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Exploring new investment frontiers

Rob Morgan
BlackRock Frontiers Investment Trust invests in the world's nascent stock markets.

Frontier markets are countries with investable stock markets that are less established than those in emerging markets. They are nascent, much smaller and less accessible than emerging markets such as China, India or Brazil, and have fewer companies to invest in. They will also almost certainly be more risky countries, perhaps with increased danger of political unrest. The largest country weights in the MSCI Frontiers Index are Argentina, Kuwait and Vietnam.

The high level of risk is enough to put off many investors even considering frontier markets. Yet that can be part of the attraction. A relative lack of institutional investment means shares in good companies can be overlooked, and might be available at prices that compensate investors well for the additional risk and volatility. Furthermore, frontier markets tend to be driven more by internal economic and political developments than global events. This means there is sometimes low correlation with both developed and emerging markets, as well as other frontier countries, potentially an attractive feature in a world where so many assets and markets are interconnected. It means frontier markets can be a source of diversification in a portfolio.

BlackRock Frontiers Investment Trust, managed by Sam Vecht and Emily Fletcher, represents this niche area on the Charles Stanley Direct Foundation Fundlist of preferred investments. The managers spend a lot of time looking at the economic and political conditions of a country before considering individual companies to invest in. Essentially, they are looking for stable economies, and to avoid unhelpful political situations or where currency movements or inflation could hinder equity market performance. Governance standards can be a lot lower in frontier markets, and they place considerable emphasis on finding credible management who have regard for shareholder interests. Dividends are one sign that a company respects minority shareholders, and the Trust owns a number of stocks with surprisingly generous pay outs giving it a yield of around 3.1% (source: BlackRock); yields are variable and not guaranteed.

Returns have been strong since inception, and the past couple of years have been particularly good; although past performance is not a reliable guide to the future. In particular, returns from the largest constituents of the frontier market index, Argentina and Kuwait, have helped. Argentina emerged from recession in the first quarter of 2017 and the economy continued to expand through the rest of the year. In addition, a general election in October returned the incumbent pro-reform government. One particularly strong performer in the portfolio was utility Pampa Energia following the announcement of tariff hikes, as well as growth in its exploration and production business.

In Kuwait, the government continues to slowly implement a reform agenda and economic activity has picked up, leading to acceleration in company earnings. It was announced in September 2017 the country will be reclassified as an Emerging Market with effect from September 2018, and this could increase investor interest and help support share prices. The portfolio has had less exposure to Kuwait than the benchmark, which has slightly hindered returns on a relative basis given the strong performance of the market.

Elsewhere, positions in Kazakhstan such as Halyk Bank, Nigeria and Egypt have been key drivers, while more recently adjustments have been made to the portfolio resulting in an increase in exposure to Africa and the Middle East. This has largely been at the expense of South Asian countries such as Pakistan where the managers' views of the economic environment, currency strength and the investment opportunities available have changed.

Our view

One of the key advantages of using a small investment trust like this one to invest in this asset class is the ‘closed-ended’ structure. This allows the managers to adjust positions solely on investment grounds as frontier markets evolve, rather than being forced to do so as investors buy or sell the fund. Unlike unit trusts and OEICs there is a fixed amount of capital to invest, and this can be helpful when dealing with ‘illiquid’ frontier market shares in which trading can be difficult, or even impossible, in a given time period.

It is important to bear in mind that this niche asset class can have periods of weak returns, often linked to political instability, economic changes, currency movements or investor sentiment. Given the strong research-driven approach of the management team, we think BlackRock Frontiers is worth considering for exposure, but only for those investing a small part of a diversified portfolio in this still relatively unknown and potentially very risky area.

This research article is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investors should be aware that past performance is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. Investment decisions in collectives should only be made after reading the Key Information Document, Supplementary Information Document and/or Prospectus. If you are unsure of the suitability of your investment please seek professional advice.