InvestmentsMar 29 2016

Fund Review: BlackRock Frontiers Investment Trust

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This £163m trust is run by Sam Vecht and Emily Fletcher and aims to achieve long-term capital growth by investing in firms operating in frontier markets, or stocks listed in those countries.

Ms Fletcher explains: “We typically look at companies trading with an average daily liquidity of around $1-2m – firms that have a market cap of around $1bn (£690m). We use that as a starting point. We give equal weight to both the top down and the bottom up in terms of determining the sorts of companies that we want to be invested in.

“The ideal would be an undiscovered story, stocks in countries with positive macro trends. We’re looking for firms with long runways of growth, sustainable margins and strong cashflows.”

The managers also take a view on currency on the basis that some of the countries they are investing in have much less developed capital markets.“We feel if you have a negative view on currency in a lot of these countries then the equity market is very likely to trade in tandem with that,” Ms Fletcher says. “The investors in our fund are hard-currency investors, they’re sterling or dollar investors, and that is how they are looking at their returns. We believe it’s important to take account of currency and fixed income markets when investing in these countries.”

One of the well-known benefits of investing in frontiers is the lack of correlation. She notes: “Not only are countries in frontier markets much less correlated to the more developed markets – to emerging markets or to the S&P [500 index] – they’re also less correlated to each other. But that low correlation means you can create a portfolio with low volatility at the headline level.”

One of the biggest changes to the fund in the past 12-18 months has been a reduction in exposure to Nigeria. The manager says: “Our view was with the oil price having fallen substantially, given the leverage the Nigerian economy has to the oil price, we believe that would put significant pressure on the domestic economic activity.” Meanwhile, the trust’s managers have been increasing exposure to Argentina, particularly in the run-up to the elections there last year. Ms Fletcher adds: “We believe the government is taking the right steps economically, and therefore we expect that over time the risk premium for investing in Argentina could come down substantially.”

Ongoing charges of 1.6 per cent apply to this fund.

The trust is down 0.05 per cent in the year to March 15, although it has protected itself from some of the downside, with the MSCI Frontier Markets index losing 11.5 per cent in the same period. The vehicle’s five-year performance is much better, delivering 45.2 per cent versus the Association of Investment Companies Global Emerging Markets Equities sector average return of a negative 3.2 per cent and the index’s positive gain of 20.4 per cent.

EXPERT VIEW - Lena Tsymbaluk, manager research analyst, Morningstar
We believe the team’s main strength lies in its ability to tactically shift the portfolio based on its macro views and experience in the region. For example, returns in 2015 were helped by the portfolio managers’ decision to reduce exposure to oil-exporting countries, such as Nigeria, in favour of countries benefiting from lower energy costs, including Sri Lanka, Pakistan and Bangladesh. The fund’s track record since inception in December 2010 has been strong, although investors should note the year-on-year relative returns can be irregular given the unconstrained approach.

Ms Fletcher attributes any outperformance to its holdings in Bangladesh and Pakistan. “In Pakistan we participated in some of the privatisations when the government was selling down stakes in various stocks. There have been one or two periods during the year when markets have sold off. We obviously are a closed-ended fund and therefore aren’t subject to the vagaries of daily flows, and that means if we see markets sell off we’re able to really take advantage of that.”

One of its Bangladesh-based stocks, Olympic Industries, was up more than 60 per cent last year, while the portfolio’s positioning in Argentine banks also helped performance. However, the managers sold out of some Iraqi oil stocks last year as they hurt performance.

“Sri Lanka is an illiquid market, and one or two of our holdings were hurt by competitors having outflows and needing to sell and there being insufficient buyers, so valuations were taken down somewhat,” Ms Fletcher says. But she is hopeful a loan from the International Monetary Fund to Sri Lanka will help the country, which is running a wide fiscal deficit.

The manager expects merger and acquisition deals to be more of a feature in frontier markets over the next five years, with one or two of the trust’s holdings currently subject to potential bids. “We believe frontier markets offer growth, they offer yield, they offer cheap valuations and they offer low volatility. They are one of the remaining areas within equity land where you are able to get substantial portfolio diversification and that is a significant benefit for investors.”