BlackRock Frontiers Investment Trust plc (LON:BRFI) is the topic of conversation when Kepler Trust Intelligence’ Research Analyst John Dowie caught up with DirectorsTalk for an exclusive interview.
Q1: John, can you explain for us what opportunities BRFI offer an individual investor that they wouldn’t be able to get anywhere else?
A1: So, BlackRock Frontiers Investment Trust invests in quite an unusual opportunity set.
If you think about emerging market equities, they’ve been an asset class, it’s been around for a bit of a while now, really coming to attention of investors somewhere in the early nineties when it was dominated by countries like Malaysia and Latin America but it’s very much changed over the years.
Now when you look at the emerging market equities, they’re really dominated by China and the big Chinese tech companies like Tencent and Alibaba and also, Taiwan Semiconductor, based in Taiwan, and Samsung in Korea.
So, really, the funny thing about emerging markets now is that they’ve really become an Asian-dominated sector and it’s really become what you might call middle-developed countries where really Thailand and Korea and China are a long way along the road of their economic development.
Where BRFI is very different is they’re now looking at the next set of countries which could go through economic convergence. So, they’re looking at the smallest, least developed economies in the world, looking at the likes of Sub-Saharan Africa, the Middle East, smaller Southeast Asian countries such as Vietnam and Thailand where really the countries look more like emerging markets did a generation ago.
These regions offer some intriguing growth opportunities, demographically they’re very young, even when you look at countries like China, they’re already starting to look more European in their demographics and the working population is shrinking, as of about two years ago. Really these frontier countries are starting with a very low economic base and so the opportunity to growth is very large.
Now, the thing is, in these countries, their stock markets are very small, if you look at something like the MSCI Frontiers Market, it’s got a market capitalisation 25 times less than just Apple Inc. on its own. So, frankly there are just not many people or many strategies that invest in it, frankly because the large institutional investors wouldn’t even look at buying simply because they couldn’t deploy a lot of capital.
So, really, BRFI’s opportunity set is really investing in smaller emerging markets, these frontier markets that are the future of economic growth in the emerging world rather than the more established incumbents that we see that dominate the index today.
Q2: So, what markets do they actually invest in?
A2: If you look at the markets they’re looking at, the biggest position at the moment is actually Saudi Arabia so they’re very keen on the outlook for this country. The reason being is that Saudi Arabia obviously is not a liberal democracy by any stretch of the imagination, it’s still essentially an absolute monarchy. It is obviously associated with pre-modern cultural framework, however, the country’s changed radically in the last five years.
Of course, it’s always been dependant economically on oil and, of course, a large segment of the thesis is on the currently high commodity crisis that we can see. However, there’s a lot more going on, we’re seeing quite radical social, cultural, economic change in Saudi Arabia, underneath the surface of the lack of political change that that people might see.
So, for example, one of the positions they held in is called the Leejam Sports, which is a gym operator in Saudi Arabia and it’s the first gym operator that has actually built a gym, especially for women. So, you’re seeing this combination of an excellent underlying bottom up proposition, they just like the company, the management and their growth prospects, but also the fact that the country that they’re looking at, they believe has got excellent prospects.
Looking at the portfolio, you’ll see a mixture of other regions as well so obviously we talked about the Middle East and the Middle East is a very interesting one because it’s currently only 6% of the MSCI Emerging Markets Index. This reflects the fact that obviously it’s not been, geopolitically, a stable region for a very long time, and this has scared away a lot of asset allocators. However, the managers of BRFI, so Sam and Emily are quite positive about the future of the Middle East, some of the major countries in that region is seeing the restarting of cross border investment between Saudi Arabia and Qatar, for example, are seeing flights that are restarting to countries like Dubai and Turkey who’ve been historically quite, shall we say, not getting on the best of terms.
