Best Stock Pickers Trawl Frontier Markets as U.S. Funds LoseMichael Patterson
Stock pickers focused on the least-developed markets are trouncing their benchmark index and producing annual returns at least seven percentage points higher than mutual fund managers around the world.
Mark Mobius’s Templeton Frontier Markets Fund and 12 peers investing in countries from Vietnam to Nigeria and Romania earned an average 24 percent last year, topping the 8.4 percent gain in the MSCI Frontier Markets Index. They beat the Standard & Poor’s 500 Index, the Stoxx Europe 600 Index, the Topix Index and the MSCI Emerging Markets Index even as funds in the U.S., Europe, Japan and emerging markets trailed the benchmark gauges.
The winners are traveling to nations that most money managers avoid, taking advantage of scarce information to buy undervalued stocks. Investments in companies such as Nairobi-based East African Breweries Ltd. and Nigeria’s Access Bank Plc delivered higher returns with lower volatility than developed-market counterparts more than 50 times their size, including Anheuser-Busch InBev NV and Bank of America Corp.
“The companies are overlooked and under-owned,” Carlos von Hardenberg, an Istanbul-based money manager at Franklin Templeton Investments who helped Mobius post a 24 percent gain in the firm’s $1.3 billion frontier fund last year, said in a Jan. 16 phone interview. “Markets are far less efficient.”
Frontier funds’ 24 percent average return last year compares with 14 percent for U.S. funds, 16 percent in both Japan and emerging markets, and 17 percent in Europe, according to data compiled by Bloomberg.
MSCI Inc.’s frontier gauge, comprised of 141 stocks with an average market value of $3 billion, climbed 7.5 percent last month, including dividends, and reached the highest level since August 2011 on Jan. 31. The MSCI All-Country World Index of shares in developed and emerging countries is up 4.6 percent in 2013, following a 17 percent gain last year.
Nigeria’s All-Share Index rose 0.6 percent as of 10:39 a.m. in London, while Romania’s BET Index climbed 2.1 percent and Vietnam’s VN Index increased 0.8 percent.
While advanced-nation fund managers are beating benchmark indexes in January as the six-year lockstep moves in stocks break down, frontier investors may outperform in 2013 because the shares are undervalued versus bigger markets, according to New York-based BlackRock Inc., which oversees $3.8 trillion.
The world’s biggest asset manager is “much more positive” on frontier countries than emerging nations, Sam Vecht, whose BlackRock Frontiers Investment Trust Plc returned 21 percent in dollar terms last year, said in a Jan. 18 phone interview.
The MSCI frontier index is valued at 11.6 times reported profits, a 27 percent discount to the MSCI All-Country index, after trading at a premium as recently as June 2011, data compiled by Bloomberg show. The frontier index’s dividend yield of about 3.6 percent and its projected earnings growth of 17 percent are both about one percentage point higher than the emerging-market gauge.
Consumer spending in frontier nations will climb 9.2 percent on average this year, faster than the 8.3 percent pace in emerging markets, according to Euromonitor International, a consumer research firm.
Smaller price swings and lower correlations in frontier countries appeal to investors looking for returns less tied to fluctuations in global markets, said Rami Sidani, a money manager at Schroder Investment Management in Dubai.
The MSCI frontier measure’s 50-day historical volatility of 5 and its correlation of 0.4 with the All-Country index compare with readings of 8.6 and 0.6 for the emerging gauge, according to data compiled by Bloomberg. A correlation of 1 means prices are moving in tandem while zero indicates no relationship.
“What happens in the U.S. has an impact on China’s exports, but it has less of an impact on how many beers the average guy in Kenya is drinking” said Hans-Henrik Skov, whose $58 million BankInvest New Emerging Markets Equities Fund climbed about 37 percent last year and owns shares of East African Breweries.
Frontier funds may lose some of their advantage as the lockstep moves among equities in bigger markets diminish.
A measure of how much the 2,073 companies in the FTSE All-World Developed Index fluctuate in unison has dropped 31 percent since June, the biggest decline since at least 1993, data compiled by Societe Generale SA and Bloomberg show. That makes it easier for money managers to pick stocks that beat the market, according to Morgan Stanley.
Low trading volumes and government intervention pose challenges for investors. About $6 million of shares changed hands each day on Sri Lanka’s bourse during the past month, less than 1 percent of the $17 billion on the Shanghai Stock Exchange in China, data compiled by Bloomberg show.
