An emerging market investment trust that goes where others fear to tread

Many emerging market funds ignore “frontier” markets completely. But there are great opportunities in these less developed countries and companies, says Max King.

If the dividing line between developed and emerging markets can appear arbitrary, the one between emerging and frontier markets is incomprehensible. In the real world, it is hard to see the need for such a category. But in the investment world, these definitions are an administrative convenience.

When investment bank Morgan Stanley first compiled the benchmark MSCI Emerging Markets index, it chose to exclude markets that were too small or too illiquid for inclusion and lumped them in a separate Frontier Markets index. Bizarrely, this category today includes markets in the Gulf which are economically developed, such as Kuwait; European Union members, such as Romania; countries which are down but perhaps not out, such as Argentina; and finally those developing economies, like Vietnam, on a steady upward path.

The aggregate value of these markets is just $17bn, compared with $1.4trn for emerging markets, so it is easy for most fund managers to justify ignoring them. However, a return of almost 70% for the BlackRock Frontiers Investment Trust (LSE: BRFI) since its inception in late 2010, nearly four times that of the MSCI Emerging Markets index, shows that there is great opportunity in these countries and companies that others overlook to their detriment. "These are inefficient markets which present opportunities for adding value," says Emily Fletcher, co-manager of BRFI. "Over the last six years, companies have seen consistent earnings growth of 10%-15%, yet valuations remain very attractive." The MSCI Frontier Markets index still stands 40% below the level reached in 2007 and trades on below 12 times earnings, compared with 17 for developed markets and more than 12 for emerging markets.

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A good deal of BRFI's success lies in shrewd asset allocation. Fletcher and her co-manager, Sam Vecht, have been long-standing sceptics about Africa, and especially the hugely volatile Nigerian market. They have also been cautious about the Middle Eastern markets, yet have been prepared to trade tactically into markets such as Qatar and United Arab Emirates that stood to benefit from promotion to the MSCI Emerging Markets index and hence were likely to be boosted by buying from index funds.

BRFI's largest exposure is to Argentina, which is undergoing an economic renaissance following the election of President Mauricio Macri late last year, after eight years of escalating economic chaos. Its 15% allocation includes large positions in banks, a sector that was wiped out in the 2001 currency devaluation. Fletcher agrees that the peso is still over-valued, but believes that inward investment reduces the risk of a further fall. Overweight positions include Romania, at 7% above benchmark, which is now seeing 4.5% growth. Next comes Ukraine, described as a kleptocracy by Forbes magazine a sign that BRFI is not afraid to be contrarian. And the managers' determination to leave no stone unturned is shown by a photograph in the fund's presentations, taken on a trip to Iran, of Vecht standing next to a large poster of Iranian leader Ayatollah Khomeini. BRFI's exposure to Iran is currently zero, but nowhere is out of bounds in principle.

It is not surprising that a fund with a great record, focused on a part of the market that offers compelling long-term opportunities, trades at a small premium to net asset value. What is a surprise is that it offers a historic dividend yield of 3.5%. Given that this has increased by a compound 20% over the last five years, further growth looks very likely.

Activist watch

Dutch paint group Akzo Nobel is trying to fight off a bid from US suitor PPG but it "may find itself increasingly isolated from shareholder allies it needs", writes Stephen Wilmot in The Wall Street Journal. Activist investor Elliott Management has formally requested an extraordinary general meeting (EGM) of shareholders to vote on the removal of supervisory-board chairman Antony Burgmans. Akzo rejected the agenda item to fire Burgmans, but said the board members were considering the EGM proposal "thus raising the bizarre prospect of an EGM without anything to vote on". Investors with 17% of Akzo's shares have already publicly backed Elliott's calls for the paint group to enter talks with PPG.

In the news this week

Asset management staff globally saw cuts to their bonuses in 2016, says Attracta Mooney in the Financial Times. This was likely as a result of "volatile markets, increased demand for cheaper passive products and rising costs", all of which "put profits under pressure at many of the world's largest fund houses". Both UK-listed asset managers, such as Schroders, Henderson and Aberdeen, and US-listed fund houses, such as Franklin Templeton and Legg Mason, were among the companies that "took an axe to bonuses" last year. Franklin Templeton spent 6% less on total employee remuneration and benefits than it paid last year, having cut bonuses by $108.4m. Globally, the average pay level for an employee at an asset-management firm fell by 2% last year though average pay still sits at a hefty $99,000.

India-focused equity funds run by JPMorgan, Invesco, HSBC and Jupiter have topped a ranking of the best-performing investment products in the first quarter of 2017, says Chris Flood, also in the FT. India-focused funds returned between 15.5% and 18.5% in the first three months of the year, while the country's stock exchange has seen an 11.5% gain over the same period. Investor sentiment towards India has been "boosted by rising confidence that the government's reform agenda will strengthen economic growth and corporate earnings".

Max King
Investment Writer

Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.

After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.