So, the Middle East has become a big theme but we’re also seeing plays in Southeast Asia so Vietnam has been a major position for them for a long time. Vietnam is a country that is going through almost the transition that China did 15 years ago, just very high levels of economic growth driven by excellent demographics and market reforms. It really is a country that wants to improve the living standard of its populous.
You’ll also see in the portfolio, countries of former Soviet republics, Kazakhstan, there are various themes they’ll be playing here. Kazakhstan is home to the world’s lowest cost uranium miner in the world. So, they can play a top down theme of nuclear energy with a play there.
So, that’s some of the examples of what we’ll see in the portfolio.
Q3: What is the opportunity in these markets?
A3: The real opportunity is growth, the underlying economic situation of these countries is that they’re starting, frankly, from very low base, they’re often some of the poorest countries in the world, and that means that even the most basic growth can become very explosive very soon. As long as there is some kind of framework for markets to operate, companies can operate and grow enormously because frankly, if you are starting say with banking, many countries have enormous unbanked populations, they can start straight from, usually, banking through their smartphones, for example, and then suddenly they can reach tens of millions of new customers overnight.
So, for example, a stock like Kaspi, which is a Kazak stock, it comes under the FinTech label to use a bit of a buzz phrase, but it really is a model that shows the type of growth opportunities available when frankly, you had still had people who really had pretty poor access to financial services and they could really leapfrog the historical stages of development in the west to reach millions of new customers.
There’s also more traditional plays within these frontier and small emerging markets, they’re often driven by commodities so there are often commodity exporters, this makes them more similar to emerging markets 20 years ago. What’s interesting about commodities is you’re not necessarily just playing oil and gas, though that is a major theme in the portfolio because obviously there’s a lot of talk around the energy transition with the recent COP26 conference in Glasgow coming to an interesting conclusion in the end.
You can play other themes through commodities so for example, with electrification of cars, which is a trend we’re seeing globally, there is of course major debate about which car manufacturer will become the leader, whether you believe in Tesla or whether you think more established car manufacturers will be to catch up. Now, the nice thing about playing electrification through commodities, say lithium, is you don’t need to pick a winner because whoever wins, they will need car batteries, very likely that the technology will be based on lithium, therefore, if you have exposure to lithium, you have exposure to electrification of cars without making on the bet on the managerial skills of say, Elon Musk. So for example, BRFI invests in Cotizacion SQM, this is a mine in Chile, and it has got one of the largest lithium reserves in the world.
So, that is some of the opportunities, there are some growth opportunities, but there are also more traditional value type opportunities with mining, oil, energy and there’s also banking which is probably the most direct exposure to the economic growth in these underlying countries.
Q4: Now, you mentioned earlier that some of the asset managers are steering clear, but how do BRFI managers pick stocks for the portfolio?A4: There’s really two approaches they take that are complementary so might call it the top and the bottom up so top down and bottom up.
So, top down is really before we even start looking at individual stocks in a country, is taking a view on the country because especially with smaller emerging markets and frontier markets, you can get problems with economic stability and political stability. Right now, as we’re talking, there is clearly a currency crisis frankly unfolding in Turkey, right now BRFI does not have any exposure to Turkey. Interesting, Sam, the manager, was actually in Turkey a couple months ago talking to companies on the ground, which is an important part of this process but they took the view that just given the very poor current account positions, the very poor governance around the central bank and the political pressure it’s under, that they simply didn’t want exposure to a country in that situation.
So that first step is to take a view on a country, really trying to view the stability of its currency and finances, debt levels, trying to make sure frankly, the country’s solvent so they’re not going to get caught in a crisis. It doesn’t always work, BRFI was caught a little bit with the Argentinian exposures in 2018/ 2019 with the unexpected political changes that occurred there. However, by and large, they have successfully navigated away from most of the potential pitfalls.
