BlackRock Frontiers (BRFI) has announced its final results for the year ended 30 September 2018. During the year, which the trust’s chairman describes as being a transition year, BRFI provided an NAV total return of -6.6% (in US dollar terms) thereby underperforming its reference index, which rose by 2.3%. (With effect from 1 April 2018, the Reference Index changed to the MSCI Emerging Markets Index ex Selected Countries + MSCI Frontier Markets Index +MSCI Saudi Arabia Index. Prior to 1 April 2018, the Reference Index was the MSCI Frontier Markets Index.) During the same, BRFI’s share price total return was -5.7% in US dollar terms.
2018 – a transition year
On 1 April 2018, BRFI adopted a revised investment policy and new benchmark which the Board and the Manager believe provides a better and more consistent basis for the fund in the future. BRFI’s chairman, Audley Twiston-Davies, says that, “To some extent therefore, 2018 represents a transition year as the portfolio is realigned to reflect the new investment policy. Our NAV total return was ahead of the outcome for the year of the previous benchmark, the MSCI Frontier Markets Index, but behind the new Reference Index. Relative performance has been measured against the performance of the previous benchmark up to 31 March 2018, chain-linked with the performance of the new Reference Index from 1 April 2018 to the financial year end. No performance fee will be payable this year”.
Long-term outperformer
In US dollar terms, BRFI has generated a total return of 48.8%, since its launch in 2010, and has therefore outperformed the 35.8% provided by the reference index over the same period. Returns are higher for sterling based investors given the depreciation of the pound, with a sterling equivalent NAV total return of 77.5% since launch, compared with the return on the reference index in sterling terms of 62.3% over the same period.
Manager’s commentary on performance attribution:
“Argentina (-46%) was both a contributor and detractor during the year. In the first half of the period, the Argentine market index was approximately flat, whilst the Company benefited from stock selection with our holdings in Argentine financials, such as Grupo Galicia and Grupo Supervielle, contributing strongly to returns. Whilst we did significantly decrease exposure to Argentina through this period, we did not cut our exposure sufficiently as the market fell 46% over the following six months, hurting performance of the Company. As US quantitative tightening started to impact markets, those countries which had twin deficits and a high reliance on external funding fared particularly badly and Argentina, with an arguably overvalued currency and reliance on huge monthly bond auctions, was at the forefront of this. Aware of their vulnerability, the Central Bank in Argentina approached the IMF (International Monetary Fund) at the first sign of problems in April, and were able to agree a US$50bn package with the IMF. Thinking that this would be sufficient to comfort the markets with respect to Argentina’s financing requirements, we added to our remaining positions into this sell off. In hindsight, these additions were too early, with the market continuing to fall throughout the summer.
Crisis point for Argentina was reached in August with a run on the currency which the Central Bank was unable to contain on its own. This precipitated an expanded agreement with the IMF, which came with additional requirements for Argentina to further reduce its fiscal deficit and shift from inflation targeting to monetary aggregate targeting. Under the agreement, the IMF will cover the gross financing requirement to the end of 2019 in the event that Argentina is not able to access debt markets. Whilst it is impossible to categorically rule out a debt default by Argentina, given current yields, the extent of the currency devaluation and the IMF backstop, we think risk reward tilts in our favour by remaining long.
The positions in Greek banks performed poorly over the period, falling over 26% as investors were concerned about an escalation of the tensions post elections in Italy spilling over into the wider Eurozone. Furthermore, our holdings in National Bank of Greece and Alpha Bank reported disappointing results as they struggled to reduce stock of non-performing exposures (“NPE”s) on balance sheets to the extent that investors expected. This led to increased fears about the potential for capital raises from the banks which given their valuations would be very dilutive for shareholders. Whilst the results missed our expectations, we think that the extent of the reaction to these results was excessive and we would expect better news on NPE reductions going forward.
Turkey (-41%) has had a troubled year with the currency devaluing by 25% in August alone. Investors became concerned with a central bank substantially behind the curve, spiralling inflation and a government which continued to stoke activity with loose fiscal policy. We are currently zero weighted in Turkey, concerned about the extent of foreign currency debt owed by the corporate sector and have no desire to add to exposure until the government reverses its current policy course. In a similar vein, we have had no exposure to Pakistan, have significantly reduced our exposure to Sri Lanka and Bangladesh and are running meaningful short exposure in the Philippines.
On a more positive note, the Kazakhstan (+23%) market rose over the period driven by Halyk Bank which rallied post the take-over of competitor, Kazkommertsbank. We remain holders of the bank given its strong market position and competitive advantage in terms of cost of funding versus peers.
