Valerio Baselli: Frontier markets might be tempting for growth-hungry investors with a big appetite for risk. To talk about that, today I’m joined by Rami Sidani, Manager of the Schroder Frontier Markets Equity Fund.
So, Rami, I’d like to start asking you if you can explain very briefly what are the main differences between emerging markets and frontier markets.
Rami Sidani: The frontier market by definition, it’s just basically not under the emerging market status as per the MSCI classification. The common denominator among all frontier markets would be underdeveloped capital markets. These are nascent markets that are less developed than their emerging market counterpart.
VB: Perfect. And among those markets, what are the most attractive right now and why?
RS: So, Vietnam by far is the largest component of the frontier universe. It represents close to 30% of the asset class. You need to think of Vietnam, what people used to think about China for the emerging market universe 20 or 25 years ago, when China was going through its strife, recording GDP growth of 6% to 7% and acting as the manufacturing center of the world. The size of Vietnam in the asset class reflects the size of the opportunity. This is by far, I would say, the most compelling. It’s an economy growing at 6% to 7% attracting close to $30 billion in FDIs (Foreign direct investments). So as the world looks for alternatives, Vietnam is emerging as a new manufacturing center attracting these FDIs.
The large investments are expanding the middle class and creating a wealth effect that is highly supportive for the domestic consumption story. Vietnam got upgraded by the World Bank from a lower income country to a lower middle-income country with expectations for it to get upgraded again to an upper middle-income country over the next couple of years. So, this is a compelling structural growth story that we think will continue to deliver very strong returns.
Another interesting story across our universe is the Philippines, which also continues to benefit from a competitive cost advantage, attracting FDIs especially in the areas of BPoS (Banking Product or Service), where international companies are investing in a country that enjoys a highly skilled labor, English speaking and an intelligent culture. This is also attracting investments which, as I said, consequently is highly supportive for the job creation and is subsequently the domestic consumption story.
In Europe, the largest position and exposure we have is Kazakhstan. Kazakhstan is a turnaround story across the frontier universe. This is, again, a country that’s not really a mainstream market on the global investment map, but there is a new leadership that is implementing reforms, clamping down on corruption and setting the right multi-friendly policy to attract investment. We’re talking about fully penetrated economy with massive financial buffers, a sovereign wealth fund with close to 60% of GDP that is also presenting a compelling structural growth story for the next five years.
VB: All right. And on the other hand, what are the main risks involved in these markets and how do you manage them? I think, for example, of liquidity risk or even on a broader level, political risk.
RS: So, these markets have been implementing a flurry of reforms over the past few years in order to attract investments, which, as I said, has been a very important driver to create jobs and has been a pillar for the investment case for these markets. So, these reforms are key for our investment case when investing in these markets. The largest, for instance, in our universe is Vietnam, and today Vietnam is emerging as an alternative manufacturing center for global companies given the need to diversify away from China. So, we’re seeing heavy FDIs going into these markets, which, as I said, is driving economic growth.
A main risk would be any slowdown or delay to implement these reforms could become potentially an impediment against the ability for these markets to attract investments and act as an alternative production center for the world, which is the trend we’ve been seeing over the past few years. As you rightly mentioned, these markets are smaller, they’re less liquid, and accordingly, one needs to be disciplined on the size of assets that is being managed across these markets. And this is something we keep a close watch on.
VB: All right. And finally, why, in your opinion, an investor should invest in frontier markets over emerging markets?
RS: These markets, simply put, are emerging as the new manufacturing centers. They are the manufacturing centers of tomorrow. We’ve seen a massive rise in China over the past 30 years. Today, the world is looking for alternatives. We’re seeing massive FDIs coming into these markets. We are seeing a step-up as the educated new generation get into the more complex industries. These nations and these economies are no longer making saree, garment, t-shirts, footwear. They are today going up the ladder of the manufacturing complexity to produce more high-tech stuff, just the more complex and more expensive items, which is creating the wealth effect that’s highly supportive for the domestic consumption story.
Baselli: Very interesting. Thank you so much for your time, Rami. For Morningstar, I’m Valerio Baselli. Thanks for watching.
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