An uncertain environment
Geopolitical events have weighed heavily on equity markets in recent months. From sanctions against Russia and the potential for Greece to leave the Eurozone, to speculation about the end of quantitative easing in the US and when that might commence in the Eurozone, there is no shortage of events to raise investor concern.
Frontier markets are not immune to these worries, but they do have a lower correlation with developed markets than their emerging counterparts just 0.49 compared to 0.84. This means that frontier markets tend to be driven much more by local factors than large-scale macroeconomic and political developments.
From an economic perspective, these local factors remain very supportive. Not only are we expecting solid growth across the frontier market universe this year, significantly ahead of most developed or emerging economies, we also expect this to continue through the medium to long term, helped by supportive demographics.
The effect of oil
One of the most significant developments in recent months has been the sharp decline in the oil price. Many investors have assumed that this is negative for frontier markets, but it’s our belief that this concern is misplaced.
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For one thing, many frontier market countries are net oil importers, positioned to benefit from the oil price fall. Everything else being equal, the combination of a supportive economic environment and lower energy costs should be positive for companies in countries such as Sri Lanka, Bangladesh and Kenya.
For oil exporters, much also depends on the reaction of the authorities in countries which are affected. In the case of Saudi Arabia, the government has maintained its commitment to spending in areas such as education and healthcare. This has reassured the market, and has been beneficial for companies operating in these sectors.
Two keys to success
As we look out through the remainder of 2015, the keys to success will be security selection and geographical diversification.
The companies which are likely to deliver the most attractive long-term returns are well-managed, high-quality companies where we see potential for strong earnings growth for multiple years from here.
Identifying these companies requires thorough fundamental research and careful due diligence, as well as a deep understanding of their business model and competitive environment.
And also being conscious of the fact that theres an advantage in having a relatively broad geographical breadth to the portfolio to ensure prudent diversification.
As mentioned, one of the virtues of frontier markets is that markets tend to have low levels of correlation with each other as well as with developed markets. By looking for companies which are attractive individually and ensuring a level of geographical breadth, investors benefit from a more robust and less volatile investment portfolio.
Michael Levy is investment manager of the Baring Frontier Markets Fund.
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