Exploring investment frontiers

Rob Morgan takes a look at BlackRock Frontiers Investment Trust, which invests in the world's nascent stock markets.

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  1. Rob Morgan

Frontier markets are countries with stock markets that are less established than those in emerging markets. They are nascent, much smaller and less accessible than emerging markets such as China, India or Brazil, and have fewer companies to invest in. They will also almost certainly be more risky countries, perhaps with increased danger of political unrest. The largest country weights in the MSCI Frontiers Index are currently Kuwait, Argentina, and Vietnam.

The high level of risk is enough to put off many investors even considering frontier markets. Yet that can be part of the attraction. A relative lack of interest means shares in good companies can be overlooked, and might be available at prices that compensate investors well for the additional risk and volatility. Furthermore, frontier markets tend to be driven more by internal economic and political developments than global events.  This means there can be low correlation with both developed and emerging markets, as well as other frontier countries, providing a source of diversification in a portfolio.

BlackRock Frontiers Investment Trust represents this niche area on our Foundation Fundlist of preferred investments, and has been managed by Sam Vecht since December 2010 with Emily Fletcher added as co-manager in 2013. Mr Vecht and his team spend a lot of time looking at the economic and political conditions of a country before considering individual companies to invest in. Essentially, they are looking for stable economies, and to avoid unhelpful political situations or where currency movements or inflation could hinder equity market performance.

Governance standards can be a lot lower in frontier markets, and they place considerable emphasis on finding credible management who have regard for shareholder interests. Dividends are one sign that a company respects minority shareholders, and the Trust owns a number of stocks with surprisingly generous pay outs giving it a yield of around 4.2% (source: Blackrock); yields are variable and not guaranteed.

As well as assessing the economic and political landscape, the stock selection process relies heavily on face-to-face meetings, not just with the managers of companies but also with their competitors, local politicians, and suppliers, giving them a well-rounded picture of the company and its operations.

Returns have been strong since inception, both in absolute terms and relative to the fund’s benchmark; although past performance is not a reliable guide to the future. 2018 was more tricky year for the Trust, however, with frontier markets succumbing to the general weakening of sentiment among investors in the latter part of the year. Having sold off broadly in line with developed and larger emerging markets, the managers now believe a compelling opportunity is opening up. They assert that valuations of companies are highly attractive in relation to the growth opportunities on offer, as well as in relation to firms in more established markets.

Mr Vecht and and Ms Fletcher have positioned the portfolio for an environment characterised by lower interest rates, a weaker US Dollar and lower global growth. Emerging and frontier markets could have the ability to outperform in these circumstances owing to relatively easy borrowing conditions, however they would likely not be immune to a widespread share market decline caused by escalating global growth concerns.

As usual, the portfolio is highly diversified by country, with a total of 27 countries, the largest weightings being Indonesia, Vietnam and Egypt. Indonesia, at 12% of the portfolio, has been increased in recent months following a sharp sell-off in the market amid fears the nation is overly reliant on external funding. The trust’s largest holding, Astra International, is a conglomerate serving various consumer industries, including car sales.

In Vietnam the managers see opportunities in the consumer sector owing to the under-penetration of basic consumer services such as supermarkets, while they favour Egypt due to its reduction of national debt and burgeoning consumer spending power. The team is also bullish on Romania, the fastest growing economy in Europe, and is invested in energy companies such as Romgaz and banks such as BRD. Positions in Argentina, meanwhile, were reduced last year following a strong run.

It its worth noting that the trust no longer uses the MSCI Frontier Markets index as a definitive guide to the countries it can invest in. Instead it covers those countries that are not listed in the MSCI index of developed countries and are not one of the largest eight countries on the MSCI Emerging Markets index. This allows some flexibility around the frequent reclassifications of markets between the Frontier and Emerging indices, and means the managers do not have to sell holdings in the event of a country being promoted to the larger index. This recently occurred with the UAE and Qata  and the Trust retains exposure to both. These markets retain many of the traits of frontier markets, low correlation to other markets and a low level of liquidity – the ease at which an investor can trade assets.

Our view

One of the key advantages of using a small investment trust like this one to invest in this asset class is the ‘closed-ended’ structure. This allows the managers to adjust positions solely on investment grounds as frontier markets evolve, rather than being forced to do so as investors buy or sell the fund. Unlike unit trusts and OEICs there is a fixed amount of capital to invest, and this can be helpful when dealing with ‘illiquid’ frontier market shares in which trading can be difficult, or even impossible, in a given time period.

It is important to bear in mind that this niche asset class can have periods of weak returns, often linked to political instability, economic changes, currency movements or investor sentiment.  Given the strong research-driven approach of Mr Vecht’s team, we think BlackRock Frontiers is worth considering for exposure, but only for those investing a small part of a diversified portfolio in this still relatively unknown and potentially very risky area.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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