The mid-year update on frontier emerging markets

city street in India

After strong performance in both 2016 and 2017, frontier emerging markets (FEM) equities are down 8–9% year-to-date in 2018 (all returns in U.S. dollars)1. As seen in Chart 1, other international equity asset classes, including international developed markets and traditional emerging markets such as China and India, were also weak, with many investors seeking the perceived safety of the U.S. market. Global investors also became nervous, given headlines about trade wars.


Chart 1: Market performance year-to-date as at June 30, 2018 (in U.S. dollars)

Total Return (%)
1 month
1 year
3 years
5 years
MSCI Frontier Emerging
S&P 500
S&P/TSX Comp
Source: FMR.


As seen in Chart 2, energy and consumer discretionary stocks performed well as oil prices rallied, while utilities and industrial sectors performed poorly, with the rise in global interest rates hurting stocks sensitive to economics and interest rates.


Chart 2: Top five/bottom five FEM sectors year-to-date in 2018 (in U.S. dollars)
Chart 2: Top five/bottom five FEM sectors year-to-date in 2018 (in U.S. dollars)
Source: FMR.


In terms of frontier countries, as Chart 3 shows, large countries like Argentina came under pressure. Conversely, energy-geared countries performed well, including Colombia. However, as seen in Chart 4, which ranks frontier country equity market performance annually, diversification matters: the ranking changes each year.


Chart 3: Top five/bottom five FEM countries year-to-date in 2018 (in U.S. dollars)
Chart 3: Top five/bottom five FEM countries year-to-date in 2018 (in U.S. dollars)
Source: FMR.


Chart 4: FEM countries’ annual performance ranked by best (top) to worst (bottom) (in U.S. dollars)
Chart 4: FEM countries’ annual performance ranked by best (top) to worst (bottom) (in U.S. dollars)
Source: FMR.


So how is the outlook for the rest of 2018? From my perspective, frontier markets have taken a breather after strong earlier performance and are facing many headwinds, including rising global rates, weaker commodity prices and strong results from global technology companies. As seen in Chart 5, valuations (using a simple price/book measure) across global equity classes support frontier equities, especially relative to the U.S. market. In addition, with the pullback in many markets and the headlines about trade wars and emerging-market contagion, investor sentiment levels have been reset, thus improving the relative opportunity for global investors. As seen in Chart 6, revenue and earnings expectations for frontier equities in 2018 and 2019 are fairly robust.


Chart 5: Equity asset classes – Average trailing price/book
Chart 5: Equity asset classes – Average trailing price/book
Source: FactSet and MSCI.


Chart 6: Revenues and earnings expectations (2018–2019) (%)


2018 EPS

2019 EPS
Source: Bloomberg.

Structurally, FEM fundamentals remain attractive, given higher relative returns on capital, low levels of debt, the ongoing gain of manufacturing share from China, low levels of investor participation and attractive valuations. Accordingly, given the pullback, the Fund has been putting capital to work in the markets with the most attractive fundamentals, including Vietnam, Bangladesh and, to a lesser degree, Argentina. Given the political and sovereign issues in Pakistan, equities have become very attractive there, due to the market share gains for textile manufacturing and Chinese infrastructure investments. However, we need to get past the volatility of upcoming elections in Pakistan; while we wait, we are researching the best ideas, including companies in the automotive, financials and cement  industries.

By region, the portfolio has the following positioning and themes: in Asia, the Fund is biased toward companies gaining manufacturing share (Vietnam, Bangladesh). Secondly, in the Middle East and Africa, the focus is on opportunities in Middle East tourism, African staples and African fin-tech (particularly companies in the UAE and Kenya). Finally, in Latin America, the Fund’s exposure is a mix of cyclical and consumer-oriented companies, most based in Chile and Colombia.


Thanks for reading,

Adam Kutas

1 FMR., as at June 30, 2018.

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