Emerging Market

Beverly Chandler takes a closer look at some of the companies that make up the frontier markets opportunity, finding a rich mix of local consumer-finance, technology and manufacturing names that offer investors their last chance to buy into a secular growth trend

N ot so much the wild frontier as the performing frontier, the frontier market sector is increasingly proving its worth against the more established emerging markets. The MSCI Frontier Markets index has achieved returns of 26.26% year to date; 13.22% over three years and 4.62% over five. The MSCI Emerging Markets index for the same period shows a 3.25% year to date; 6.32% over three years and 2.66% over five.

What is a frontier market? The usual definitions are rather loose – emerging countries with less-established stock markets. Most frontier-market asset managers  work with one of the index country lists and add in a few more of their own on top.

“We invest in all the markets outside of the developed and emerging market indices as defined by MSCI, plus some of the smaller emerging markets such as Columbia, UAE, the Philippines, Egypt and Greece,” says Julie Dickson, a portfolio manager at Ashmore, which runs four different frontier strategies. “The way they behave is not that different from what has been defined as frontier.”

Dickson notes that financials tend to be the first businesses that list when markets open up – insurance, banks and micro lenders, very domestically-oriented companies participating in the local development of businesses.

Financials have certainly paid off for Somerset Capital’s George Birch Reynardson, manager of its Frontier Markets fund. One of  his best performing stocks since the fund launched last December is Oman’s Bank Muscat, which enjoys a 40% share of the country’s loan market.

“We particularly like it because they are the most proactive in the Islamic finance segment,” he says. “Oman, unlike other markets in that region, allows a bank to be both a ‘normal’ commercial bank and offer Islamic products. Islamic financial products were introduced in Oman in 2012 and Bank Muscat has taken a 70% share.”

After financials comes the consumer sector, which has benefited from the rise of middle classes in these frontier economies. “This is an area which has had great success over the last few years but is expensive  – we have to be very selective of what we are buying,” warns Dickson.

Indeed, in frontier markets, finance, the consumer and telecoms often come together as a nexus – as illustrated by the example of Kenya’s Safaricom. It has a mobile money platform which, while accounting for just 20% of operating profit, enjoys exceptionally low turnover in its customer base as those customers become increasingly used to paying for taxis, groceries and other everyday things by text message. The data required for such payments is negligible, and the advantage of not having to carry cash in places where security can be a problem helps explain how these money platforms have caused transactions to leapfrog credit cards and go straight to mobile.

For Birch Reynardson, Saudi Arabia has offered one of his favourtite consumer-focused names, a consumer company working in ceramics. “Saudi Ceramic, a building material company, is the leading domestic player for ceramic tiles in Saudi with a 20% market share,” he says. “The next largest player has only 2-3%, so it’s got clear scale advantage and 60% of the market is taken up by imports so there is room for growth, particularly through import substitution.”

The firm incurs cheap manufacturing and energy costs and enjoys cheap access to raw materials, which means it can generate a higher margin than global peers.

“The customers are the people building their own houses, rather than large-scale orders from contractors,” Birch Reynardsn explains. “People go into the showroom, so the brand name counts for something.”

Saudi Arabia is contemplating opening up to foreign investors as early as the first half of 2015.  “It makes the market extremely interesting from our perspective, as it will become a large part of the frontier index if it does open up, as you will see lots of inflows,” Birch Reynardson says.

Infrastructure is another important sector in frontier markets as governments attempt to improve railways and roads as their economies develop. Pakistan’s Lucky Cement has proved popular with a number of frontier managers, despite the political unrest in the country which, so far, hasn’t experienced stocks being sold off aggressively.

“Lucky Cement and MCB Bank have robust balance sheets and have high-quality, strong returns that have held up, so that, after a 10-15% selloff in the midst of protests, they have bounced back almost to where they were before,” says Birch Reynardson. “It is surprising that it has been the locals selling, while foreigners are the net buyers.”

However, Birch Reynardson remains sceptical about the buoyancy of the market considering the loss of credibility that the government has suffered.

One of his big country overweights is Vietnam, where a favoured stock is FPT Corp – its leading IT services company, with a 50% market share in outsourcing and a customer base that includes the likes of Unilever and Proctor & Gamble as well as large local banks and consumer companies.

“What we like so much about them is that they have a 40% cost advantage over companies like Infosys and Satyam in India,” says Birch Reynardson. “The IT segment is nowhere near as sophisticated but the fact that the cost advantage is there shows it has exceptionally good growth prospects.”

FPT has gone one stage further in supporting the development of Vietnam, by providing education. “They have their own university, educating potential employees – three-quarters of the people at the university are studying IT and nearly half will end up working for this company,” says Birch Reynardson.

James Johnstone, a portfolio manager at emerging market and frontier market specialist Everest Capital, sees these opportunities as “your last chance to buy early secular stories in growing economies” with “very idiosyncratic growth”.

“The bulk of global growth is dependent on a US recovery and Chinese bank liquidity and few countries can forge their own path to growth,” he reasons. “But frontier markets are so early they haven’t yet taken the great significant structural reform steps.”