Stockholm (Ekonamik) – “With the rising importance of emerging markets, increasing interest in frontier markets and fears over advanced economy stagnation, the global economy has witnessed a paradigm shift,” noted Euromonitor, a leading independent provider of strategic market research, in February 2019. “The turning point was in 2008 when emerging markets overtook developed countries for the first time in their contribution to world GDP in purchasing power price terms.”
Frontier Markets, often distinguished from Emerging Market by their lower income per capital and less liquid markets, are on the cusp of this trend. In our review of asset managers’ insights from this market segment, considerations about market concentration as well as the challenges and opportunities at the frontier were paramount.
Index Performance and Concentration
As we noted in another article, the result of the limited number of frontier market countries and their low liquidity means that the indices end up quite concentrated around two or three countries. As a result, small variations in index composition create clear differences in performance.
The S&P’s Select Frontier Index total returns were down 0.8% in April in terms, although the fund was up 14.15% year-to-date, 15.9% over the last three years, 4.96% over the last five years and 8.52% over the last ten years. The fund, which only includes the 40 largest and most liquid stocks from the S&P Extended Frontier 150, had outperformed, which had experienced losses of 1.29% in April, and grown only 6.61%, 5.11% and 3.88% year-to-date, over the last three years and over the last ten years, respectively. The benchmark experienced losses of 1.78% over the five-year horizon Kuwait, Argentina and Vietnam remained the three largest constituents of the index, accounting for 68% together.
The MSCI Frontier Markets Index performed better than its S&P counterpart in April, posting a 0.43% monthly growth, according to MSCI’s end of April review. It is up 9.3%, 6.97%, 4.2% and 8.58% on a year-to-date, three-year, five-year and 10 year basis. This index is much less concentrated, with Kuwait, Argentina and Vietnam accounting only for 55.33% of the whole index.
Of the three, the FTSE Russell Frontier Index reported the worst performance at the end of the first quarter of 2019, with no added returns year-to-date, and a 5.7% and -8.5% returns on a three-year, and five-year basis. Of the three indices, the FTSE Russell Frontier Index is also the least concentrated. Kuwait is not a member of FTSE Russell’s Frontier Markets so the third largest country is actually Bangladesh, after Argentina and Vietnam, which together make up 47.32%.
On a technical note, Tundra Fonder also noted the effect that the coming upgrades of Argentina and Kuwait to Emerging Market status will have on the MSCI indices, concentrating it even further. According to the asset manager, much of the difference between its performance and the index can be traced back to its absence from GCC markets, which are not consistent with its thematic vision. The remaining is the result of its focus on mid and small caps which do well in the long term, but have struggled lately.
Tundra also noted that while a downgrade for Pakistan from Emerging Market status to Frontier is unlikely it would probably be positive for the country since it would represent a large proportion of the Frontier Market. As a member of the Emerging Market index, its share is less than 0.1%, however.
With regards to Pakistan‘s potential downgrade, the country narrowly escaped such a decision from by MSCI in the beginning of May. All three of Pakistan’s constituents – HBL, OGDC, and MCB – secured the status of the standard index despite falling short of meeting the MSCI size requirements of the EM index. The MSCI’s buffer rule most likely saved Pakistan from the downgrade.
Despite index definition, Pakistan is often treated as a frontier market. That’s the case for Tundra Fonder, who noted in its April review that economic conditions in the south Asian country were the driver of the 9% losses in the fund. “The economic impact of a 33% devaluation and a cumulative interest rate increase of 5% lies like a heavy blanket across the country.” The Swedish frontier market fund argues that the previous government’s investments have not resulted in the expected foreign capital currency flows from increased exports nor foreign investment. Without these capital flow, paying off the existing stock of foreign debt and meeting current account deficits will remain difficult, due to the overvalued currency, despite the current account deficit falling from 6% to 2.5% of GDP. “In April, the market took hold of the deteriorating economic outlook. With an increase in raw material and product prices, coupled with a 2x increase in finance costs along with a reduced purchasing power, the earnings have collapsed to near break-even for various pro-growth cyclical sectors”.
Further East, Emre Akcakmak, Portfolio Advisor at East Capital, noted that “Vietnam was also among the largest alpha detractors for two primary reasons.” The portfolio adviser illustrated this case with the example of FPT Corp. “Firstly, we took the opportunity to buy block shares in order to significantly increase investments in FPT Corp, but had to pay a slightly higher than 10% premium in order to secure these shares due to foreign ownership limitations. Effectively, we had to reflect a loss on day 1, costing us some 60bps alpha, due to the premium we had to pay over the market price. Were we to sell the shares today, we are confident that we could secure similar levels of premium, thus reversing these paper losses.”
“The Vietnam market continued to consolidate in April. The Index gained 2.7% net (SEK) at month close, compared MSCI Emerging Markets rising 4.6% and MSCI Frontier Markets xGCC rising 0.9%,” explains Tundra Fonder‘s April comment. During April, macroeconomic conditions remained positive according to Tundra.”However, the Index was practically unchanged if we overlook the currency effect of the weaker Swedish krona,” the swedish frontier market fund explains. “Liquidity dropped to USD 164.5m in average daily traded value as retail investors were less active. Foreign investors continued to net buy USD 30.6m worth of shares during the month.” Seasonal issues were important drivers of investor behaviour in the South East Asian country. “Due to the overall ‘sell in May’ sentiment, local investors were cautious and tended to cut off their stock positions to reduce risk.” However, “the market is nowhere near overheating this year. Due to the cautiousness of retail investors, the index has been cooling down since late March. Liquidity is low and there is no sign of over-speculation.” Tundra Fonder’s April comment concludes that “the current margin lending balance from brokers is well below average which indicates that a massive margin force sell is unlikely.”
In line with these hopes, Frontier Global Partners advised investors “to plunge into Vietnamese stocks with an eye on the distant horizon of opportunity and ignoring the near-term waves,” noting that “the macroeconomic picture is strong, with GDP growth of 6-7%, modest inflation and a strong trade outlook.” However, the investment solution provider warned prospective investors against foreign ownership limits, volatility and liquidity and the quality and availability of information due to over the counter trading.
Further east, Finnish fund manager Evli, in its April Monthly review of Malaysia and Thailand. With Evli we see again the loose application of Frontier and Emerging market distinctions at work. “In Malaysia we met a current holding which has returned over 500% since our first investment three years ago.” According to the fund manager, the interaction with this undisclosed tech company highlighted the gains that can be achieved through engagement, particularly when executives are unwilling to take investor calls. “The CEO and CFO were happy to welcome us for a meeting because we made the trip to their office which is located an hour’s flight from the country’s capital,” the review explains. “The meeting was insightful, increased our conviction, and highlighted the importance of meeting companies in these markets in person.” In Thailand, Evli met companies in various industries. The common theme throughout all meetings was how local competition is “squeezing margins and influencing companies to invest in projects outside of their core businesses”. This together with overvalued market prices, “makes Thailand a difficult place to find value in quality companies,” concludes Evli’s review.
Finally, in Latin America, Argentina remains a concern, despite the announced upgrade. According to Aberdeen Frontier Markets, “Argentina was one of the main laggards. Its economy contracted 2.5% last year and shrank 6.2% in the final quarter of 2018 – its weakest quarterly performance since the global financial crisis. The peso depreciated further to reach new lows. The central bank set an interest-rate floor of 62.5% in early April after inflation hit its highest rate in almost three decades.
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