Colombian oil producer, Ecopetrol (+50%), was one of the largest stock contributors to returns. Whilst the increase in the oil price was no doubt helpful for returns, the company was also able to stabilise production post a number of years of declines and to achieve better than expected cost discipline. Following the strong performance, we have fully exited the position.
Positions in Romania (+19%) also benefited returns, as both BRD, a leading bank in the country, and Romgaz, an oil and gas producer, reported strong earnings backed by robust cash flow generation supported by strong domestic macro-economic environment.
Vietnam (+35%) was the best performing country in the universe over the period. The economy continued to be supported by strong net Foreign Direct Investment as attractive labour costs attracted many companies to set up manufacturing operations in the country. The resulting strong growth in exports has provided a good support to both domestic activity and the current account surplus. The Company’s exposure to Vietnam contributed well to performance. Our position in a listed brokerage firm, Saigon Securities, rose over 70% as it benefited from increasing trading volumes and increasing market valuations.
A holding in MHP, a Ukrainian food processor specialising in poultry exports, added to performance. The stock benefited from increased margins as a result of strong pricing, especially across the Middle East where they took market share from the Brazilian poultry exporters on the back of their domestic problems. The company continued to expand its international customer base and strengthen its position as Europe’s largest poultry farm thanks to the development and capacity expansion of the Vinnytsia Complex.
Saudi Arabia (+7%) rose over the period thanks to a strong oil price and US dollar, to which the market is sensitive. The holding in Al Rajhi Bank contributed to returns as the stock rose helped by good earnings due to increased loan volumes.”
Manager’s commentary on portfolio activity:
“We started the year somewhat geared, something that we reduced through the year to reach a net exposure of exactly 100% at the end of September 2018. We have most significantly decreased exposure to Argentina since the start of the period by locking in the profits in the names that performed well and keeping the exposure to high conviction names. We have mainly exited or significantly reduced exposure to positions in Sri Lanka, Bangladesh, Estonia, Slovenia and Morocco, taking profits in a number of long held names as we see better opportunities elsewhere. The Company has maintained its exposure to Egypt on the back of an improved macro environment with lower than expected inflation and a lower trade deficit. We also added to exposure in Nigeria as we believed the exchange rate had reached a sustainable level and the stock market was overly pessimistic on the country.
Following the benchmark change, we built up the exposure to ASEAN countries, Thailand and Indonesia. In Thailand, consumption remains firm and its current account is in surplus. We initiated a position in Land and Houses, a real estate development company with a strong balance sheet and Polyethylene Tirephtallate (PET) plastic producer, Indorama. In Indonesia, we bought a position in conglomerate Astra International, where we thought that analysts were too pessimistic on revenue and margin turnaround potential for their auto business. We also initiated a position in a clothing retailer which is midst implementation of a balance sheet turnaround plan.
In Eastern Europe. we bought Gedeon Richter, a Hungarian generic pharmaceutical producer that also has two speciality drugs in the women’s health and central nervous system areas, which are currently in the ramp up stage. We expect the performance of both drugs to beat analyst expectations and think that the company is cheap on that basis. We added to Alior Bank, the largest challenger bank in Poland, which benefits from a strong IT platform. The bank trades at attractive valuations and is seeing rapid earnings growth as it completes a restructuring programme. We also took advantages of the Company’s ability to short on a limited basis and had some short positions in Turkey on the back of macro concerns.
In the Middle East, we added a number of positions in UAE and Qatar, including Industries Qatar, a domestic commodity producer which we have since exited following strong share price performance, and Emaar Properties, the largest UAE real estate developer, where we think the market is overly discounting the company’s long-term potential.
Over the period MSCI announced index changes affecting Argentina, Saudi Arabia and Kuwait. Our expanded investment universe encompassing all but the largest eight Emerging Markets is unaffected by these latest MSCI announcements. Argentina, Saudi Arabia and Kuwait will remain part of our investable universe and offer interesting investment opportunities for investors in our view.”
Manager’s commentary on outlook:
“We continue to be positive on the Frontiers Universe, especially where those markets are experiencing improved macroeconomic conditions, better political governance, cash flow growth, and cheap valuations.
Emerging and Frontier Markets have de-rated considerably. Whilst further rises in US rates would likely put pressure on some Emerging Market Central Banks to mirror these increases, we believe that, in general, Emerging Markets are better positioned to weather this strain than they were in the previous periods of monetary tightening of 2013 and 2015. At current levels, Emerging Markets are historically low on price to book valuations, which we believe is an attractive level. Despite the sell off and increased market concerns in 2018, we think that the expanded Frontiers Universe continues to exhibit strong GDP growth, has low government debt levels, and represents an opportunity to invest in companies with strong cash flow and high dividend yields, on some of the lowest valuations in the world.”