Small is beautiful: why frontier markets are an option for volatile markets

  • Frontier markets are more insulated and less subject to the ebb and flow of international sentiment
  • These markets are idiosyncratic and well-suited to a stock picking approach
  • Frontier markets have some notable advantages: high growth, supportive demographics, entrepreneurial cultures, a willingness to embrace technological change and political reform

By Mark Gordon-James, Senior Investment Manager, Aberdeen Frontier Markets Investment Company Limited

At a time when developing markets are under pressure, it seems an odd moment to consider looking at the smallest and least sophisticated of the world’s stock markets. Yet ‘frontier’ markets, those markets considered even more emerging than emerging markets, may have a place at a time when global stock markets are trending lower.

They are certainly small. Bangladesh’s GDP is around one-third the market capitalisation of Apple. That brings associated, but it also has notable upside. Larger emerging markets that are more integrated into the global economy can be hit by perceptions around the strength of the dollar, or the path of US interest rates, as has been seen this year. However, with the exception of Argentina, frontier economies largely dance to their own tune.

Unlike larger developing markets, these stock markets – which include Pakistan, Vietnam, Morocco and Nigeria – are dominated by local rather than international investors. That means they are less subject to the ebb and flow of international sentiment, which can withdraw capital when the global economy is bad and reintroduce it when it is buoyant, creating volatility. That means, frontier markets can be beneficial from a portfolio diversification point of view. They have different risks and drivers and – counterintuitive though it may seem – can play a role in bringing down the overall volatility of a portfolio.

It also means that each country must be looked at on its own merits. Frontier markets can be very different: from the economies of the Middle East, which are wealthy but are deemed ‘frontier’ because their capital markets are closed to external investors, to those of Kenya or Pakistan, which are fast-growing but starting from a low base. Each will perform differently in different market environments and that creates opportunities for stockpickers.

Frontier markets will certainly be less sophisticated than developed markets. Nevertheless, they have some notable advantages, with high growth, supportive demographics, entrepreneurial cultures, a willingness to embrace technological change and political reform. Bangladesh is predicted to grow at 7.3% for 2018, Vietnam at 6.6%. These countries are interesting because small positive changes can have an outsized impact.

Companies that harness these advantages can provide opportunities that can’t be found elsewhere. There are ways in which frontier markets are bypassing a whole level of development – moving straight to mobile payments rather than establishing high street banks, for example – and this is creating new, local technology groups. In Kenya, the trend to mobile money is well-established and we hold Safaricom in the portfolio for exposure.

Elsewhere, Bangladesh’s Square Pharmaceuticals now exports to 36 countries around the world and is at the forefront of the changing medical demands of growing, maturing populations. It has been going since 1958 and has a strong, well-established management team.

Companies tend to be poorly researched, which creates opportunities for those willing to roll their sleeves up. While investors won’t find the same transparency of reporting they receive for developed market companies, it is possible for diligent analysts to get under the skin of these companies. We speak to the management team on the ground, a company’s competitors, plus policymakers and local academics. We are long-term shareholders and want to ensure we can build a relationship with the companies in which we invest.

Inevitably macroeconomic factors will be important and must form part of any analysis. Nigeria, for example, has been struggling because of the weakness in the oil price. It is important to understand the cycle in these countries and how they are developing. In Nigeria, a period of weakness has forced the government to recognise that is has to rebalance the economy away from oil and improve its balance of trade through a process of industrialisation and import substitution. This will create a stronger economy in the long-term and we believe it is in the foothills of an economic upswing. Nigerian banks are key beneficiaries of this improvement and are among the largest holdings in our

In terms of our portfolio, we want to invest in those countries with proper frontier characteristics, which means avoiding areas such as Kuwait or the Gulf (which are the highest weightings in the MSCI Frontier Market index). These are low growth, high income economies and are not where the excitement lies in frontier markets. We like Vietnam, Nigeria, Pakistan and Kenya, where investors can get access to companies with outsized growth opportunities.

At the same time, these countries will often have some legacy of high state control and commodity dependence. We aim to steer clear of those companies with heavy state ownership, or that may be seen as mission critical for the government. It is only six years since Argentina’s president, Cristina Fernández de Kirchner, announced that the government would seize a majority stake in YPF, the nation’s largest oil company, and this remains a risk in politically fragile countries. We prefer belowthe-radar companies, with high quality assets, a strong management team and good governance. They tend to be family-owned or owned by multi-nationals.

It has been a difficult year for frontier markets. However, this has created some attractive opportunities in a unique asset class. We believe it has a role in a balanced portfolio at a time when markets are trickier.

Important information

Risk factors you should consider prior to investing:

• The value of investments and the income from them can fall and investors may get back less than the amount invested.

• Past performance is not a guide to future results.

• Frontier market countries typically have smaller economies and even less developed capital markets or legal and political systems than traditional, more developed emerging market countries. As a result, the investment in frontier markets can be riskier than investing in emerging market countries.

• Investing globally can bring additional returns and diversify risk. However,currency exchange rate fluctuations may have a positive or negative impact on the value of your investment.

• The Company can use derivatives in order to meet its investment objectives or to protect from price and currency movements. This may result in gains or losses that are greater than the original amount invested.

• This Fund may invest through non-regulated markets which are subject to increased risk relating to ownership and custody of investments.

• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.

• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.

• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.

• The Company may charge expenses to capital which may erode the capital value of the investment.

• Movements in exchange rates will impact on both the level of income received and the capital value of your investment.

• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.

• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.

• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

Other important information:

An investment trust should be considered only as part of a balanced portfolio.

Investors should review the relevant Key Information Document (KID) and brochure prior to making an investment decision. These can be obtained free of charge from or by writing to Aberdeen Fund Managers Limited, PO Box 9029, Chelmsford, CM99 2WJ.

Nothing herein constitutes investment, legal, tax or other advice and is not to be relied upon in making an investment or other decision.

This is not an invitation to subscribe for shares in the investment trust and is by way of information only.

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