Over BlackRock Frontiers’s (BRFI’s) year to 30 September 2020, its NAV returned -20.0% while the benchmark delivered -15.6%. Performance has been much better over the post reporting period, with the NAV up 27.9% from 30 September to 8 December, compared to the benchmark’s 15.5% return.
BRFI’s managers, Sam Vecht and Emily Fletcher, believe that the value on offer across frontier markets remains under-appreciated, despite a number of countries displaying economic and medical resilience throughout the pandemic. As an example, they note that while the “IMF estimates Indonesia will grow by 8.2% in 2021, the market trades at a 36% discount to its 10-year average price to book multiple. Similarly, while Vietnam is expected to grow by 7% next year, the market trades at a 38% discount on the same basis. This is in stark comparison to developed markets which are only expected to offer 4.5% growth next year but are trading at a 24.5% premium to its 10-year average price to book.”
‘Indonesia and the Philippines among the largest detractors’
“As is always the case with a sharp sell-off, there was a lack of discrimination shown by investors towards the stocks perceived as COVID-19 losers and we were able to use this opportunity to buy a number of high-quality industrials where we felt that valuations looked extremely attractive. One such example was Wizz Air, thought to be the lowest cost carrier globally. Wizz Air entered this crisis with more than US$2bn of cash on its balance sheet, and so we expect it to be positioned to take substantial market share from the many flag carriers who find themselves currently in very precarious positions. Taking advantage of a number of opportunities such as this, net exposure had increased to around 106% by the start of June.
With frontier markets yet to see the rebound of more developed markets, performance has been disappointing, down 15.6% for the year. There is, as yet, no anticipation of recovery priced in, with 11 markets still down more than 20% over the last twelve months. Despite the action taken to contain net exposure as described above, relative performance was dampened with the Company’s NAV falling by 20.0%. Given our constructive early year positioning, this relative performance was to be expected. However, whilst relative positioning has been costly this year, we believe it sets us up very nicely for 2021 as those markets return to drivers of performance. Added to this is the unprecedented monetary expansion in the US and record low global interest rates which are likely to drive investors hunting for yield into emerging markets.
Our positive view on fast-growing economies, Indonesia and the Philippines, was among the largest detractors. While we did see some recovery from March lows, both markets remain considerably lower than where we started the year. We note the better than expected remittance trends in the Philippines and foreign exchange reserves are at all-time highs. Fiscal trends calendar year to date are better than expected in Indonesia and we maintain our high conviction in this trade as these countries continue to offer significant growth and yield in a world where both are increasingly difficult to come by.
At the stock level, Malaysian positioning was a major drag on relative performance, as we did not own rubber glove manufacturers Top Glove and Hartelega. Both companies rallied significantly as global demand for personal protective equipment surged. It was a frustrating trade to miss but given the huge capacity expansion we have seen globally we do not believe that earnings will be sustained at the current levels.”
‘Frontier markets currently represent close to 30% of the world’s population and only 1% of world indices’
“While COVID-19 remains a key short-term global uncertainty, we are more optimistic on the medium-term outlook for frontier markets. Many countries within our universe have seen a near V-shaped rebound in economic activity and now have considerably less fiscal overhang than their peers in developed markets. It is also worth highlighting that these smaller economies remain a material source of growth and yield in a world that lacks both. Furthermore, in several countries, currencies are now highly attractive on a real effective exchange rate basis.
On our analysis, frontier markets currently represent close to 30% of the world’s population, 12% of total gross domestic product (GDP), and 5% of net profits. Despite this, they account for only 1% of world indices, a number that has declined significantly over the last 10 years. We remain convinced that over time frontier markets’ index representation should grow towards their share of world profits, which in turn should be more reflective of their contribution to GDP. Over the longer term, as these countries become richer, we believe that considerably more than 1% of investors’ capital will be allocated to the countries in which nearly 3 billion people live. In an investment world increasingly focused on ESG, we find it strange that the poorest 3 billion have been increasingly side lined by both index providers and allocators of capital.
While during recent years, frontier markets, despite their growth, have been out of favour, we believe that in a post-COVID-19 world awash with record liquidity, investors will remember the considerable attractions of our investment universe. The megatrends highlighted above have not been impacted by COVID-19. On the contrary, their importance and duration have been amplified during this most challenging of years.
We have identified climate change, rapid urbanisation, emerging global wealth, and demographics as key megatrends that will dominate the investment climate for years to come. We believe that nowhere are these themes more prevalent than in frontier markets; and that this will become increasingly recognised over the next decade offering numerous opportunities to the Company.
We are broadly positioned for a normalisation in global economic activity. We remain positive on areas where policymakers have taken upfront, prudent measures to contain COVID-19, where the foreign currency debt situation is relatively manageable, and countries that will benefit from a lower oil price and whose currencies appear inexpensive. As such, Indonesia, the Philippines, and Vietnam appear attractive. Like all asset classes, frontier markets are not without risk but we think that these risks are largely reflected in asset prices.”
BRFI: BlackRock Frontiers sees discounts in key markets as not reflective of economic reality