Frontier market valuations are recovering after a lacklustre 2009 and offer opportunities for growth and yield, according to Sam Vecht, manager of the just-launched BlackRock Frontiers.
Frontier markets largely missed out on the rally that propelled equities higher in 2009. According to Financial Express, the MSCI Frontier Markets index fell by 1% in sterling terms, compared with gains of 59% and 16% for MSCI Emerging Markets and MSCI World. The frontier benchmark outpaced its developing and developed world peers in 2010, but remains well behind both indices on a two-year measure.
Sam Vecht, the manager of BlackRock Frontiers, which was launched on the London Stock Exchange last month, says frontier valuations were held back by several factors in 2009. Such markets require intensive research and are difficult to access, he says, which put off investors looking for “big, liquid opportunities”. In addition, most western investors were unaware of positive reforms in many countries.
”I’m going to be buying a collection of consumer companies in Saudi Arabia trading on seven or eight times earnings with a 6-7% yield. Those opportunities will not hang around for too long”
However, Vecht notes that in 2010 some of the smaller emerging market economies, including Indonesia, Peru and Malaysia, outperformed their much-favoured large emerging market counterparts such as Brazil and China. Vecht, who was part-way through building the opening BlackRock Frontiers portfolio on December 21, expects to see a re-rating of frontier stockmarkets this year.
“Frontier markets are a natural home for anyone looking for growth, yield, and assets that are uncorrelated,” he says. “It is difficult to think that I’m going to be buying a collection of consumer companies in Saudi Arabia trading on seven or eight times earnings with a 6-7% dividend yield. Those opportunities will not hang around for too long. The world is increasingly integrated and people will see those opportunities.” (article continues below)
Vecht identifies four groups of “natural buyers” for frontier markets: investors based in large emerging economies, local investors, western companies and western fund managers. BlackRock Frontiers is the first “pure play” London-listed investment trust in the region (Advance Frontier Markets is a fund of funds), he says, but the amount fund managers allocate to the asset class could grow significantly.
On local demand, Vecht highlights Qatar, where investors are able to get 1% on bank deposits or a 7-8% dividend yield on equities – what he terms “a no-brainer”. Indeed, Qatar is one of Vecht’s three preferred markets, alongside Saudi Arabia and Nigeria. Qatar’s economy is growing fast, he says, and will be boosted by $60-$70 billion (£40-45 billion) of infrastructure spending in the run-up to the 2022 World Cup.
Vecht’s investment universe covers 140 countries and he sees attractive opportunities in Ghana, Kazakhstan, Romania and Ukraine (“a wealth of excellent agricultural companies).” More broadly, 70-75% of BlackRock Frontiers is in stocks benefiting from domestic growth. Vecht favours consumer staples, financials and locally-based firms servicing infrastructure.
BlackRock’s emerging markets team has access to research from the group’s natural resources and fixed income franchises. However, much of its information is gleaned from 250 meetings it holds globally each year. Vecht was in Saudi Arabia, Jordan and Oman last week, and colleagues recently returned from Serbia, Bulgaria and Argentina. Another team member will visit Ukraine and Mongolia this month.
Vecht says the team usually meets a company five or six times before investing and researches its customers, suppliers and competitors to “to get a sense of what’s really happening on the ground.” This bottom-up data is used to create a portfolio of 40-50 stocks, with maximum weightings typically at 5-7% – although Vecht expects the largest position sizes to be 4-4.5% initially. Stocks are also screened for liquidity, with minimum limits of $250,000 in daily trading and market capitalisations of $50m.
BlackRock Frontiers was likely to contain some short positions at launch, in common with the Eastern European investment trust that Vecht has managed since May 2009. Vecht declines to give further details but confirms that up to 10% of the fund can be used for this purpose. “It is something we are experienced in doing in the market so, where appropriate, we will make full use of the powers that the board has given us.”
According to the Association of Investment Companies, BlackRock Frontiers traded at a premium to net asset value (NAV) of 10% on December 22. Investors will be entitled to tender their holding in full at NAV at the trust’s fifth annual general meeting, and every five years subsequently.
* This article was updated on January 25, 2011. The article originally stated that Indonesia, Peru and Malaysia are frontier markets. These countries are classified as emerging markets.