Frontier market have now come back from the lows after the global financial crisis, but still have room to re-rate further, according to HSBC Asset Management portfolio manager, frontier markets, Andrew Brudenell.
Brudenell said seven “c’s” will drive frontier market convergence with emerging and developed markets over time and form the investment case for asset allocators. The factors include “cheap” or valuations, “change” or postive political, economic and social developments, “consumers” or the growing middle class population with disposable incomes, “commodity wealth” and “correlations”. He added that frontier markets can be defined as those with high institutional voids in areas such as product markets, capital markets, labour markets, regulation and contract enforcement. “Small reductions on institutional voids can lead to large productivity gains, creating a return opportunity for equity investors,” Brudenell said. He cited Pakistan and Nigeria as examples, following recent democratic changes of government.
Another attraction of frontier markets is the low correlation to emerging and developed markets of 0.58 and 0.55 respectively, according to Bloomberg over a five-year period to March 2015. Correlations between individual countries are typically even lower than these figures; Vietnam has a marginally negative correlation to Kenya, Kuwait and Qatar for instance. As well as favourable demographics, Brudenell picked valuation as a big opportunity for investors: “From a return and profitability point of view, there are some very well-run, good companies which are generating impressive returns. The return on equity is nearly as high as in emerging markets but for a lot less money.” Compared to the MSCI benchmark, Brudenell said he is overweighting UAE and Pakistan among other countries and underweighting Kenya, Morocco, Argentina, Philippines and Slovenia at present.