Frontier rewards outweigh the risks

Fund Strategy - 25 Jun 2012 | By Beth Brearley

When BlackRock’s Sam Vecht was asked to run a frontiers market mandate in 2007, he “vigorously” refused, highlighting a plethora of problems in these markets.

Despite liking the long-term story for frontiers markets, Vecht was wary of several concerns, such as the extended property bubble in Dubai and the Middle East, going so far as to short these countries in some of his portfolios.

However, three years later the world was a different place, with some markets having fallen 70-80% in dollar terms since 2007. By December 2010 the time seemed ripe to launch the BlackRock Frontiers investment trust.

“Fast forward to 2010 and many of the problems we talked about had occurred,” Vecht says. “We thought, ’now is an interesting time to be launching’. We thought we would launch when there was upside to be had, instead of when the outlook was questionable.” (Investment trusts continues below)

When building the product, there were three criteria that needed to be established, Vecht says. The vehicle had to be closed ended to enable the managers to focus on investing rather than flows; the managers must take a five-year view owing to the risky nature of the markets; and the board should take the unusual step of providing a get-out clause for investors, enabling them to redeem at net asset value (NAV) less cost after the first five years.

“We want investors to relax,” Vecht says. “They can redeem their shares in December 2015 so there is no focus on whether the trust is trading at a discount. Very few investment trusts do this.”

In the six months to March 31, the trust outperformed the MSCI Frontier Markets index benchmark, with the NAV up by 12.1% against the 11.2% average. The trust also paid out its maiden dividend last year and is paying out an interim dividend this month.

“Because stocks are so cheap and companies are paying out chunky dividends, and there are areas in Muslim countries that are expected to pay dividends, we paid three US cents for the year ending September 30 2011. This year we are paying an interim dividend of 1.3 US cents and have forecast a further dividend this year.”

Vecht attributes the trust’s recent performance in part to its exposure to Nigeria, a significant overweight in the portfolio, and also to Iraq.

“Nigeria went through a severe banking crisis in 2008/2009, which it is emerging from now,” Vecht says. “The banking system is being cleared up and the banks are trading on five or six times earnings. They are being re-rated from extremely depressed valuations but are still extremely cheap, while the dividends are better than expected.”

Vecht highlights United Bank of Africa as the largest single contributor to performance in April after rising nearly 50% that month. “We initiated the position in February after the company announced a profit warning on 2011 earnings. The stock was extremely cheap and significant write-downs had masked strong underlying profitability driven by a low-cost deposit base.”

Looking at the performance from Iraq and the county’s potential, Vecht says: “Over time Iraq will become an important place for the production of oil. We began to see this in Q1 this year.”

He adds that the entry of oil and gas firm Exxon into the Kurdistan region of Iraq has proved to be “extremely profitable” for the company’s long-term holdings in the area.

On the flipside, Vecht says “anything in Europe” has hampered performance. “The debt levels in the European frontier markets are far lower than in the rest of Europe but they are guilty by association.”

”We thought we would launch when there was upside to be had, instead of when the outlook was questionable”

However, this has enabled the manager to add to stocks on great valuations, such as Kazmunaigas Exploration, Kazakhstan’s largest energy company, which trades on a cheap price to earnings ratio of just five times, with a dividend yield of 7%.

Vecht maintains a low turnover in the portfolio, with a change of just 1% in May and 30-35% last year. There have been no notable changes to the trust’s core countries - Nigeria, Qatar and Kazakhstan - but Vecht has been adding to Vietnam after being negative on the country 18 months ago.

“[In April] Vietnam continued its good run, which has seen the bourse gain over 35% year-to-date, rebounding strongly after poor performance in 2011. The shift in sentiment in Vietnam reflects policy measure to address inflation, which declined to 10.5%, down from August’s high of 23%.”

Vecht also opened a position in Bangladesh this year after the market fell between 50-60% in the year to January 2012, investing in stocks such as Grameenphone, a Bangladeshi telecom company. “Bangladesh has many of the characteristics of India but is far smaller, just 1% of India,” Vecht says. “It has a hard-working population and the ability to grow its economy. We were concerned about the market as the valuations were excessive, but the market fell when the speculative boom ended.”

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