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Emma Wall: Hello and welcome to Morningstar series, "Why Should I Invest With You?" I am Emma Wall and I am joined today by Michael Levy, manager of Baring Frontier Markets Fund.
Hello Michael.
Michael Levy: Good morning.
Wall: So, your fund went great guns last year for about two-thirds of the year and then there has been a sell off both in the fund and in the benchmark. What caused that?
Levy: In Q4 of 2014 we certainly saw a correction in frontier markets. In the fourth quarter the markets were down about 12.5% in U.S. dollar terms. I think there's a variety of facts that caused the correction. Oil prices were certainly influential and the fall in the oil price had an impact on some of large frontier markets like Nigeria, Kuwait and Kazakhstan. Additionally, localised political factors also had an impact.
So, for example, in Bangladesh there were some strikes organised by the opposition, some of these were violent strikes and had a negative impact on investor sentiment. In the South China Sea there was tension between China and its neighbours like Vietnam. That also impact investor sentiment in Vietnam. So, there were a variety of factors that caused the sell-off. But ultimately, I think the markets in frontier markets are really consolidating after a very strong period of returns.
2013 and 2014 were both very strong years. So it's natural for markets to consolidate. Additionally, some of the inflows into frontier market started to stem off as uncertainty surrounding the U.S. rate cycle caused investors to maybe momentarily reduce or stop asset allocation shifts.
Wall: Of course, the thing about frontier market is, we have to be able to storm volatility. It's not just going to be a slow and steady smooth ride. It's going to be periods of fantastic rallies and then periods where there are little corrections because these markets do have these political risks associated as you mentioned.
So, then I suppose the question is, as a fund manager do you stick to the stocks in your basket knowing that the fundamentals are strong or when you do have this sort of backdrop, do you make corrections because the oil price thing may go on for some time?
Levy: Firstly, on the point of volatility, I think it's true to say that individual frontier markets can be volatile by nature, they are frontier markets. But the overall asset class volatility historically has not been very high compared to, for example, emerging markets and the return volatility trade off in frontier markets has actually been more favorable than it has been for emerging markets.
So part of that is down to the fact that frontier markets are very, very diversified. They are very heterogeneous and intra-country correlation is low. So, as a result, frontier markets are a fantastic source of diversification for investors.
In terms of how we deal with volatility. The way we invest at Baring is we invest in high-quality companies that have long-term structural growth opportunities where there is lots upside. So we typically use any volatility to adjust position sizes in portfolios. But we have a medium to long-term outlook for our stocks and we just use price action to maximize opportunities.
Wall: Talking about those opportunities then, you've got about – you've got a good chunk of the fund in Africa stocks, you've got a good chunk in the Middle East. But I know you've been moving out of the Middle East into Asia. Perhaps, you could talk about the opportunities there.
Levy: Certainly, all our moves in the portfolio are driven by bottom-up factors. Whilst we look at macroeconomic and political cycles, really what drives our decision are bottom-up stock-specific factors. So, we've really been finding better opportunities in the Asian markets and I can give you a few examples. So, for example, in Bangladesh, there is bank called BRAC Bank, which is an SME lender. There is a lot of growth in the SME lending market as one could imagine because of the under penetration. But what's exciting about BRAC Bank is it has Bangladesh's leading mobile money platform called bKash.
In frontier markets mobile money is a huge theme. People don't have bank accounts but they have mobile phones. So in Bangladesh 75% of the population has a mobile phone only 20% of the population has a bank account. So the way people transact and become economically and financially inclusive is by using mobile money transfer.
Wall: We're only just getting this in the U.K. So they are streets ahead of us.
Levy: They are streets ahead and Kenya has actually set the world record. It is the market leader in the globe. But Bangladesh is catching up rapidly. So, if you look at Bangladesh, in 2012 0.7% of the GDP was transacted on a mobile platform.
By the end of 2015 we expect about 10% of GDP to be transacted on a mobile platform. So, it's a huge growth opportunity and bKash has a leading market share. It has around 60% to 70% market share. It has the best network, the best brand. So, we expect that to be a great model to exploit, this trend and this opportunity.
Wall: You did mention there earlier that 2013 and most of 2014 were extremely positive for frontier markets. Going forward now that we've had this split can we expect the same or is it difficult to tell?
Levy: Look, it's always difficult to give short-term forecasts for market directions, but our belief is that frontier markets in the medium to long-term are an incredible exciting opportunity, probably one of the best opportunities in public equities. They not only give you diversification, they give you currently pretty cheap valuations. Frontier markets are trading on a forward P/E of around 9 times, which is far, far lower than emerging and developed markets.
We're seeing political reform in frontier markets. Whilst there are political issues, there's very strong reform agendas in markets like Pakistan, Nigeria, Sri Lanka. On top of that, and ultimately why we want to invest in frontier markets is growth and there are fantastic structural growth opportunities in frontier markets.
I mentioned mobile money transfers, but it's also true in education, in healthcare, in the consumer space we're finding a plethora of stock-specific opportunities that we think will be long-term winners. So we have a very optimistic view of frontier markets.
Wall: Michael, thank you very much.
Levy: My pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.