Investible assets come in all shapes and sizes but for Sam Vecht, manager of BlackRock Frontiers Investment Trust (BRFI), basic investment principles remain the same. He may invest in some of the racier and more exotic areas of equity markets, but for him one of the central facets of investing is a basic metric: valuation.
"The key is to remember the price, because buying shares at high valuations rarely makes money and buying low rarely loses money," says Mr Vecht. "It is all about risk and the price you pay for that unit of risk. Wonderful as a story may be, you should ensure you are not overpaying for it."
He says valuations in frontier markets are attractive as they trade on a price to earnings ratio of around 10 times, compared with emerging markets on 12.5 times and developed markets on 15 times."
Frontier markets are around 50 per cent below their 2008 peak.
"Many investors perceive growth as a winning strategy but the reality is different," he continues. "For example, empirical evidence shows that even poorly-run state-owned companies have outperformed stories, themes and dreams due to initial undervaluation. Valuation is a proven determinant of global emerging markets returns."
The seven key attractions of frontier markets, according to Sam Vecht, are:
■ World's fast-growing economies;
■ 30 per cent of global population;
■ Consumers of the future;
■ Vast untapped commodity reserves;
■ Low government debt burden;
■ Ability and willingness to resolve past challenges;
■ Largely uncorrelated to global markets.
Around 80 per cent of the trust's assets are exposed to domestic consumption, with consumer discretionary accounting for more than 6 per cent of the portfolio, even though it is a very small part of the frontiers market index. This can be achieved because Mr Vecht looks beyond the MSCI Frontier Markets Index and includes shares from countries such as Saudi Arabia, which has a well-regulated market. Saudi Arabia accounts for around 9.7 per cent of the trust's assets.
Another, perhaps surprising attribute is the reasonably attractive dividend yields you can get in some frontier market companies. Usually, high-risk, high-growth investments don't offer a yield. "We are not a dividend fund but some of our underlying companies yield around 3.5 per cent," he says.
Mr Vecht expects frontier markets will experience much of what emerging markets began to experience around 20 years ago. "Looking back at the trends which transformed mainstream emerging markets over two decades ago, from a niche asset class to a mainstream investment, we believe that the opportunity exists for frontier markets to follow the same development path," he adds. "Previously isolated economies liberalised, grew at a phenomenal rate, lifted millions out of poverty and created a new generation of consumers. Today is the right time to buy frontier markets at the right price."
In addition, frontier market debt levels are lower than emerging markets, and emerging markets have a relatively high correlation with developed markets. "But with frontier markets we can build a diversified fund that doesn't react to the latest news out of the eurozone," he says.
There are good opportunities for active managers as frontier shares are hardly covered by analysts. For example, while nine analysts cover Unilever (ULVR) and nine cover its Indian subsidiary, only one covers Unilever Nigeria. "Even if you are half good at your job you can add alpha," says Mr Vecht.
Adding alpha
Mr Vecht's team combine top down (macroeconomic) research with bottom up research (company fundamentals). They have a preference for companies with a market capitalisation over $100m (£63.5m) and trading volume of at least $50,000 a day, and then they apply macroeconomic and political analysis. They believe a sound economy is essential to corporate success, while understanding history and politics is vital to making clear judgements. If they think corporate governance is worsening in a country they will be very cautious about it. "Once a company has lied once you don't know where the next lie is coming from. But GDP is not necessarily correlated with market performance and just buying the fastest-growing companies doesn't help; rather it is a case of deploying your capital where it is required and respected," he says.
On the ground scrutiny of individual companies results in the team of 11 having over 1,000 meetings a year. They also think due diligence on financial statements is rewarded and focus on company cash flows, as this drives equity returns. "We like companies that make efficient use of capital, positive operating leverage, earnings power above market expectations, turnaround situations and unrecognised opportunities," says Mr Vecht.
Diversity is one of the key ways they reduce risk, so if something does go down in value it will not have a major effect on the overall portfolio - as well as low valuations. The portfolio holds 40 to 60 shares and positions are deliberately diversified and scaled.
The trust also takes short positions on companies with poor cash-flow generation, unsustainable margins or aggressive accounting policies, and companies that are in structural decline.
In terms of country allocation, Nigeria is the largest exposure, accounting for more than 15 per cent of assets and two top 10 holdings - First Bank Nigeria and Zenith Bank.
"We hold positions in frontier countries which stand to benefit from positive structural reforms, high growth and have well capitalised liquid banking systems, so they are well-placed in the current global environment," he explains.
He also likes Vietnam, which accounts for more than 5 per cent of assets, a 2.1 per cent overweight relative to the MSCI Frontiers Index. "Vietnam has a trade surplus for the first time since 1992, a strong private sector benefiting from low-cost skilled labour, a large pool of private savings and no immediate triggers for a banking crisis," he says.
And, of course, cheap valuations.
