By Philip van Doorn, MarketWatch
Investors’ interest in emerging markets stocks is back. They may want to travel a bit farther to so-called frontier markets for even better returns, said Sandra Ackermann-Schaufler, portfolio manager for international and emerging markets for SEI Investments.
Frontier markets — those that haven’t yet achieved designation as emerging markets by MSCI Inc. — may grow even faster, she said.
First, here’s how the MSCI Emerging Markets Index /zigman2/quotes/210598082/delayed XX:891800 +1.09% has performed over the past five years:
The five-year return of 53% isn’t impressive when compared with the 102% return for the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.66% over the same period. Of course, that’s not a fair comparison, but it does illustrate how difficult the ride has been for emerging markets — until recently. The MSCI EM Index has returned 22% over the past year.
But over the long term, the faster growth rates for emerging and developing markets could lead to better investment performance than in developed economies. This chart, using data compiled by Ashmore Group, compares average historical and expected gross domestic product (GDP) growth rates:
Ackermann-Schaufler oversees the management of 10 international equity funds with combined assets of more than $19 billion. She joined SEI in 2009 to reorganize the company’s International and Emerging Markets Equity Investment Strategies Group and improve its performance. Before that, she was a portfolio manager at Merrill Lynch.
In an interview and subsequent email exchange, we focused on two funds:
• The $1.9 billion SIT Emerging Markets Equity Fund, which has Class F /zigman2/quotes/205452926/realtime SIEMX +1.30% and Class Y /zigman2/quotes/203355956/realtime SEQFX +1.30% shares, and was described by Ackermann-Schaufler as a “classic” EM fund.
• The $1.2 billion SIIT Emerging Markets Equity Fund /zigman2/quotes/206689117/realtime SMQFX +1.15% , which invests more heavily in small-cap EM companies and has exposure to frontier markets. (Editor’s note: It’s correct that one is called SIT and the other SIIT.)
MSCI reviews its market classifications annually, and it’s an important process because of the passively managed funds that aim to mirror the index and the actively managed funds that benchmark against it. Here’a link to MSCI’s current lists of countries in developed, emerging and frontier markets .
“We believe a lot of smaller EM countries have similar characteristics to frontier markets,” Ackermann-Schaufler said, pointing to significant growth potential as people in those countries adopt new technology and develop more sophisticated financial services.
She went on to say that “there is a lot of benefit to stay away from more developed countries, such as Korea and Taiwan,” because the less developed countries have much younger populations and are “more geared toward the consumer sector.”
“We decided it would benefit out clients to lean away from more developed EM markets toward frontier markets,” Ackermann-Schaufler said.
When discussing specific emerging market and frontier market stocks, Ackermann-Schaufler pointed out that information-technology companies make up 26.6% of the MSCI EM index, while financial-services companies account for 23.6%.
Some investors may still believe that “emerging markets” means materials and energy, which make up 7.1% and 6.6% of the index, respectively. The banking sector in particular is “underpenetrated” in frontier and smaller emerging markets, she said.
Seven frontier-market stocks
Here are some of Ackermann-Schaufler’s favorite frontier-market stocks, in five countries:
Halyk Savings Bank of Kazakhstan /zigman2/quotes/201781414/delayed UK:HSBK +2.06% is held by the SIIT Emerging Markets Equity Fund. The bank acquired KKB, a distressed competitor, with government assistance in July, making it “the largest bank in the region,” according to Ackermann-Schaufler.
She likes the bank because of her positive view of the “turnaround” in Kazakhstan’s currency and because the bank’s leading position should enable it to attract more deposits and make more loans.
Kaz Minerals is held by both SEI funds. The company expects 78% of its revenue this year to come from copper, with zinc, gold and silver making up the rest.
Ackermann-Schaufler expects Kaz Minerals to “nearly double” its revenue in 2017, with production “ramping” at two recently commissioned copper mines in Kazakhstan. Another copper mine is in the “scoping stage,” she said.
She sees “meaningful” upside potential for the shares, which trade for about six times the consensus forward earnings estimate. “Clearly, commodity pricing and sentiment as well as any delays or production issues will be the key risks we are monitoring for this investment,” she added.
Both of the Argentine banks Ackermann-Schaufler discussed are held by both funds.
Under the administration of Mauricio Macri, who was sworn in as Argentina’s president in December 2015, investors are looking at an “attractive, credible macro story,” which should allow the country’s banks “to have ample room to grow and create value,” Ackermann-Schaufler said.
“Credit to GDP is at 15%” in Argentina, which compares with 88% in Chile, 52% in Brazil, 43% in Colombia, 40% in Peru and 22% in Mexico,” Ackermann-Schaufle said. This leads her to expect Argentina to have the fastest growth in credit over the next two to three years.
She called MSCI’s decision in June not to upgrade Argentina to an emerging-market designation from a frontier market “a bit of a blow,” but also said “it is only a matter of time when, and not if, it will happen.” The World Bank expects the country’s economy to expand by 2.7% this year, accelerating to 3.2% in 2018 and in 2019.