Flash update: BlackRock Frontiers

• BlackRock Frontiers (BRFI) has a strong track record across all time periods.
• Domestic rate cuts and political developments are supportive of markets in many key countries in BRFI’s universe.
• Recent drivers of performance have been very diverse, reflecting the variety in the investment universe of the smaller emerging markets and the frontier markets. In the six months to the end of March, they included a Polish Bank, a Turkish gold miner, and holdings in Kazakhstan and Indonesia.
• Managers Sam Vecht, Emily Fletcher, and Sudaif Niaz remain positive on Indonesia and have increased their weightings to the Philippines. They have also initiated positions in Bangladesh, Egypt, Kenya, Nigeria, and Pakistan, all countries they have not had exposure to in some time.
• The managers’ positive outlook for their region is reflected in net gearing rising to 15% as of the end of June from 12% at the end of September 2023, well above the five-year average net gearing position of 107%. Both long and net exposure have been close to the highest it has been over the period in recent months.
• Strong earnings growth in the portfolio has led to an increase in revenue generated from dividends, resulting in a hike to the interim dividend from 3.1 cents to 3.5 cents per share.
• The shares trade on a discount to NAV of 9.3% at the time of writing, and the board has not been buying back shares, based on its assessment of the reasons for the discount.

Performance

BlackRock Frontiers (BRFI) published interims this summer, in which it reported a NAV per share gain of 12% in USD for the six months ending 31/03/2024. This was well ahead of the benchmark’s return of 8.6%. Perhaps more significantly, it was also ahead of the 10.4% return delivered by the MSCI Emerging Markets Index, against which most investors are likely to benchmark their emerging market holdings. Since the period end, BRFI’s NAV has fallen slightly, but it remains ahead of these comparators over a one-year view and indeed three- or five-year views.

There were remarkably strong performances from some stocks in the six months to the end of March. PKO Bank Polski rose 69.9% as the Polish market rallied after elections in October. Bank Syariah Indonesia rose 61.1%, while Turkish gold miner Eldorado Gold rose 57.2% as the gold price rallied. Individual positions in Georgia, Kazakhstan, and Latin America also delivered strong returns.

Some of these companies benefitted from political developments. For example, Polish election results were seen as pro-business, while Argentinian stocks rallied following the election of Javier Milei as president. The newly elected president of Indonesia was also viewed as a net positive for markets, expected to continue the policy direction of his predecessor.

On the other hand, there were some negative political developments in certain countries which underlines the potential volatility and the need for active management in this universe. Political instability hurt Thai equities, for example, while Georgian equities sold off at the end of the reporting period and since as the government implements controversial pro-Russia press reforms.

The managers note that 75 countries, representing c. 50% of the world’s population, will hold elections by the end of 2024, which is leading to opportunities and risks across their universe, and this is informing their current positioning (see below).

Over the longer run, BRFI has delivered attractive returns versus mainstream emerging markets investments and its own benchmark. As the below chart shows, over five years, it is significantly ahead of both.

Positioning and outlook

Saudi Arabia makes up the largest allocation in the portfolio in absolute terms, although the portfolio is underweight versus its benchmark. In 2024, the managers have taken out a new position in Al Rajhi Bank, which they expect to outperform in the event of rate cuts. As the Saudi currency, the Riyal, is pegged to the US dollar, rate cuts should follow whenever the US Federal Reserve moves. Additionally, the managers note that the evolution of the Saudi economy is opening up exciting opportunities, with the banks offering exposure to them by virtue of supplying credit.

Indonesia is the second-largest absolute exposure and remains a country of high conviction. It is benefitting from its role as a major source of nickel, and its ability to do business with both China and the USA. The country has banned the export of nickel, encouraging the domestic production of products that use the metal, including those in the electric vehicle supply chain. This has encouraged investment by Chinese EV manufacturers BYD and Neta Auto, while the US continues to pursue a deal to give it access to Indonesia’s raw materials too. Sam, Emily, and Sudaif point out that, so successful has the country’s management of this economic advantage been, that the current account deficit has halved from 3% to 1.5% of GDP. They argue this should foster a virtuous cycle as it makes Indonesia less reliant on borrowing from abroad and therefore attracts foreign capital, potentially resulting in increased domestic liquidity and higher economic growth.

In the same region, the managers have recently increased their exposure to the Philippines. Rate cuts seem to be on the horizon, and Sam, Emily, and Sudaif take the view that an improving macroeconomic backdrop, the potential for a boost from lower rates, and low sentiment towards equities, particularly from foreign investors, have improved the risk/reward calculus. In fact, there are a number of countries in their universe in which it looks like rate cuts could be imminent, which should be positive for the respective equity markets.

BRFI’s universe is strikingly diverse, full of countries with different drivers and complex domestic situations. The managers integrate macroeconomic, company-specific, and political analysis to handle this challenge. They spend a considerable amount of time travelling around their universe, which provides them insights into the economic and political situation that can’t be earned at a desk in London. Additionally, they build a model of the economies in their universe and where they stand in the economic cycle. Strikingly, in recent months the managers have initiated some small positions in countries in which they have not invested for some time, namely Bangladesh, Egypt, Kenya, Nigeria, and Pakistan. They see these countries as having struggled in a difficult global environment in which the pandemic and subsequent high interest rates have reduced the availability of and raised the cost of external funding. Having passed through a recession, Sam, Emily, and Sudaif think they are poised to expand once more, informed by their macroeconomic analysis and recent visits, and the managers argue that buying at this point in the cycle can deliver strong returns.

Overall, the managers sound a positive note on their universe, and this bullishness is reflected in the level of gearing they have implemented. As of the end of March, net gearing (the green line in the chart below) was around the highest it has been over the past five years, thanks to high levels of long positioning. They argue many of the smaller markets look especially attractive, with equity markets and currencies both cheap and politics, stable or better.

Kepler view

We think it is always worth sitting up and taking notice when managers increase their gearing levels, as it can be hard evidence that they are bullish about their portfolio rather than talking about their own book. In that light, we think BRFI’s net gearing being near historical highs goes to show the level of conviction Sam, Emily, and Sudaif have in the immediate outlook for their universe. It seems that a strong macroeconomic picture is combined with a supportive political environment in many of their countries of investment, while valuations remain cheap by international comparison. While BRFI has delivered good returns over the past year, we think the fundamentals imply that we are still at the beginning of an upward move in its markets, and in that light, the discount of c. 9% at the time of writing is particularly attractive.

However, there are risks to be borne in mind. The recent interims highlighted a few examples of the volatility that can be seen in the smaller emerging markets. Notably, events in Georgia threaten political instability and the possibility of a difficult environment for foreign investment. That said, BRFI’s diversification offsets somewhat the risks of issues in any one market. Another risk to be borne in mind is that any significant downturn in the global economy would likely drag in the smaller emerging and frontier markets in which BRFI invests. Fortunately, the current picture is brighter than it has been for some time in the developed world, which is a key source of demand and investment for emerging markets.

We think BRFI’s differentiated proposition should offer a lot to many portfolios. The smaller emerging and frontier markets are unlikely to figure in the typical emerging market fund, and the resources BRFI devotes to researching companies in these often-overlooked countries increases the chance the managers can add alpha and manage the risks. While Chinese equities are also cheap, and indeed bounced in Q1, its economy still remains troubled and political risk remains high, and we think balancing out exposure to this country and the more developed north Asian countries of Korea and Taiwan remains appealing.

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