Hunting for frontier ideas in emerging markets – focus on the ‘Four neighbours’

Adam talks about why some EM-based companies growing aggressively in frontier markets, and explains the “Four neighbours” phenomenon.

One aspect of the fund I like to highlight to investors is the name: it is the Frontier Emerging Markets Fund instead of the Frontier Markets fund. Why?

One trend we notice at Fidelity is the amount of investment by Emerging Markets (EM) companies in frontier markets (FEM). These corporates seek out opportunities beyond their borders partly because their home market has become more mature. Thus we find great stock ideas in EM that are geared to the positive trends in frontier markets but with relatively higher levels of trading liquidity and corporate governance.

These stock ideas, though, tend to be concentrated in four EM countries: South Africa, Chile, Poland and Thailand. As you can see from the chart 1 below, almost 50% of the purchases by companies in the “Four neighbours” are located in frontier while it’s only around 10% in the rest of EM.  

Why does this phenomenon exist? In my view, the economies of the four neighbours are more mature and have a lower cost of capital.

As seen in chart 2, the four neighbours tend to have slower real GDP growth than the rest of EM - hence the companies are looking for likely external opportunities for growth.

As well, their domestic consumers have quite high relative income / capita vs EM and FEM (see chart 3) which in addition to high local market share, generates significant cash flows to reinvest.

And with a wide spread between their own and FEM cost of capital (see chart 4), its logical they would want to invest in FEM countries which likely remind them of their own countries 20-30 years ago in terms of penetration of general products and services.

Add on the final benefit of geography and sometimes similar cultures or languages and you have a great recipe for EM based companies growing aggressively in frontier markets.

Hence South African companies tend to look north to Sub-Saharan Africa, Polish companies have expanded into the rest of Eastern and Southern Europe, Chilean companies are quite active in the Andean region and finally, Thai companies have invested significant capital in Indochina including Myanmar.

This back drop has generated many very attractive stock ideas which are in the portfolio today.

Thanks for reading,

Adam Kutas

 

Chart 1: South Africa, Chile, Poland and Thailand companies versus rest of EM: FEM targets % of total outbound deals
South Africa, Chile, Poland and Thailand companies versus rest of EM: FEM targets % of total outbound deals
Source: Credit Suisse

 

Chart 2: Real GDP growth for Chile, Poland, South Africa and Thailand versus EM % YoY
Real GDP growth for Chile, Poland, South Africa and Thailand versus EM % YoY
Source: Credit Suisse

 

Chart 3: Gross National Income (GNI) per capita (PPP adjusted US$) for FEM, EM and Chile, Poland, South Africa and Thailand
Gross National Income (GNI) per capita (PPP adjusted US$) for FEM, EM and Chile, Poland, South Africa and Thailand
Source: World Bank

 

Chart 4: Nominal policy rates for Chile, Poland, South Africa and Thailand versus FEM (GDP weighted)
Nominal policy rates for Chile, Poland, South Africa and Thailand versus FEM (GDP weighted)
Source: Thomson Reuters


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