Focusing on the world’s smaller markets brings its challenges, but they offer rare and idiosyncratic opportunities says Emily Fletcher, manager of the BlackRock Frontiers investment trust.
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 small markets are difficult to analyse. Information is scarce, liquidity is lower, and they may have a range of political and economic idiosyncrasies. This complexity means they are often over-looked, but in our view, they are worth the extra effort.
We recognise that these markets come with obstacles. Data is often delayed and may be unreliable. In large, developed markets inflation data may be revealed with the lag of a month or two; in some markets, it may take longer. This lag can be a challenge when trying to analyse why a country’s currency is behaving as it does, or whether its current account deficit is improving.
The same is true for company data. While companies need to have fully audited accounts before they are considered for inclusion in the portfolio, this is not enough. We want to verify that data by understanding the ecosystem around these companies – their suppliers and competitors, for example. While time-consuming work, it is absolutely necessary for due diligence.
Equally, it is not enough to look at a company in isolation. The macroeconomic environment may not matter too much for a UK or US company, which may draw its revenues from around the world, but companies in frontier markets are often more dependent on the local environment. While this means that they provide real diversification from the world’s largest markets, it also requires a more forensic focus on the economics of individual markets.
Structural growth
Naturally, we believe that the effort is worth it. There could be a perception that smaller markets are focused on less exciting areas, such as brewing, or retail banking. This may be part of the mix, but we seek to find companies in these countries focused on areas of significant structural growth.
Saudi Arabia and UAE are examples of countries where we are seeing positive developments and potential for structural growth. Saudi Arabia has for example undergone a range of social reforms over the past years, where the entertainment sector is one of the beneficiaries.1 While these markets have historically been known for their hydrocarbon reliance, we believe that recent measures taken by the governments of these countries to also focus on other sectors of the economy will pay dividends in the long run. We believe that more opportunities will arise as the countries are using their natural endowments to invest across different areas within the economy more broadly.
Vietnam is becoming a vital part of global supply chains, as international companies pivot from China in an effort to diversify their manufacturing bases.2 Global suppliers to major technology manufacturers such as Apple are relocating there, driving growth and opportunity across the region. Vietnam is benefitting from an increase in foreign direct investment (FDI) inflows, and the country looks to be one of the major winners of the supply chain decoupling.3
Another example of an exciting market within our universe is Indonesia. This is a country which we think has seen a substantial improvement in economic outlook over the last few years. Indonesia is the world’s largest exporter of nickel.4 Historically, the metal was predominantly used in stainless steel production, but by 2030 it is likely that its main use will be in the production of batteries for electric vehicles. In 2020 the value of nickel exports was $12bn, and by 2025 this number is estimated to be $45bn.5
Indonesia along with Australia have the largest nickel reserves in the world and the metal is changing its economic fortunes.6 The IMF expects the country to grow by 5% in 2023 and by 5.1% in 2024.7 We believe Indonesia should be able to sustain this GDP growth as foreign direct investment remains favourable to help grow the exports base.
The Trust holds a variety of different companies, not only brewers and banks. The holdings are a reflection of the potential opportunity set in these markets and examples of holdings include property companies, software outsourcing companies, lithium producers and nickel companies. Frontier markets are beneficiaries of many of the same trends seen elsewhere, including digitalisation, the energy transition and financial inclusion.
These markets often fly under the radar, which means value can take time to be discovered. That said, many companies already pay a dividend. The average for the MSCI Frontier Markets index is 4.7%,8 compared to around 2% for the MSCI World index.9 This means there is no penalty for waiting for the value unlock and we can remain patient while the world catches up.
We believe the world’s small markets provide idiosyncratic opportunities that often aren’t available elsewhere. As active investors, we have to perform proper due diligence on the companies within our universe. While this requires hard work and skill, going where very few are looking, can allow for the discovery of unique and potentially alpha generative ideas.
Sources:
1 Moore Kingston Smith – 06/07/56
2 Financial Times - 03/07/23
3 Asia Nikkei – 20/12/22
4 Mining Technology - 04/07/23
5 Trustnet – 24/08/23
6 ASEAN Briefing – 30/05/23
7 IMF – 22/06/23
8 MSCI Frontier Markets Index - 21/08/23
9 MSCI World Index – 25/09/23
Risk Warnings
Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
Investors should refer to the prospectus or offering documentation for the funds full list of risks.
Trust Specific Risks
Exchange rate risk: The return of your investment may increase or decrease as a result of currency fluctuations.
Counterparty risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Currency risk: The return of your investment may increase or decrease as a result of currency fluctuations.
Emerging Markets risk: Emerging market investments are usually associated with higher investment risk than developed market investments. Therefore, the value of these investments may be unpredictable and subject to greater variation.
Frontier Markets risk: The Company invests in a number of developing emerging markets (“Frontier Markets”). Frontier Markets tend to be more volatile than more established markets and therefore present a higher degree of risk as they are less well regulated and may be affected by political and social instability and other factors.
Gearing risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
