Top-performing emerging markets trust is considering expanding the range of countries it can invest in to ensure it maintains the record that won it a Citywire award last month.
Top-performing emerging markets fund BlackRock Frontiers (BRFI) is considering expanding the range of countries it can invest in to ensure it maintains the performance that won it a Citywire award last month.
Winner in the Global Emerging Markets category of our Investment Trust Awards, BlackRock Frontiers invests in countries that have not yet achieved full emerging market status. This has been a profitable strategy in the past five years, generating a 137% total return for shareholders compared to the average 52% return from trusts in the AIC's Global Emerging Markes sector.
However, its board has become concerned that the tendency for the best frontier countries to be promoted to emerging markets risks depriving the trust of access to the fastest-growing regions in the world.
Chairman Audley Twiston-Davies said in recent years UAE and Qatar among others had been re-classified as emerging markets by MSCI, compiler of the leading global emerging markets index, making them ineligible investments for the fund. Pakistan was elevated from frontier to emerging market this year while Nigeria and Argentina - one of the trust's strongest markets with a one-year gain of 46% - were under review, he said.
‘In light of this, the board has discussed with the investment managers, the option of widening the trust’s remit to construct a sustainable and consistent investment universe which will allow the company to access those markets which are fast growing and frontier in nature, show low correlation to more developed markets and are inefficient, and therefore offer the opportunity to generate attractive returns in excess of those available from the index,’ he said.
The MSCI Emerging Markets index is dominated by Brazil, China, India, Korea, Mexico, Russia, South Africa and Taiwan, with a combined weight of 85% and another 16 countries represent the remaining 15% of the index.
Twiston-Davies said those 16 countries were ‘often overlooked by investors in emerging markets’ and ‘share many characteristics with the markets which are currently defined as frontier markets’.
‘We have discussed whether it would be sensible for the company to expand its range of permitted markets to include these small emerging markets countries as and when opportunities are identified, but no decision has been made at the present time,’ he said.
The trust's fund managers, Sam Vecht and Emily Fletcher, said the problem was made worse by the fact that new additions to the frontiers index were not keeping pace with the number of countries gaining promotion to the emerging markets index.
‘As these countries leave the frontier markets index, there is a risk that the index loses the best performing countries and that concentration increases within the remaining index.’
Any change in the trust's mandate, which will require approval by shareholders, would not have convinced the managers to remain in Pakistan, however.
Pakistan's stock market has been a strong performer for the trust in the past five years but had become overvalued after its inclusion in the MSCI Emerging Markets index, the managers said, with ‘limited upside potential’.
The discussions around its remit were highlighted in the trust's latest annual report which revealed that the dollar-denominated portfolio achieved a total return of 21.5% on net assets in the year to 30 September. This was a good result but lagged the MSCI Frontier Markets index, which recorded a net return of 25.5% in dollar terms, and the MSCI Emerging Markets index which grew 22.5%.
In sterling terms, UK investors saw the net asset value of their holdings with income reinvested gain 17.7%, again trailing the MSCI Frontiers on 21.5% and the MSCI Emerging Markets on 18.6%.
Vecht and Fletcher said the underperformance was partly caused by them not allocating the full index weighting in Kuwait, which had soared 41% in response to economic reforms and rising corporate profits. The country is set to join the MSCI Emerging Markets index next September.
Like developed markets such as the US, the managers noted that the bulk of the gains in frontier markets had come from a narrow band of stocks. Just nine stocks in Argentina and Kuwait had generated around half of the frontier index return during the year.
Despite the trust's underperformance, Twiston-Davies said frontier markets ‘look relatively well positioned, with many of their economies displaying superior growth rates, lower debt burdens and pro-business governments which are implementing structural reforms to encourage and support growth’.
Over the year the managers increased exposure to the Middle East and Africa, adding to a position in Kuwait, where they said local stocks were ‘attractively priced following a number of years of underperformance’.
The devaluation of the Egyptian pound also provided an entry point for the fund in the north African country.
The trust's long-term performance is ahead of the MSCI benchmarks. Since its launch in 2010 to the end of September, the trust's total net asset value return in sterling has been 84.8%, beating the frontiers index net return of 54.2% and the emerging markets index net return of 33.7%.
Recognition of this has increased investor demand for the shares, recently pushing the stock to an 11% premium over net aset value at the end of November. This has eased back to 6% this month, but still above the 2.5% average premium of the past year.