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Frontier markets less risky than the FTSE when the price is right

Sam Vecht, manager of BlackRock Frontiers Investment Trust, tells Kate Beioley why his shares are less risky than you'd think
October 29, 2015

Sam Vecht, manager of IC Top 100 Fund BlackRock Frontiers Investment Trust (BRFI), doesn't care about demographics or development trajectories. For him, buying frontier markets is about one thing and one thing only.

"Price is absolutely everything when it comes to frontier markets," he says. "It's not how good the story is or how many middle-class consumers you see on the front page of whatever publication. It's what are you actually paying for and what's priced by the market? That's what we think about on a daily basis.

The London Business School has shown that you should buy emerging and frontier markets when the currency is cheap, the market is cheap and when gross domestic product (GDP) growth is disappointing, not the reverse and this really goes to the core of the way we think about things. Price is critical."

Mr Vecht's portfolio ethos is based on in-depth understanding of local markets and also on the principles of buying stocks cheap and selling them when they hit a target price. In the past two years, he has shifted from high weightings to Middle Eastern countries and Nigeria, to Southeast Asia. Now around 30 per cent of his assets are spread between Bangladesh, Pakistan and Sri Lanka, which only accounted for around 5 per cent in 2011.

In fact, south Asia has been the principle beneficiary of a move he took before the oil price crash last year, one he describes as "rather fortuitous" rather than calculated.

"We actually took considerable portfolio action in the third quarter of 2014 and reduced indirect oil exposure before the oil price fell sharply," he says. "We used to have exposure in Qatar, the United Arab Emirates (UAE) and Kuwait - and even in Nigeria. But we took that down significantly before the price collapsed."

In February 2013 Nigeria accounted for 15 per cent of holdings. By September it was down to 11 per cent and now it stands at just 4.3 per cent.

The oil price crash was rare in its widespread impact on a swath of frontier nations. Normally, Mr Vecht says, each frontier country is buffeted by a very different host of domestic issues to the next, demanding on-the-ground understanding and analysis.

"Typically, frontier markets are local in nature which means there they are not really buffeted by global headwinds and tailwinds." Currently, he likes markets in Southeast Asia and has moved away from African and Middle Eastern stocks.

"Nothing has soared in the past year, not least because it has been a difficult time for many markets and we are coming off a very strong 2013 and 2014. But there have been really big differentials," he says. "In parts of south Asia, such as Pakistan, Bangladesh and Sri Lanka, individual stocks are up 40 per cent in dollar terms, particularly consumer stocks and pharmaceuticals (like top 10 holding Square Pharmaceuticals (SQURPHARMA) in Bangladesh) have done particularly well. Even financials in that part of the world have done well." Other Pakistan holdings include Hub Power (HUBC:KAR)

"Contrast that with other regions, thankfully ones we don't have that much exposure to, such as Nigeria, which have suffered as a result of the oil price. Then there are other frontier markets in emerging Europe. We do have some exposure to Kazakhstan, but have seen stocks fall by 30 or 40 per cent in dollar terms, so we've seen a big spread of returns across frontier markets."

Despite those dramatic figures, Mr Vecht maintains that frontier markets are less risky and far less volatile than people think. Recent fund performance would appear to bear that out. In one year BlackRock Frontiers has fallen less than its index - 11.42 compared with 16.8 per cent - and over three years returned 36 per cent compared with a loss of 4.2 per cent for the MSCI Emerging Markets and return of 25.7 per cent for MSCI Frontier Markets.

"Frontier markets are so diversified that they don't move together," he says. "So even if each of these countries is risky on its own - think about investing in Nigeria, Vietnam or Pakistan, for example, which are individually risky - put them together and they are remarkably less risky than one would imagine. So, in fact, the volatility of our investment trust - the amount it moves on a daily basis - is considerably lower than the FTSE 100 over the past five years.

One thing we're fairly sure about saying is that as long as we have diversified ownership, frontier markets will continue to be considerably less volatile than emerging markets and possibly even less volatile as a whole than developed markets."

Mr Vecht invests in any country classified as a frontier market, meaning that countries including Argentina, Pakistan, Kuwait, Morocco and Romania are all within his remit. But he also looks beyond these to countries that haven't attained frontier status yet. Those include Panama, Iraq and Belarus.

"Our focus is very much on the countries classed as frontier or those that aren't even frontier," he says.

But despite the rapid pace of change and often sudden political and economic changes affecting those markets, Mr Vecht says portfolio turnover is not high.

"It's kind of interesting because there have been periods where turnover has been remarkably low," he says. "In 2012 we bought stocks, held them and they didn't reach our target prices so we did very little.

Over the past year, quite a few stocks have hit target prices and when they do, even if it's three or four years from when we initially put them in the portfolio, we sell. That's what generates turnover. Historically, turnover has been around 30-40 per cent and most of the holdings in the portfolio have a duration of somewhere between two and four years."

So do expect this fund to look different in two to four years, but do not expect Mr Vecht to have changed his mind on the calm nature of frontier market returns.

 

Sam Vecht CV

Sam Vecht is head of BlackRock's emerging Europe equity team and co-manages BlackRock Greater Europe Investment Trust (BRGE), BlackRock Frontiers Fund and BlackRock Emerging Europe (BEEP) investment trust. He joined the BlackRock global emerging markets team in 2000.

Mr Vecht was awarded a degree in international relations and history from the London School of Economics in 2000.