Frontier markets could outstrip emerging markets over the next year, according to investors including Mark Mobius, with fixed income plays looking particularly attractive.
We asked three explorers used to boldly going where few investors have gone before what lies ahead.
Mike Conelius, T.Rowe Price
Portfolio manager, emerging market bonds
Frontier markets are a heterogeneous group consisting of several dozen lower-rated countries. Economic growth, debt levels, monetary policy, institutional independence and transparency can vary significantly, stressing the importance of fundamental research that can require significant on-site due diligence.
However, these inefficiencies can also generate attractive, idiosyncratic investment themes in countries that are relatively uncorrelated with global capital flows.
Today, a number of frontier countries offer the right mix of improving fundamentals and adequate market liquidity. The majority of opportunities reside in hard currency bonds, although in some cases, the local currency bond market offers attractive real yields or declining interest rates.
Jamaica and Serbia are countries that continue to reward investors through sustained, long-term reform programs that have improved debt sustainability, fiscal deficits and policymaker effectiveness.
More recently, countries such as Egypt have emerged as good investment candidates, boasting IMF-supported adjustments that seek to anchor fundamentals through a floating exchange rate, tax reforms and replacing poorly targeted subsidies with an improved social safety net.
At a time when many asset classes appear richly valued and susceptible to political and economic uncertainty, well-chosen frontier markets have the potential to offer long-term investors attractively priced, idiosyncratic investment opportunities.
Mike Cirami, Eaton Vance
Co-director, global income & portfolio manager
Frontier markets can offer great opportunities for investors who are willing to research the right countries. While the growth profiles and trajectories of these economies vary, they are generally under-represented in benchmarks and overlooked by investors, which creates strong investment potential.
First, this oversight leads to significant inefficiencies between the direction of a country’s economic and political fundamentals and the way assets are valued.
For instance, Serbian local debt markets are not part of any major benchmark, but have seen a dramatic decline in risk premia – most notably in the decline in interest rates – as the policy environment has improved significantly over the past decade.
Second, the under-representation of frontier markets in investors’ portfolios means they tend to be uncorrelated with traditional ‘risky’ assets.
Volatility is closely linked to investors’ herding mentality, so this decorrelation allows frontier market assets to trade more purely on fundamental changes such as policy reforms, often irrespective of what is happening in bigger markets, more influenced by the ECB, the Fed, Brexit, presidential elections and so on.
Getting the country right is by far the most important factor in international investing, whether the market is frontier, emerging or developed.
For this reason fundamental country analysis is always the primary focus of our research.
Thomas Delabre, H2O Asset Management
Investment management team
This trend dates back to the pre-global financial crisis era when low global yields forced investors into new territories. This new appetite enticed frontier economies to move away from largely concessional- based financing from the likes of the World Bank and IMF to a more market-based model.
The shift has proved to be a win-win as investors have since been collecting higher yields, while these countries gained access to new funds for their much-needed development.
The trend is likely to continue, along with the rise of marketable sovereign debt, as the share of concessional debt remains high in relation to these economies’ increasing financial needs, especially if commodity prices remain at a lower level than before.
Furthermore, frontier markets represent long-term investment opportunities for yield enhancement purposes as they tend to pay higher premiums due to weaker institutions and lower liquidity.
However, the argument that these markets, as a sub-asset class, provide superior diversification is weaker. Their beta remains high in periods of market stress and the fact that they exhibit a significant correlation with commodity markets will keep their fate closely linked to mainstream emerging economies.
As a result, differentiation will be key at the global emerging market level, between frontier and ‘mainstream’ markets.
This article was originally published in the April issue of Citywire Americas. To sign up to receive our free magazine, follow this link.