It may seem only for the brave, but investing in smaller and more illiquid markets may boost a share portfolio’s long-term returns — though local investors will have to scratch hard to find many “frontier market” options.
One of these is the dollar-denominated Allan Gray Frontier Markets Equity Fund, which had $716m under management at the end of January.
At first glance the fund’s average returns since inception almost six years ago — an annualised 5% — aren’t exactly what you’d expect as compensation for the risk of investing in these emerging markets.
Why, in fact, put your money there at all? “A great starting point is when you judge [some of these frontier stocks] on their long-term valuations,” says Allan Gray’s Varshan Maharaj. “They are trading at very low p:e valuations.” In addition, the currencies in which these stocks trade, on local bourses, are “very weak against the US dollar” at the moment, he says.
Another reason for the low valuations is that “sentiment is very negative against frontier markets” right now. “Over the past few years money has been taken out of frontier markets and moved back to the US,” Maharaj says.
The divestment from these markets, which include the likes of Kenya, Egypt, Bangladesh, the Philippines, Kazakhstan and Slovenia, has razed stock market prices. In fact, 2022 was a horrid year for them: the MSCI frontier markets index slumped more than 26% in dollar terms, compared with the MSCI emerging markets index’s 19.7% decline. The MSCI frontier emerging markets index, which Maharaj’s fund tracks, has eked out a slightly better performance of a 17.8% decline.
But, says Maharaj, these declines mean only one thing: “There is a mismatch between what these [frontier market] companies are trading at and what we value them for.”
There is a mismatch between what these [frontier market] companies are trading at and what we value them for
— Varshan Maharaj
In Bangladesh, Maharaj’s fund has picked up Olympic Industries, a fast-moving consumer goods company with some runway left. He likes the “high-quality business, with a high return on equity”. The stock traded at a p:e of 14.4 on February 13 and a dividend yield of 3.6% in the Bangladeshi currency, taka.
“Where South Africa’s AVI has saturated this country’s market, Olympic Industries is still growing,” he says. “In Bangladesh, GDP is still increasing, and we see better opportunities in Olympic Industries than in AVI.” Originally a battery manufacturer which listed on the Dhaka Stock Exchange in 1989, Olympic Industries expanded into the production of biscuits, cookies, confectionery and bakery goods.
“What we also like about Olympic is that the same family who started it still owns a large stake in the company,” says Maharaj. “It’s good to have skin in the business.”
Another Bangladeshi pick is Square Pharmaceuticals. The company was founded in 1985 and today takes advantage of the trade-related aspects of TRIPS, the World Trade Organisation’s intellectual property rights exemption. In essence, the exemption allows for states that cannot afford patent rights in health care to manufacture key medicines without coughing up royalties.
On February 13, Square traded on a p:e of 8.75 and a dividend yield of 4.6%. “The company is growing sales and earnings a lot,” says Maharaj. In 2022, Square’s basic earnings per share jumped 14% after a similar increase a year earlier. “Even in US dollars, they’re growing.”
Two things about Square stand out for Maharaj. “About 30% of the company’s market cap sits in net cash on its balance sheet. Over the years the company has grown its cash pile due to uncertainty about, among other things, the local economy.”
— Maharaj draws a comparison between the Philippines, with its more than 113-million people, and Vietnam — a recent strong contender for investor funds
Second, Square seems to have dodged the bullet during the Covid pandemic. “[Unlike] its domestic rivals, such as Renata, Square didn’t participate in the vaccine rollout,” says Maharaj. Many pharmaceutical distributors across the world ended up with large vaccine stockpiles which had to be written off as large-scale vaccinations didn’t materialise as expected.
Maharaj draws a comparison between the Philippines, with its more than 113-million people, and Vietnam — a recent strong contender for investor funds. “Both countries have large populations, but stocks in Vietnam are expensive.” In the Philippines, Maharaj sees “most value in about 10 family-owned conglomerates on the stock exchange”.
One such conglomerate is Alliance Global Group, which owns the McDonald’s master franchise in the Philippines and 85% of the listed liquor producer Emperador. Alliance reported net sales of 82.6bn pesos ($1.5bn) for the six months to June 30 — or 26% higher than the comparable period a year earlier.
“Alliance is trading on a forward p:e of six,” says Maharaj. “We are buying more of this stock.”
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