Managing Risks in Frontier Markets

Patricia Oey: Hi, I'm Patty Oey, and I'm here at the Morningstar Investment Conference. I'm sitting here with Laura Geritz--she's the lead portfolio manager for Wasatch Frontier Emerging Small Countries Fund (WAFMX).

Laura, welcome.

Laura Geritz: Thank you very much for having me.

Oey: Frontier markets is a very small and niche area of the investment universe. Yet, your fund realized about $1 billion in assets in about a year and half. Can you tell us about the genesis of this fund and why you're excited to invest in frontier markets?

Geritz: All of our funds actually start because we want to get better at one of the existing funds that we do at Wasatch. We were working on an emerging-markets small-cap strategy for a long time. As we were exploring the companies in that strategy, we were finding that more and more of our companies were getting active in the frontier. So, the genesis of the product was really to ask, "Are these countries interesting on a standalone basis as investments and will they make us better at what we already do?" And as we explored the markets, we found that the asset class was extremely interesting and a great fit for Wasatch's process, which is a deep due diligence, high-quality, focused process, long-term investing. What you had was really inefficient markets--stocks that weren't covered very well, coupled with great growth opportunities and extremely high-quality companies. So, we thought it was a great time to start a strategy surrounding frontier markets, and we still think it's a great time for investing in those markets.

Oey: People often think that frontier markets sound incredibly risky. Could you talk a little bit about how risky this asset class is maybe vis-à-vis emerging markets? Is it really that much more risky?

Geritz: It's funny because I'm probably one of the most conservative investors at the firm. So, to have me working on a frontier product is comical within the firm. But if you look at the asset class, each one of the countries is small. Each country is driven by a unique set of economic drivers. This means that, as a portfolio manager, it's really an ideal asset class where you can mix countries to mitigate risk. But also, as a firm, Wasatch has a 30-year-plus history of investing long term in high-quality companies with good balance sheets and cash flow statements. Long duration. Sustainable growth. And this asset class has an abundance of those companies. You really see it in the sense that you have a lot of separately listed multinational companies--for instance, Nestlé Sri Lanka or Nestlé Nigeria. These companies really help mitigate risk as well. So, we've actually seen this fund have really good downside protection. We actually participate a little bit less in upmarkets, and we are pretty defensive on the downside. So, I think the risk is probably exaggerated and misunderstood. You can really diversify away a lot of risk by holding broad country portfolios.

<TRANSCRIPT>

Oey: So, growth is definitely a big theme in frontier markets. Can you share your observations about how some of this growth is really fast-paced and maybe a company or two that's capitalizing on this growth?

Geritz: I think one of the concerns with the asset class over the last year is that you haven't seen it behave as well. It's been lagging, which has made valuations more attractive. I think, as a manager, you sit there and think, "Am I missing something? Should I be diving deeper?" So, what we've been doing as a team--as a firm--is getting out and really kicking the tires. As you know, we travel heavily; it's part of our process. I've only been back in the office about four weeks this year. We've been everywhere from Vietnam to Sri Lanka, Egypt, the Middle East, Tunisia, Turkey, Japan, Australia, New Zealand--those [last few] are developed markets, but I think it's important to understand the broad global picture in order to understand what's going on in the frontier universe. But the growth I see in places like Vietnam, when everybody talks about how challenged the world is for growth, these are not growth-challenged places right now.

Vietnam is growing 6.5%. If they free up the economy more, it could grow even faster. The companies benefit. There are very high-quality companies there. You have almost the perfect demography for growth. Vietnam looks like Korea did roughly 30 years before it went on its quick pace of development. So, I see that as extremely positive.

I think a lot of people refer to these economies as the next BRICS [Brazil, Russia, India, China, and South Africa]. I like to think of them more as sort of the modern Silk Road economies. A lot of the frontier sits along the old Silk Road trading paths, and as a lot of people know, China is investing aggressively in this region of the world to recreate those trading paths. So, a lot of the countries we invest in--like Pakistan, for instance--benefit from this. China is investing a lot of money there. It's roughly 20% of Pakistan's GDP. You've got incrementally positive change going on in Pakistan in the sense that the politics are getting better and you have a great demography.

So, places like Pakistan and Vietnam we're really optimistic on. What I like, company-wise, is Vietnam Dairy. It's in an oligopoly industry. It's very focused on cash flow. There is a lot of growth potential because there is more consumption on a per capita basis in Vietnam. Then, there is also a story of the consumer trading up in value through the years. Also, the stock is really cheap because the market is hard to access. So, if it opens, the stock is going to get a lot more expensive. In Pakistan, we like the cement companies a lot--Lucky Cement is one that we like. And that's because it will benefit from the push for infrastructure expansion from China.