Secular growth, the key to a successful Frontier Markets manager

The only way we think an investment manager can make money in Frontier Markets.


Secular growth, the key to a successful Frontier Markets manager

Frontier Markets continue to get more and more attention.  Investors searching for asset classes with a low correlation with their existing portfolio, investors seeking alternatives to expensive equities in deflationary developed markets, and investors who see the EM story as played out have begun contemplating an asset allocation shift to Frontier Markets.  These new players threaten to overwhelm those of us that have been in the market for a long time.

The ground level reality of Frontier Markets is that the investable universe remains constrained and it would be entirely overwhelmed if anything above 1% of equity investments elsewhere was diverted to Frontier Markets.  In the long-term, a smooth gradual shift to Frontier Markets would be orderly and inevitable.  However, in the short-term we have seen several investment strategies that have been launched by ‘asset gathering’ shops, that are generating higher fees than they would in other equity strategies.  These strategies are happy to be benchmarked to a deeply flawed benchmark, the MSCI FM. The quartile chart below (as at Dec 31, 2015) shows how poorly the benchmark has done, relative to investment managers; it is an easy benchmark to beat, but that doesn’t mean they are doing well on an absolute basis.


If you are looking to invest in Frontier Markets via an investment manager, in our view there is really only one way for an investment manager to do well within Frontier Markets.  That is by investing in clear secular growth trends.

First, it makes sense to address alternative approaches that work quite well in other equity regions, but cannot work well in Frontier Markets at this time.

Quantitative strategies

Quant strategies make a lot of sense if they are well-constructed and monitored in developed and emerging markets.  However, in Frontier Markets, the data source simply is not rich enough for quantitative strategies to excel.  Yes, they can certainly beat the benchmark, given how poorly constructed it is, but to actually deliver strong absolute returns, quantitative strategies need the data available in Frontier Markets to significantly improve.  This is at least several years away.

Top-down, Macro Funds

A top-down macro approach to Frontier Markets is very difficult to implement.  Even if your views are correct, would you actually be able to hedge the currency in an inexpensive manner? How difficult is it to enter and exit markets, what are the transaction costs like? The answer to all of these questions for Frontier Markets as a whole is unfortunately not conducive to top-down strategies.  Similar to quant strategies, it is certainly possible to beat the benchmark, but not a reasonable absolute return objective over time.

What is Secular Growth?

Secular vs. cyclical growth is an important concept to understand.  Jeremy Siegel, in his seminal ‘Stocks for the Long Run’ posits that stocks, in general, will outperform other asset classes on a secular basis, or over the long run.  Secular growth to us means companies that would be expected to grow or, at least, remain with stable business regardless of global or country-specific economic conditions.  This contrasts with cyclical growth which tends to come from capital-intensive businesses whose revenue and income vary with the economic cycle of the time.  Sectors such as mining, airlines, utilities, energy are all fairly unattractive from this perspective.

Secular Growth in Frontier Markets

The benefit of Frontier Markets is that secular growth is much easier to find.  A bank that is focused on a country such as Tanzania (13.8% credit to GDP) has a long runway ahead of it by adding unbanked members of the population and simply taking in more deposits and lending out more, versus a bank in Japan (187% credit to GDP), where there is no remaining population that is unbanked and growth is dependent on wider macroeconomic factors.

Additionally, Frontier markets are so diffuse that virtually any existing secular growth story can be found in some shape or form within Frontier Markets.  Certainly, in many cases, an EM-listed or developed market-listed equity is the best way to capitalize on a secular growth trend, but there remain many investable options to invest in secular growth trends within Frontier Markets.

The benefit of such a strategy in Frontier Markets is that by default, it is an all-weather approach that requires less turnover in the portfolio and thus fewer transaction costs in expensive execution markets.  Furthermore, the number of companies that are investable diminishes and an investment manager may focus on a smaller subset of companies which are understood exceptionally well.

