Mon, 17 Feb 2014
Because frontier markets are seen as risky, risk tends to get priced more dearly, and valuations look more appropriate for the type of risk you are taking, says Wasatch Frontier Emerging Markets Small Countries Fund manager Laura Geritz.
Jason Stipp: I'm Jason Stipp for Morningstar.
As some investors begin to consider emerging markets as emerged, some of them are looking to frontier markets for additional diversification or growth. What should be on our radar before jumping in?
I'm joined today by Laura Geritz, she's a manager Wasatch Frontier Emerging Markets Small Countries Fund. She's going to give us some ideas about investing in these markets today.
Thanks for joining me, Laura.
Laura Geritz: Thanks for having me.
Stipp: Let's start out broadly from a portfolio perspective. Let's say I'm an investor, I have an emerging-markets index fund. What would be the case for getting exposure to some of these frontier markets, where you look for investments?
Geritz: I think one of the primary cases would be that you can mitigate the risk of your aggregate portfolio holdings by adding frontier to your asset allocation. You have lower correlation with these countries. You have a lot of different economic drivers from one country to another.
And then I think one of the other great attributes of the frontier markets is you have faster growth in a lot of these countries. Four of the top 10 fastest-growing countries in the world are in Africa.
Stipp: I want to talk about the markets that you invest in and how your fund has performed recently and your process.
In your recent letter to your fundholders you mentioned Argentina as being a market that had powerful performance in 2013. But you said the fund didn't keep up with that, and that's--perhaps as you would expect--because of your process. Can you talk about your process--in terms of that country and just generally--why it wouldn't keep up when markets like that are exploding?
Geritz: We focus on high-quality companies, companies with great cash flow statements, great balance sheets, and that can do well in any cycle. And then we marry that with analysis of the country and the particular risk we're taking in that country.
Last year one of the biggest drivers of frontier markets was Argentina. You had a big oil and gas company bouncing there off a bottom, YPF. And this year we have a different story. Those companies aren't doing so well. Argentina has seen a much rougher environment, and fortunately our process proved out over a longer period of time; we avoided the higher-risk companies and countries.
Our process is focusing on high-quality companies with good cash flow, good balance sheets in a good environment, and at the right valuations, and we didn't have that recipe last year in Argentina.
Stipp: Have you found that process helps to mitigate some of the volatility that you might otherwise see in a frontier markets portfolio?
Geritz: It does. We have very good downside protection in the fund. When you have big market correction days, we tend to do better, and we think that's for multiple reasons. One is because of country diversification, but two is because of the quality of the company that we focus on; we're really focusing on good companies that can do well in any environment.
Stipp: Let's talk more broadly about downside protection. We've seen the Federal Reserve tapering have a broad impact on emerging markets in recent times. Exogenous factors can have an impact when you're trying to do fundamental investing sometimes. So how do you think about some of the exogenous factors that you have to deal with in some of these markets when you're trying to invest from a fundamental perspective?
Geritz: I think it's very important to price risk adequately when you're looking across the world, not just in frontier markets--but developed markets and emerging markets as well. In my opinion, emerging markets, really, nothing much had changed there last year, except for the fact that risk was just not being priced dearly enough. I think that was one of the advantages of investing in frontier is, people think of those markets as risky, so risk tends to get priced more dearly, and so valuations look more appropriate for the type of risk that you are taking.
And that's what we do. When we go to a country, we make sure that we're pricing risk adequately, that we're making our money dear when we give investments to the companies. …
Stipp: Looking for those margins safety.
Geritz: And one of the things we do to look for those margins of safety is we really focus on the banks. So looking at how the banks are being priced from country to country is a really good indicator of quality and value and what people are willing to pay for the risk of that particular country. We spend a lot of time thinking about how banks are priced. Just for instance, … you have typically had a history of high inflation countries like Nigeria and Kenya, and I think that the banks get priced more adequately for the type of historical environment that they've been in.
Stipp: Investors often hear about emerging markets talked about as a group or even frontier markets discussed as a group. But we also see some real divergence among these countries, and so you wonder can you really speak of them as a group anymore? What kind of distinctions do you look for or do you consider as you are investing in the frontier markets' landscape?
Geritz: We look at each country independently, uniquely, and we do the same thing for each company. I don't think you can look at emerging markets carte blanche, and say they are one great big fast-growing region. Just like you can't look at Africa and call it a country; it's a continent of many different countries.
We look at each country, and we assess the risk in each country. One of the most interesting aspects of how countries can change is looking at a place like Zimbabwe. For years, we talked about hyperinflation. They dollarized their economy, and now actually with low-priced goods and the rand weakening--their next door neighbor's currency has been very weak--so right now one of their biggest problems is the movement of deflation into the country from cheap-rand priced goods.
So I think it's very important to assess each country at a point in time and recognize that all countries change, too.
Stipp: Are there some countries where you just wouldn't invest, because you think the country risk is just too high, and does that also change over time?
Geritz: It has changed over time. And there haven't been places where we haven't been willing to invest. I think a lot of people talk about Myanmar and the rapid growth of that country. But other than through companies that just have some participation in the economy, I have found that the companies tend to get overpriced for the theme. We want to buy good companies, not themes. So we really focus on the quality of the company.
Stipp: Also in your manager letter, you said that you are continuing to find companies that are high-quality, as you've been discussing, in frontier and emerging markets at reasonable valuations. So where are you finding opportunities these days?
Geritz: Still all over the world. In emerging markets where you've had pullback, where we think, the baby was thrown out with a bath water. An example would be the Philippines. I still see that macroeconomic environment as very strong; companies have been putting up good results, and they have pulled back. So you are seeing very good opportunities there.
We are still finding lots of names across Africa, West Africa. And then you have also frontier Europe that is in recovery mode. Those stocks were left behind. So we've been finding interesting ideas in that region of the world as well.
Stipp: Laura Geritz, some very interesting insights on a very interesting and rapidly changing part of the world, the frontier markets. Thanks for joining me today.
Geritz: Thank you very much.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.