Smaller volumes make it more difficult for money managers to sell holdings without affecting prices, Andrew Brudenell, whose $92 million HSBC GIF Frontier Markets fund returned about 24 percent last year, said in a Jan. 17 phone interview from London.
The MSCI Argentina Index tumbled 39 percent in 2012 and touched an eight-year low in November as President Cristina Fernandez de Kirchner seized control of the nation’s largest oil company and investors speculated the government may stop paying its international debt.
Fund managers can reduce risk by making long-term investments and avoiding countries that have a high chance of government intervention, said Thomas Vester Nielsen, who helps oversee more than $250 million in frontier markets as a senior money manager at Lloyd George Management in London. The LG Frontier Markets Fund, which returned about 37 percent in 2012, didn’t sell a single stock last year, he said.
One advantage of smaller markets is there are fewer money managers vying for access to politicians and company executives, according to Nielsen, who met with 284 companies in 24 countries last year. That makes it easier to visit with officials and gauge government policy and corporate strategy, he said.
Institutional investors have about $15 billion in frontier countries, said Schroder’s Sidani. That compares with about $330 billion in global emerging market funds, according to Cambridge, Massachusetts-based EPFR Global.
“It’s very early days for pension funds to have allocations to frontier markets because they are relatively small and illiquid,” Timothy Drinkall, the manager of Morgan Stanley Investment Management’s $54 million Frontier Emerging Markets Portfolio, which rose about 22 percent last year, said in a Jan. 23 phone interview.
Scarce information makes on-the-ground research more valuable. The fifty biggest companies in the MSCI frontier index have about 9 analyst recommendations on average, versus 29 for the MSCI emerging market index and 33 for the S&P 500, data compiled by Bloomberg show.
“Sometimes companies wonder why I’m there, they’ve never had a foreign investor visit before,” Stephen Mack, who helps oversee more than $100 million including the Frontaura Global Frontier Fund, which returned about 18 percent in 2012, said in a phone interview from Chicago. “You’ve just got to do the legwork.”
BankInvest’s Skov boosted holdings in East African Breweries after he learned during a November trip that the company is tapping into demand from Kenya’s poorest consumers.
Senator brand beer, introduced in 2004, has become popular among Kenyans who can’t afford the company’s premium brands such as Tusker, Skov said in a Jan. 15 phone interview from Copenhagen.
To keep prices and costs low, Senator is distributed to local bars in kegs instead of individual bottles. The company also gets a tax break from the government because the beer has become an alternative to home-brewed alcoholic drinks that pose health risks, said Skov, who oversees more than $200 million.
While East African Breweries returned 88 percent in the past 12 months, the $2.7 billion company is valued at 22 times reported earnings, less than the average of 40 times for brewers in Africa and the Middle East, data compiled by Bloomberg show.
The stock’s 50-day volatility of 15 compares with a reading of 16 for AB InBev, the world’s biggest brewer. The Leuven, Belgium-based company, which has a market value of $151 billion, has climbed 53 percent in the past year.
When Mobius and von Hardenberg were looking for investment opportunities in Nigeria as bad loans to speculators sent the country’s bank stocks tumbling in 2009, they turned to Nestle SA for advice.
The world’s biggest food company, which has operated in Africa’s most-populous nation since 1961, said it trusted Lagos-based Access Bank to finance its local unit. The Templeton fund bought shares and was rewarded as the lender gained 136 percent in the past 12 months, lifting its market value to $1.6 billion.
Nigeria was Mobius’s biggest country holding as of Dec. 31, accounting for about 13 percent of the Templeton frontier fund. The nation’s All-Share Index surged 40 percent last year after Central Bank Governor Lamido Sanusi removed soured loans from banks and encouraged takeovers.
Net income at Access Bank, which fell 47 percent in 2010, rebounded 41 percent the following year and increased at a 43 percent annual pace in the third quarter of 2012, according to data compiled by Bloomberg.
The lender trades for 1.1 times net assets, versus an average of 1.5 for regional peers. Its 50-day volatility of 29 compares with 31 for Bank of America, the second-biggest U.S. lender by assets. The Charlotte-based bank has gained 60 percent in the past 12 months and has a market value of $123 billion.
“These markets are tomorrow’s emerging markets,” Sidani, whose $57 million Schroder Frontier Markets Equity fund returned about 19 percent last year, said in a Jan. 14 phone interview. “They’re offering great growth prospects.”
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