(May 15, 2013) – The Cornwall Pension Fund has become the second local government pension fund to issue a tender for the management of an active global frontier market equity portfolio in the past few months.
Cornwall Pension Fund’s tender — which is for an initial £60 million investment — follows that of the Clwyd Pension Fund, which allocated £7 million to a segregated frontier market multi asset portfolio in December, 2012.
The tenders are extremely unusual for UK schemes – some pooled emerging market (EM) funds have small volumes of frontier market investment, but bespoke portfolios in the asset class are almost unheard of.
Is this the mark of a few pioneers, or the beginning of a new trend?
Jan Dehn, co-head of research at Ashmore Investment Management, told aiCIO while the interest in frontier markets wasn’t new, it had been more pronounced in recent months.
“Interest declined during the height of the global crisis in 2008 and 2009; we are now seeing a return to previous levels of interest,” she said.
“This interest in frontier markets is entirely justified. They are growing strongly and rapidly entering global capital markets – and market access is a major credit improvement for these countries which have previously not had access to pools of global capital.”
EPFR Global, which provides fund flows and asset allocation data to financial institutions, reported this week that the top 10 year to date leaders in gathering new assets were Bangladesh, Pakistan, Colombia, Philippines, Argentina and Vietnam Equity Funds.
In addition, net dollar flows into frontier market funds recently moved over the $1.8 billion mark. Dedicated BRIC equity funds, by comparison, have now posted outflows for 26 consecutive weeks.
David Wickham, senior product specialist at HSBC Global Asset Management, recently wrote in HSBC’s Investment Quarterly that now was a good time to consider frontier markets.
“The valuation opportunity looks attractive, with frontier markets trading on cheap valuations but with higher levels of return-on-equity,” he wrote.
“At present, frontier markets are trading on a price-to-book value of 1.6x, compared to 1.7x in EMs and 1.9x in developed markets.”
Wickham added that frontier markets generate in excess of 4% dividend on average, compared to global emerging markets and US equities at approximately 2%-3%.
Year to date returns in frontier markets are now up 14%, compared with -0.8% for emerging markets in USD terms, based on MSCI data.
“Frontier markets even exceed emerging market small caps and the S&P 500 so investors in the US, UK, Europe and Asia, whether institutional or retail are taking notice,” Wickham concluded.
The result of these good-looking valuations is pension funds wanting to find out more about the region.
A sentiment survey from Pension Mandate, which advises asset managers of mandates tendering, found frontier markets were believed to be the market’s best performers for the long-term by 19% of their respondents, and 15.6% believed the asset class would perform best in 2013.
And so, fund managers have started to move money into frontier market regions. Julie Dickson, head of equities at Ashmore, confirmed she had witnessed flows increase into so-called “off-benchmark” by global emerging equity managers as they seek to improve the income and yield profiles of their Global EM portfolios.
“Foundations have long been natural allocators to frontier market equities, and the disappointing returns in global emerging markets, coupled with lower dividends and higher volatility have made frontier equities a more attractive proposition,” she said.
Dickson’s not the only one spotting inflows – Bill Stoops, chief investment officer for Dragon Capital – a fund manager based in Ho Chi Minh City in Vietnam told aiCIO he too had seen more interest from dedicated emerging market fund managers.
“There’s lots of reconnaissance missions going on at the moment,” he said. “Many will come to Vietnam as part of a wider trip to other mainstream emerging market destinations, such as Thailand.
“They’re attracted to Vietnam because the economy has stabilised and the valuations are cheap compared to others in the region, such as Thailand, the Philippines, Singapore and China.”
The Vietnamese government has introduced a number of measures to help boost the economy, including introducing watchdogs to oversee economic policy, turning the trade deficit into a trade surplus and “whipping” inflation, according to Stoops.
“You don’t have to go from being bad to perfect – just moving from bad to less bad is enough (to attract investors),” he added.
Further steps need to be taken before major inflows will come into the region; the introduction of more privatised companies for one, the development of an institution to take away the bad loans held by many of Vietnam’s banks for another, but the steps have begun.
As with all frontier markets, concerns over environmental, social, and governance issues dog the region, including concerns over corruption and the fact it’s a one-party state, but Stoops believes the major market changes introduced are lessening investors’ fears.
“Whether concerns have diminished is hard to say, but the macro market environment is more attractive, so maybe they’re weighing that more heavily, compared to other issues in Vietnam,” he said.
Any investors considering allocating directly to frontier market funds, or indeed any other asset class, should be aware of the risks however.
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