The Frontier and small Emerging equity market is growing by number of countries, but as an institutionally managed asset class, it is struggling for survival and relevance.
The best of times. The Frontier and small Emerging equity market asset class is growing by number of countries, as the large emerging markets of Brazil, China, India, Korea and Taiwan overwhelm notionally global indices like MSCI EM. These FM and small EM countries are also generally growing faster than the rest of the world (large EM and Developed) because of a mix of improving economic policies (more orthodox), structural reform (security and governance, economic and capital market liberalisation), low penetration (of goods and services well established everywhere else) and the leap frogging of traditional developmental bottlenecks because of new technologies (eg mobile broadband and mobile money already with blockchain, distributed power, and drones still to come). Examples of poor economic policy and backsliding on reform like in Argentina, Lebanon, Nigeria, Tanzania and Zimbabwe are the exceptions rather than the rule. Consider the structural changes already achieved or underway in Colombia, Egypt, the GCC, Morocco, Peru, Pakistan and Vietnam. And there are new Frontiers on the horizon like Algeria, Ethiopia, Iraq, and Myanmar. This list might even include an ultimate return of Iran and Venezuela to the investable orbit.
The worst of times. But as an institutionally managed asset class, FM and small EM is struggling for survival and relevance. Many institutional funds focused on the “Frontier” opportunity (and their sell-side service providers) have dramatically shrunk over the last five years, perhaps from a peak of cUS$25bn assets under management to nearer US$10bn. Covering so many countries requires a large operating cost base – multiple geographies and languages and a myriad of trading and custodian accounts inhibit economies of scale. How can Bangladesh and Iceland both coherently fall under the same asset class? The liquidity accessible to foreigners is so low that it imposes a limit on how large assets under management can grow. For example, it is very difficult to deploy fresh capital into attractive stocks in appealing markets like Vietnam without getting trapped in low liquidity. As one expands the number of markets in the addressable universe beyond pure FM ie beyond the straight jacket imposed by index providers like MSCI or FTSE, the same problem of a few outsized markets affecting global emerging market funds arises: the likes of Philippines, Saudi, Thailand and Turkey overwhelm all others. And all of this against a backdrop where both FM and EM excluding Technology have underperformed DM, and asset allocators are more often than not choosing passive fund strategies in large EM for their non-DM exposure.
Keep calm and carry on. Still, the opportunity for active investors in countries that are generally growing faster than the global average, utilising technologies not available two decades ago in what have grown into today’s largest emerging markets, and, in some cases, enacting era-defining reform has, despite all the gloom, perhaps never been better. And the opportunity is still generally attractively valued. Whether the institutional fund management industry is best suited to take advantage is another story (in terms of sticky assets under management, useful benchmark indices, a mandate to address more than public equity).
In our report To the survivors the spoils, we rank the 35 equity markets we cover in FM and small EM in one framework against a backdrop of US-China friction, slow global growth, anaemic commodity prices. To access the full report, request a free trial today.