Finding Opportunities in Frontier Markets

So, Sam thanks very much for coming in.

Sam Vecht: Thank you.

Petroff: Now, let's go over what are frontier markets?

Vecht: Well, there are a series of different definition as to what a frontier market is. The one that we use is really somewhat defined by MSCI. There are about 190 countries in the world, there are about 20 or so which are classed by MSCI as developed, there are about 20 or so that are classed by MSCI as emerging, and we would consider the remaining 140-150 as frontier markets.

Petroff: Okay, so that's a pretty wide remit in a Frontier Market Fund.

Vecht: A very wide remit. We obviously don't invest in all of them. We focus on about 30 of those countries, the ones that we think are the most compelling. Clearly, some countries are moving in a positive direction, some less so.

Petroff: What do you like about those 30 frontier markets? What are you finding there that's different from emerging markets and developed markets?

Vecht: On average, frontier markets are seeing better GDP growth than we see even in emerging markets. They've got better demographic trends. We're seeing companies at lower valuations. We're seeing companies with better dividend yields. Add to that, general progression towards improvements in the political situations in many of these countries and the development of the middle class in many of these countries, and for us it's a pretty compelling story.

Petroff: I'm surprised about the dividend yield. I wouldn't have expected that in frontier markets. How do they pay a dividend?

Vecht: It's interesting. The yield on the frontier market index--the MSCI Frontier Market Index--is actually 4%. And I think it's interesting that in certain countries it's expected that you pay a dividend, especially in Islamic countries, where there are prohibitions on interest, it’s expected that the way you return money to shareholders is through dividends. So, countries like Saudi Arabia, Qatar and even countries such as Nigeria have a very good history and a track record of paying significant dividends to shareholders.

Petroff: So, which countries do you like right now?

Vecht: As we sit today, the countries that we most prefer would be Nigeria, UAE (United Arab Emirates), and Vietnam.

Petroff: Okay, and why those countries in particular?

Vecht: I think each one of those is a rather different story. Starting in the East perhaps, Vietnam is a country that's had financial challenges over recent years. We think it's gradually emerging from those challenges. Vietnam is very competitive when it comes to producing goods far cheaper than China. We think they've got inflation under control and there is a wide range of companies in a variety of sectors that are highly profitable and growing fast.

United Arab Emirates, again a country that's been troubled by financial problems in years 2008-2009, again emerging from that period of challenge. I think we're seeing a very high number of tourist arrivals in Dubai. We're seeing a re-growth in the property sector there, and I think that's a very positive development.

And Nigeria is a much longer-term story; probably the most interesting country for us to be investing in in Africa. A country with great potential and hopefully with better political stability and the right will in the government, some of its enormous potential can come to fruition.

Petroff: Now, I am just wondering about Vietnam in particular, because in January 2013, Vietnam did amazingly and Vietnam ETFs, in particular, were the best performing for that month. So, is there a concern that maybe it went too high, too fast? It's due to drop and you should wait a bit or…?

Vecht: Our strong view generally, and I think it's a really important point, is that one should look at frontier marketa as a whole as very dangerous to have exposure to any one of these countries. These are all countries with far greater risks than there are in developed markets. I would say parenthetically we don’t think there is much greater risk in investing in these than emerging markets, but clearly there are considerable risks in investing in these markets. And therefore, being exposed to any one country can create a very risky exposure for end investors.

Therefore, for us it's very important to have a blend of these countries. As I said, we are looking at 30, typically we have about 20 in our portfolio. And we have exposures across all of these countries, which help offset some of the risks in each of these individual countries. So, we are very cautious about countries where the market has gone up very sharply. That's why we didn't have very much exposure to Vietnam when we started on our investment trust. When the market fell 40% in 2010 and 2011, we added and went to a meaningful position, but now we've sort of taken our foot off for the short-term for exactly the reasons you suggest.

Petroff: Okay. And how would an individual invest in this market? You can't just necessarily go to Vietnam and open up a trading account?

Vecht: You can't. And in fact in most frontier markets this is very, very challenging. For an individual sitting in London or in Manchester, this is rather impossible. So, the best way to access these markets is either through funds, and there are some companies listed in the UK that do considerable amounts of business in frontier markets, but it's quite a challenge to build a portfolio of such stocks and that's not really our focus. So, this is a very different kettle of fish than probably investing that other people are used to. But for us, I think it's important to highlight that for any investment the key question is the risk/return profile. For us, frontier markets have a very compelling risk/return profile, far more compelling than mainstream emerging markets and that is one of the reasons why we are so positive about them.

Petroff: Okay, thank you very much for coming in today.

Vecht: Thank you.

Petroff: That was Sam Vecht from BlackRock. I'm Alanna Petroff. Thanks for watching Morningstar.