The term “frontier markets” is typically used when describing a subgroup of emerging market countries. These countries represent a differentiated risk and return opportunity from broad emerging markets and typically have a number of common characteristics (such as a less mature political, macro economic and financial frameworks). However, according to Global Evolution, what frontier markets lack in economic size and maturity, they make up for in potential. “With a high projected real GDP growth over the next 5-10 years, global frontier markets are expected to have a firm grip on the world’s growth baton for many years to come”.
The broader emerging markets fixed income universe has gone through a major transition since the early 1990s. Back then the tradable markets were dominated by Latin American dollar denominated debt instruments and with JPMorgan’s EM fixed income benchmark, EMBI comprising less than 15 countries – typically rated below investment grade. Today EMBI Global Diversified comprises 62 countries of which many are rated investment grade.
As an experienced emerging markets fixed income manager with a history dating back to the mid 1990-ties, Global Evolution sees many similarities between the features displayed by today’s frontier markets and the features that characterized emerging markets of the past. Just as early stage emerging markets investors were getting well paid for taking risk in the 90’s and early 2000’s, “today’s risk adjusted return potential in frontier markets fixed income and FX looks similarly attractive”, explains Global Evolution in a recent report. “In our diversified Frontier Markets (Fixed Income) strategy comprising more than 35 countries the idiosyncratic event risk is manageable since the single country exposure is capped at 5% of the portfolio”.
Global Evolution Frontier Markets Universe
Global Evolution has currently identified 108 countries in the frontier markets universe of which 65 are investable right now.
Benchmark heavy local fixed income markets have become crowded
Over the past few years the divergence of advanced world and developing world macro fundamentals and not least debt and fiscal metrics have made emerging markets assets even more compelling from a risk diversification perspective. However, as a result, core local fixed income and FX markets represented in traditional emerging market benchmarks have become crowded with foreign holdings now around 30% on average. In this respect, Global Evolution points out that local frontier markets are significantly better positioned since a low foreign holdings ratio (typically below 15%) makes these markets less vulnerable to changes in global risk assessment and herd behavior.
Liquidity in Frontier Markets
Some investors have the perception is that frontier markets are illiquid and dramatically more volatile than traditional emerging markets debt and – for those reasons – frontier markets can only be seen as a buy-and-hold asset class. On the contrary, the local investor base in these markets is an important liquidity provider for frontier fixed income and FX-markets.
Philosophy and strategy
Global Evolution has been investing in frontier markets for more than 10 years which gives a solid background and expertise in identifying investment opportunities with attractive risk-return characteristics. In Global Evolution’s frontier strategy the portfolio investments are typically a combination of dollar denominated and local currency denominated sovereign debt and currency instruments. Dollar denominated debt is currency hedged whereas local currency debt is unhedged.
Frontier markets fixed income strategy with a target return of 10-12%
Over the past 10-15 years traditional emerging markets debt represented by countries such as Mexico, Brazil, Russia and Turkey has seen a significant spread compression that has left credit premiums and return potentials less appealing than they used to be. “It goes without saying that the risk of US treasury yields rising from present lows represents a strong potential headwind”, states the asset manager. With this in mind Global Evolution in December 2010 launched its first dedicated frontier markets fixed income fund in a European Ucits IV format with a targeted annual return of 10-12%. So far the firm is pleased to see that the performance of the strategy has proven robust.
Global Evolution, an asset management firm specialized in emerging and frontier markets debt, is represented by Capital Stragtegies in the Americas Region.
You may access the full report through the attached pdf file.