What they then do is once they take positively on a country, they’ll then pick their individual stocks in that country and really that’s about boots on the ground. They do like to get out to these countries and visit, that’s obviously been very difficult since the pandemic so, as I mentioned, Sam had actually visited Turkey a couple of months ago as mentioned in our latest meeting with him. Really, the key there is that they are trying to both meet the company management, to understand their vision for the company, whether they’re quality managers, whether they trust them to be stewards of their capital, but also to meet suppliers of those companies, the customers of those companies, competitors of those companies, truly trying to get a fully rounded understanding of the company before they invest capital.
Frankly, one of the things is about these countries is that there’s not a lot of other research so a lot of fund managers will rely on sell-side research, research done by analysts and investment banks on stocks to health inform their view. Currently, the amount of coverage on these stocks is minimal, simply because they’re so small, as previously mentioned, the entire market capitalisation of the MSCI Frontiers Index is 25 times less than Apple. So, the amount of research being done on these companies is minimal, therefore they can bring the whole resources of their BlackRock Emerging Markets team to really understand these companies, both from a qualitative and quantitative point of view and form a view about which stocks they want to invest, once they’ve decided that that exposure to that country is favourable so that’s how they go about it.
Q5: How do the managers implement their investment ideas then?
A5: One of the issues around investing in frontier markets and smaller emerging markets is that some of the stocks are, are relatively illiquid, some of them are actually reasonably tradeable in most circumstances, but there are some of the stocks that are more difficult to access. This is in aside of one of the advantages of running strategy in a close ended vehicle, just because they can manage the flows in and out of their portfolio at their complete discretion over that.
One of the tools that Sam and Emily use to implement their portfolio, especially in some of the countries where it might be difficult to direct the access, some of these stocks they’ll use a type of derivative called Contract for Difference or CFD, something a lot of retail UK investors will actually be quite familiar with, it’s quite commonly used in the UK.
The reason they do this is that not only does it give access to stocks they otherwise wouldn’t, but they can also actually do some interesting things with them. First of all, they can actually go shorter stock so, if in the course of their research, they find a company that actually they think is rather overpriced, that’s been misunderstood by the market, and they think things aren’t actually going to go particularly well, they can actually bet against that stock. That’s a really useful tool, it just gives them another way of adding value for investors through their research which otherwise wouldn’t be possible in a more conventional portfolio. A CFD, because you can gain access to a stock without fully investing 100% of your cash to buy the instrument, you can actually gain what’s effectively a form of leverage, there are limits and controls around this level of leveraging gearing but it does mean that when market conditions are good and the managers are bullish, they can increase the overall market exposure of the portfolio, which is another way they can add value.
Q6: You’ve given a lot of background and understanding around the trust, but performance wise, how have they done compared to mainstream emerging markets?
A6: When you look in the long run, BRFI has done fantastically versus more conventional emerging market strategies, looking over a 10 year timeframe we’re looking at performance well over 100% versus around 60% for mainstream emerging markets. However, this has not been a smooth ride, it’s not a one way street, there are times when they will underperform and when they will outperform, and this is really driven by a couple of factors.
Currently, as we discussed earlier, the mainstream emerging market index is now dominated by China and some of the large tech stocks, so again, Tencent, Alibaba, TSMC and Samsung, and if those stocks do very, very well, naturally they will struggle a bit. So, for example, the immediate aftermath of the pandemic, where people saw that because of lockdowns, the global trends and digitization were going to accelerate it, those types of stocks did very well and BRFI lacked. However, when what’s now known as vaccine mandate to market participants, when Pfizer announced vaccine trials last November, there was suddenly a real switch where, because a strong recovery was anticipated, suddenly very cyclical companies that had exposed to say energy, did particularly well and this really benefited BRFI who have had a superb 2021 and really a superb rally ever since that point.
In fact, 2021, their relative performance versus EM is looking even better, frankly because in February, there was a major crackdown by the Chinese Communist Party on various tech companies in China. Some of it very politically driven, all of it politically driven, it must be said, for the likes of Alibaba and this meant China has really struggled, has really sold off, so the mainstream EM index has really struggled, whereas this is not impacted BRFI at all.
