Art by Klaus Kremmerz
As institutional investors continue looking for ways to add balance to portfolios amid ongoing market volatility, some are re-examining frontier markets. While such economies carry more risks—liquidity, governance and foreign exchange, among others—they are also experiencing tailwinds that could create outsized returns.
“One of the most interesting trends is the growth of consumption in these markets,” says Sergey Dubin, portfolio manager for frontier markets equity at Harding Loevner LP. “You have young populations that are moving from villages, where they earned a subsistence living, to cities, where they get higher-paid jobs in manufacturing. As their income goes up, their demand for all kinds of discretionary products also accelerates.”
That consumption trend is also supporting a shift in the retail landscape, from mom-and-pop stores to organized chains. At the same time, these new consumers are looking for banking solutions and turning to smartphones and fintech apps to manage their money and complete transactions, Dubin says.
Such trends create opportunity for investment. Dubin says he is following Kaspi.KZ, a fintech company in Kazakhstan that began as a digital lender but has evolved into a “super app” that allows users to manage money, pay bills and purchase goods.
While most developed counties have experienced little to no gross domestic product growth in the past year, countries like Indonesia and Kenya are growing at 5% or more, says Yalin Karadogan, partner and head of investor solutions at LeapFrog Investments.
“We’re not feeling that recessionary feeling in most of our countries that we invest in,” he says. “If anything, we are seeing buzzing, happening economies with companies getting access to financing and delivering really high company growth rates.”
Karadogan says that within emerging economies, LeapFrog is looking specifically at companies in health care, financial services and climate solutions, with an eye toward impact. That strategy is drawing increased interest from institutional investors, he adds.
“Our investments really touch the emerging consumers, and they not only generate positive impact in their lives, but they’re also able to get fantastic growth rates,” he says. “These sectors also tend to be driven by technology to a certain extent.”
Supply Chain Reshuffling
Another trend benefiting some frontier markets is a continued shift in global supply chains as international companies look to expand beyond total reliance on China or any single market.
“In addition to the economics, U.S.-China trade and policy tensions are causing big question marks for U.S. business, and one aspect of this is the uncertainty of a China-Taiwan war,” says Ashish Chugh, the global emerging market portfolio manager at Loomis, Sayles & Co. “That was brought home when Russia invaded Ukraine. Something that seemed distant and unlikely became top of mind. If Russia can do it, why can’t China?”
Such sentiment has benefited places like Vietnam, Dubin says, which has a young, literate population and benefits from lower manufacturing costs. In recent years, Vietnam has been moving from manufacturing apparel and furniture into higher-value products, including electronics such as smartphones and computers.
Some Eastern European countries are also benefiting from growing manufacturing sectors, as well as an increase in tech outsourcing. Romania, for example, has done a good job managing inflation and growth in recent years.
“Romania recently had a very big IPO of one of its utilities [Hidroelectrica] that brought in billions of capital from foreign investors,” Chugh says. “That was a big success. There are some bright spots in frontier markets, but you can’t paint everyone with the same brush.”
Chugh says that when looking at frontier market investments, it is important to consider not only the business itself, but also the country’s political stability, trade deficit and the resilience of its economies.
“If the country doesn’t have a diversified economic base, it’s vulnerable,” he says.
Karadogan says his firm considers foreign exchange risk when making investments, looking for returns that can offset even large currency swings. If a company grows revenue at 30%, for example, but the currency moves down 10%, that’s still a 20% gain.
Still, many institutional investors remain wary of the risks involved in frontier markets, which have delivered inconsistent returns for much of the past decade due to multiple exogenous events that have stymied growth.
“Sentiment around emerging markets has been pretty poor, and frontier markets are the redheaded stepchild of EM,” says Scott Thomas, lead portfolio manager for frontier emerging small companies at Wasatch Global Investors. “If people aren’t interested in EM, they’re even less interested in frontier markets.”
However, some institutional investors are turning back to frontier markets now, drawn by the belief that some may be less correlated with the trends that drive emerging and developed markets, making them a useful tool for portfolio diversification.
“The correlations are also low across these countries, which could be a positive from a portfolio diversification standpoint,” Thomas says. “Economically, what’s happening in Bangladesh is different from what’s happening in Argentina or Vietnam or Colombia. So when you put that into a portfolio, you can lower the risk and lower the beta of the portfolio overall.”
Thomas says the growth of smartphones in such countries is a major driver of significant opportunity.
“Six or eight years ago, you didn’t have the level and data and mobile phone usage to create a digital consumption platform,” he adds. “That’s creating a lot of possibility for growth in these new markets that’s attractive and exciting.”
Tags: Ashish Chugh, Harding Loevner LP, Indonesia, Kazakhstan, Kenya, LeapFrog Investments, Loomis Sayles & Company, Sergey Dubin, Special Coverage: Emerging Markets, Wasatch Global Investors, Yalin Karadogan