeton is seen as the low-risk option, particularly as no established index funds are focused on this sector.
Mobius creates some liquidity by investing in liquid shares such as SA’s MTN — though that has not proved so wise over the past 12 months — and the fund has also taken big positions in Kuwait, which is not in the Credit Suisse index as it is too wealthy and developed.
But Kuwaiti shares such as Zain (telecoms), National Bank of Kuwait and Americana all contribute to the liquidity buffer in the fund. It looks as though it might be a while before Leger has the problem of running a monster-sized fund.
But why do we go to the trouble of setting up separate emerging and frontier markets funds?
Sven Richter at Johannesburg-based Drakens Capital says there is an artificial distinction between emerging and frontier markets. But while he was at Renaissance Capital he ran a combined emerging and frontier fund that did not attract enough business.
"The trouble is that there are asset allocators who live to invest in discrete silos and want to decide the weightings into developed, emerging and frontier markets," he says.
Yet some of the richer frontier markets such as Oman, Argentina and Romania have per-capita incomes ahead of those of the fabled Brics (Brazil, Russia, India, China and SA). If they had more sophisticated financial services, they could even be knocking on the doors of developed markets.