I think this illustrates the value of the trust in that if an investor has an element of their portfolio that is dedicated or allocated to emerging markets, then BRFI is a very differentiated vehicle. It is really investing in markets are completely outside of the mainstream benchmark, there’s very little crossover with any other emerging market strategies that an investor likely owns. So, not only is it attractive with markets still very cheap, it’s still very high yielding as we said as well, but they also just tend to move very differently to the other markets that would be in an emerging market allocation. Recent performances demonstrated that where 2020 might have more difficult, 2021 has been, to date at least, a very good year for them.
Q7: Now, you touched on this a little when you said that Sam had pulled out a Turkey, but what are the managers doing with the portfolio at the moment?
A7: The current shape of the portfolio is really based on a couple of top down views, one is, and this is a position we’ve discussed before, is they’re very positive on Saudi Arabia and there are several reasons for this.
Saudi Arabia has been chronically underinvested by other asset managers for a long time, they’ve tended to be wary of the political risks in the region, geopolitical tension in the region, and it’s meant that a lot of opportunities been left on table.
The view is that actually Saudi Arabia is changing quite dramatically, socially and economically, underneath the surface of static politics and they’re seeing a lot of bottom up opportunities, a lot of individual companies that are particularly attractive. So, they’re taking the view that not only does these companies alone stand as being attractive opportunities, but there is this potential kicker that if other asset managers actually start allocating to the Middle East in due course, this would cause a rerating of that market and subsequent capital gain.
One of the advantages of being a frontier market investor, or an investor in small emerging markets, is that essentially, you’re getting ahead of the crowd and the idea being that you are, the first mover, so that you buy into places where once maybe the story picks up a little bit of momentum, starts getting a little bit more attention from more mainstream investors who might start allocating, you are in front of that wall of capital that then pushes up stock prices.
To give an example on the bottom up individual stock, the opportunities they’re seeing in the region, we’ve already discussed Leejam Sports, as a reminder it’s a gym operator that has launched the first gym where women can go to in Saudi Arabia. So it’s really kind of a cutting edge of the social and cultural changes that are occurring there.
In the wider Middle East region, they’re also looking at a company called Integrated Diagnostics, it’s an Egyptian company, they were actually invested in it pre-pandemic, but its profile has really been elevated by the pandemic as it’s obviously been involved in a great deal of testing for COVID19, it’s still been overlooked by analysts.
One of the unfortunate side effects of economic development in the Middle East has been the growth of what we might call the disease of civilisation, especially diabetes is particularly becoming a serious issue in the region and they are just a market leader in diagnostics of that awful disease. So, although the company has come to the attention of the broader market for the COVID19, really, it’s an opportunity that the team are looking for, where there is a story about developing, improving lifestyles like quality of life, in this case healthcare, in an economically developed region.
So that’s the kind of opportunities that are current being exploited in the portfolio.
Q8: Finally, John, what’s the outlook like for BlackRock Frontiers Investment Trust dividends?
A8: An interesting thing about frontier markets is that because they are relatively niche markets that are pretty keen to attract foreign investment, they tend to pay very high dividends.
So, looking at the current yield, it’s just shy of 4%, which for a strategy that actually isn’t technically an income strategy is really very attractive indeed, and if you look at the FTSE All-Share as we speak, it’s probably just over 3% in terms of yield. So, dividends of this strategy, of this trust, have been growing pretty significantly year on year and right now, we don’t see that changing.
So, it’s kind of usual in the current market landscape where you can invest for both growth opportunities, but also get a nice dividend whilst you’re there so it’s an interesting combination, somewhat unusual.
I think also an interesting proposition for income investors who are often quite concentrated in their exposures geographically obviously, often heavy concentration in the UK being another high paying market and we think this can just add a little diversification and different source of income streams for those investors who are particularly interested in receiving dividends.
You can discover more about the BlackRock Frontiers Investment Trust at blackrock.com/uk/brfi