Emerging markets have been hitting the headlines recently as one of the main causes of recent turbulence in global markets. 2013 was a dreadful year for emerging market assets and there has been no respite in 2014 as volatility spread to emerging market equities, bonds and currencies. Investors have been pouring out of emerging markets in response to the tapering of the quantitative easing policy by the U.S. Federal Reserve, together with concern that China, the world’s second largest economy, was heading for a “hard landing”.
Emerging market countries such as Turkey, South Africa and Brazil that depend on cheap foreign capital to finance current account deficits have been particularly vulnerable to the withdrawal of policy stimulus in the US, seeing their currencies depreciate significantly. A drop in currency value is of particular concern to emerging market companies that have borrowed money in foreign currencies. For example, Turkish corporates hold more than $160bn in foreign currency denominated debt and the plunge in the lira has pushed up their debt payments that will impact their profitability.
At Milford whilst we expect to see a continued downturn in emerging markets, we believe the long term prospects are still favourable based on low government debt, rapid urbanisation, favourable demographics, higher productivity and rising wealth.
In the Milford Global Fund we have a small allocation to emerging markets but are much more excited about the prospects for frontier markets. Frontier markets tend to be countries that are less developed with lower incomes than emerging markets. In effect they are up and coming emerging markets. It is a relatively new opportunity set for investors with the indices only launched in 2007. The index includes a diverse range of countries such as Kuwait, Qatar, Vietnam, Nigeria and Bangladesh. Frontier markets rose 24% in US dollar terms in 2013 while the mainstream emerging market index fell almost 3%.
The exciting thing about frontier markets is we see many of the same characteristics that emerging markets had before the big boom in their stock markets. Broadly speaking the frontier market story is one of catch up and convergence with what has occurred in emerging markets. The attraction of frontier markets includes a strong economic growth outlook, young and growing populations, rapid growth in middle class, increasing foreign investment, low government debt levels. From a market perspective they also offer diversification benefits as frontier markets have low correlations to emerging and developed markets and low correlations to each other. Foreign investors have very small allocations to frontier markets and that makes them less vulnerable to periods of market distress. In fact while emerging markets and developed markets have had a torrid time recently, frontier markets continue to shine. As I write frontier markets are up 1.9% year to date while emerging markets have fallen almost 7% and the US market is down 4%. Star performers in frontier markets include Vietnam up 10% and Dubai up 12% ytd, while in emerging markets, Brazil has fallen 10% and China is down 9% ytd.
The Milford Global team believe getting into frontier markets early has the potential to deliver strong growth for the Milford Global Fund over time. As such we have allocated just over 4% of the portfolio to frontier markets.