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Opportunities in the world’s smallest emerging markets

Frontier markets are complex, which is why they are often overlooked by investors, but they reward active management, says Emily Fletcher, Co-Portfolio Manager of the BlackRock Frontiers Investment Trust plc.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

The world’s attention is focused firmly on developed markets: investors fret about whether the Federal Reserve will shift direction on monetary policy, whether US stocks are over-valued, whether technology will continue to lead markets higher, or whether value will continue its resurgence. In this environment, almost no-one is thinking about frontier markets.

As active stock pickers in frontier markets, which we refer to as the world’s smaller emerging markets, we see some advantages in this neglect. It means these companies are under-researched, leaving those with the resources to dig deep, to understand local dynamics and risks, with an opportunity to add considerable value.

We believe this is particularly important today. Frontier markets have lagged the recovery trade that has swept through larger markets. In particular, many of the ASEAN (Association of Southeast Asian Nations) markets have been struggling under a second wave of Covid and have only just started to reopen. There is an opportunity to participate as they recover.

Frontier markets continue to be significantly cheaper than the rest of the world. Certainly, these emerging countries come with higher risks (if not higher volatility), but the discount versus history is notably high. We attribute this to the lack of recovery in activity and believe it could create a real opportunity for investors today.

Economic strength

The virus has seen many of these countries struggle, lacking the health infrastructure or deep pockets to tackle it effectively. However, it is wrong to assume that they have been permanently weakened. We have seen a significant improvement in the average current account balance since 20191, particularly among countries that fund themselves on international markets. Part of this has come from strong commodity prices and some from weaker imports as a result of Covid.

It means these countries are entering the recovery in a better position and don’t look as vulnerable to any change of monetary policy direction by the US Federal Reserve as they might have been just five years ago.

We believe frontier markets bring something truly differentiated to a portfolio.

Portfolio diversification

There are also specific characteristics that frontier markets bring to a portfolio that we believe may be particularly valuable in the current environment. There is usually a low correlation between individual frontier countries and also to the rest of the world. For example, if there was a political disruption in Kazakhstan, it would have little impact on growth in Vietnam. Political changes in Latin America have not had repercussions in Nigeria or Morocco.

Companies in frontier markets can be differentiated in their own right, driven by local rather than global growth. On the BlackRock Frontiers Investment Trust, we hold a soymilk producer in Vietnam, a diagnostic testing company in Egypt, a wind farm operator in Greece and a Chilean lithium producer.

Many of these countries face significant social challenges and many of the companies we hold look to provide solutions. For example, we have a microlender in Egypt, which is tech-enabled, allowing it to bypass the problem of a lack of branches. A female gym operator in Saudi Arabia has a significant runway for growth, while a Uranian mining company in Kazakhstan could benefit from the expansion of nuclear power.

Risk: Frontier markets are generally more sensitive to economic and political conditions than developed and emerging markets. Other factors include greater 'Liquidity Risk', restrictions on investment or transfer of assets and failed/delayed delivery of securities or payments to the Fund. There may be larger fluctuations to the value of your investment and increased risk of losing your capital.

Risk management

These countries are at an earlier stage of their development, which brings risks for the companies that operate within them. We focus on hard currency returns because domestic currencies are volatile. We look for robust earnings, longevity of growth, with products or services that are differentiated from the market.

Importantly, we also have a macroeconomic overlay, looking at all of the countries within a consistent, systematic framework. It is important to invest in each country at the right point in its own economic cycle. Frontier markets are cyclical and will have times when they’re doing better. Timing is important and we strive to get that right.

Frontier markets aren’t easy markets in which to operate, which is why they are neglected by so many investors. However, as active managers, we believe they bring something truly differentiated to a portfolio and, as such, they ‘merit the effort’.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of October 2021 and may change as subsequent conditions vary.

1Source: Bloomberg, as of 30 June 2021