An investment trust that gives exposure to frontier markets

An investment trust investing in small, illiquid emerging markets has disappointed, but deserves another chance, says Max King

Despite a strong recovery in the last 18 months, the last few years have been dismal for BlackRock Frontiers Investment Trust (LSE: BRFI). The share price is 25% below its January 2018 high. A dividend yield of 4% provides compensation and the underlying performance has been better, with the shares on a near-10% discount to net asset value (NAV). But the trust has still not fulfilled the hopes of five years ago.

Then, Emily Fletcher, co-manager, explained the investment thesis. It opts for some of the smaller, less developed countries in the world that are in neither the developed nor emerging-markets indices. This requires detailed, “on-the-ground due diligence”, as these markets are less efficient and attract scant research coverage. BRFI believes in the theory of GDP convergence, the idea that lower initial GDP will lead to higher growth rates.  

Remain patient – it’s cheap

“The trust has not lived up to expectations,” says Anthony Stern of brokers Stifel. “But investors should continue to be patient.” He points out that the trust’s investment performance in sterling over five years, 34%, lags behind the MSCI Frontiers index (52%), the MSCI Emerging Markets index (56%) and the S&P 500 (98%). “Underlying earnings in frontier markets are said to be growing at 10% per annum, but in contrast to developed markets, frontier and small emerging markets have not benefited from a market rerating and so trade on just 11 times 2021 earnings.”

Vietnam accounts for 29% of the MSCI Frontier index, Morocco 11% and Iceland 7%, so BRFI can be forgiven for having a broader benchmark to encourage diversification. Still, the geographic exposure of the trust looks strange: 16% of net assets in Saudi Arabia, 8.2% in Greece and 8.4% in Vietnam. 

Latin America accounts for just 8.8%, with zero in Argentina – Fletcher was badly caught out by the return of the Peronists in 2019. Countries in the Association of Southeast Asian Nations (ASEAN) other than Vietnam comprise 24%, Africa 8%, eastern Europe 16% and central Asia and the Gulf the rest. 

None of the trust’s ten largest equity investments account for more than 5% of the portfolio and the sector spread is broad. Financials make up 35%, materials and energy 22.6% and consumer stocks 21%. Information technology and healthcare account for just 6%, showing that opportunities in key areas of global growth are limited. Still, sectors that would be classified as mature and therefore “value” in developed markets can be high-growth in emerging markets, while BRFI’s high yield points to cash-generative companies in the portfolio.

Politics is clearly a source of instability. The news in some countries, such as Turkey and Argentina, has been so bad that investors are starting to discount change. However, change, if it is allowed to happen at all by increasingly authoritarian governments, is not necessarily for the better and improvements in countries such as Argentina tend not to last. The wealthy in these countries prefer to move their money overseas into dollars, sterling, or euros rather than invest at home. This holds back economic development and is why the theory of GDP convergence has not worked well in practice. 

Things can only get better

Disillusion with the emerging-markets thesis is now so widespread that it has contaminated countries still heading in the right direction. It gives no credence to the idea that governments, elected or not, might learn from their mistakes and realise that prosperity, not ideology or nationalism, is likely to be in their best interests.

The low valuation of BRFI’s portfolio companies, its discount, the attractive yield and the contrarian appeal of this neglected corner of the market makes BRFI’s shares attractive. Investors should give the once highly regarded investment team another chance. 

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