22 October 2019
GAM Investments’ Tim Love reflects on the performance of his frontier market plays, Vietnam, Argentina, Romania, Pakistan and Saudi Arabia (VARPS) so far this year and discusses the investment opportunities and risks associated with these economies.
Frontier markets are typically less mature than emerging markets (EM) owing to their associated political risks and lack of ability to meet the MSCI EM index inclusion rules. The latter can often be due to lack of transparency to investors surrounding a company’s values, soft capital controls and non fungibility of the currency, as well as arbitrary free float restrictions / foreign ownership level limits. This in turn can mean investors can reap significant returns, but also potentially suffer significant losses given the difficulties in accessing information, liquidity and exiting some of these markets.
Our favoured frontier markets in 2019 have been the VARPS – namely Vietnam, Argentina (US listed e-commerce plays only), Romania, Pakistan and Saudi Arabia – countries which have yielded investors attractive trading opportunities over the last few years. We explain our near-term outlook for these markets.
The Vietnamese economy continues its strong upwards trajectory, with economic growth this year projected to be in excess of 6% – the highest rate in Southeast Asia. We believe the country continues to reap the benefits of its agricultural exports and supply chain benefits deriving from the US-China trade dispute. Economic reforms have certainly bolstered the country’s outlook while its demographics are incredibly pro-business friendly – over 65% of the workforce is under the age of 35. Wages are also low enough to attract foreign investment and indeed at more attractive levels than China’s.
Vietnam was Southeast Asia’s strongest performing stock market in 2019 and is a strong country overweight of ours. We favour the construction sector, namely steel, as a beneficiary of Vietnam’s luxury real estate boom / industrialisation programme and the dairy sector as the cash-laden middle class here trade up for a healthier lifestyle.
Argentine voters will head to the polls on 27 October in order to elect the country’s president and vice president, as well as almost half of all congressional seats. The elections come at a crucial time for the country as it battles an ongoing economic crisis.
Though various governments have tried hard to repackage Argentina into an investment destination through various reforms, we feel the country has severe creditworthiness issues.
The country’s wide scale programme of monetary and fiscal tightening is likely to keep Argentina’s economy in a state of recession this year and beyond. It will be interesting to see what unfolds on the election front and it would probably be wise to wait for some of these headwinds to abate. For this reason, we believe a reduced exposure to local Argentina plays is advisable and American Depositary Receipts (ADRs) can be a preferable option to access Argentine stocks for now. ADRs are beneficial because they allow investors to access liquidity here without an immediate fear of capital controls.
Romania’s government spooked investors in late December 2018 by slapping a tax on its banking sector, triggering a slide in the country’s banking stocks. In turn, ratings agencies threatened to downgrade their outlook for Romania and the move attracted criticism from eurobloc members and the Romanian Central Bank. In the aftermath of this announcement, the bank taxes have been partly repealed and we favour an overweight position in that sector to exploit the rebound.
From a long-term perspective, we believe Romanian banking stocks are very attractive owing to strong capital buffers, strong yields and declining non-performing loans (NPLs). We also favour exposure to property because Romania is increasingly acting as an industrial hub for many European Union (EU) core companies looking to relocate production bases.
Ultimately we believe Romania is an underestimated growth engine of Eastern Europe, with Italy, Germany and France increasingly moving their supply chains there. Romania in essence is a typical ‘convergence play’ into the EU and has benefited from several strong tailwinds over the years.
Despite some risks here on the political front, Pakistani stock valuations look extremely attractive and we plan to enter attractive investment opportunities as and when they crop up. We favour exposure to politically uncomplicated sectors such as raw materials.
For now, we favour a slight underweight position to Saudi Arabia; it is currently a complicated situation here because of politics, oil shock fears and the execution risk from the economic transformation programme away from hydrocarbons. We are waiting for calmer Middle Eastern politics and more evidence of short term fiscal deficit projections before we gain more confidence here. We believe Saudi Arabia has more attractive prospects owing to the huge privatisation programme taking place which aims to unlock state-owned assets. A new reformist government is aiming to diversify the economy’s dependency away from hydrocarbons in order to make it blossom into a high value tech economy – a giant USD 500 billion mega tech city, known as NEOM, is currently being built in northwest Saudi Arabia, for example. In terms of thematic plays here, we favour car hire firms as well as the banking sector.
We believe frontier markets offer an aspect of diversification to a wider EM portfolio as they are non-correlated in nature due to their lower levels of liquidity in comparison to the more developed EM markets, such as China or India. However, as highlighted above the political and economic climate of these countries can be volatile and it is important to keep a close eye on any changes. We believe accessing the best frontier markets can also offer liquidity; after all, we feel that all the best frontier markets eventually graduate to full EM MSCI equities index status. This allows investors to capture the earlier part of that progression with the safety of full EM market diversification / liquidity benefits.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.