3 Secular Growth Trends and Investment Examples


Regardless of what happens to global growth or what the Fed does, as long as there some modicum of stability in a particular country, people will demand improving healthcare services.  Be it, doctors per capita, pharmacies per capita, hospital availability or the level of immunization in infants, all of these are bound to improve.  There is very little that individuals would emphasize more than better health.

To that end, below is a distribution of hospital beds per capita within our Frontier Markets universe compared to the OECD average.  The distribution characteristics are similar regardless of what metric you use.  The main point is Frontier Markets as a whole do not have good healthcare, and they demand improving healthcare.

Hospital Beds per Capita

Companies that are able to capitalize on this trend will likely grow in any market cycle.  Investment managers that find and identify names that are well-suited to this, are investment managers that will provide you with solid investment performance over time.

EIPCO is an example of a solid company within this space that has over time consistently delivered value to shareholders.  In business since 1980, they are Egypt’s largest pharmaceutical company and they export to most of the Frontier Markets that we cover.  No debt on the balance sheet, 20% ROIC over time, and a 7.7% earnings yield exemplify the characteristics of this company.  Good management, building a business over time that will grow alongside the need for more medicine in Frontier Markets.

Other types of companies to watch include health insurance firms, private hospital operators, pharmacy/supermarket providers, and fitness clubs.


As wealth increases, leisure time increases and a desire for travel is created.  Initially, this results in domestic travel and gradually that becomes insufficient.  The world is witnessing this change with Indians and Chinese tourists.  In 2015, 120 million Chinese (9.2% of population)  visited another country, this is up from 98 million in 2013, exhibiting growth of 10% per year.  This growth is not expected to abate and certainly hasn’t despite issues with China’s growth. Similarly, approximately 20 million Indians (1.7% of population) visited another country in 2015, up from 18 million in 2014 and 17 million in 2013.  This growth will continue into the foreseeable future.  These numbers represent fractions of each country’s respective total populations.  For comparison, 70 million Americans traveled abroad in 2015, representing 22% of the country’s population.

Frontier markets in many cases have yet to even begin moving towards these kinds of numbers, but it is inevitable, even in a 1-2% growth environment.  Travelers spend money, they bring back business ideas and develop connections that help grow economies.  The question of how to exploit this secular growth trend becomes a little more challenging than healthcare.  Airlines are generally poor business, and the online travel website sector is too diffuse to be investable.  However, there remain opportunities to invest.  Some clever investment managers have found ways to invest in luggage manufacturing, FX services, or travel insurance providers.

One example, of a great company that should be able to capitalize on tourist growth, is Nikola Tesla Airport, which is the primary airport for Belgrade, Serbia. The company has very low leverage, a consistent ROIC in the range of 10% and an attractive earnings yield.  The airport is well-positioned to benefit from both Serbians traveling abroad more and foreign tourists coming to Belgrade as the country emerges from instability experienced in the 1980s – 2000s period.  Passenger traffic in 2015 was 4.7mm compared to 2.7mm in 2010.  In addition to passenger traffic, you can also benefit from economic growth via cargo volume growth.


As citizens begin to have a higher income, they begin demanding certain things, such as cars, appliances, air, and better food.  Cars and appliances have the tendency to be more sensitive to wider economic conditions.  It is unlikely that large purchases are to be made if economic prospects do not look good.  However, small luxury items like a better diet quickly become necessities and are unlikely to be compromised until economic conditions become dire.  Economic conditions in one country could become dire, but it is highly improbable that economic conditions in dozens of countries become dire.  For this reason, it is important that a company in this sector have several export markets.  A good Frontier Markets investment manager will look for companies that focus on confectionaries, fast food, meat, and supermarkets.

It should be noted that in many cases, the best companies to capitalize on this trend are Western companies, no one in Pakistan with a higher income is looking to a domestic Pakistani confectioner to meet their need for Swiss chocolate and similarly are not looking at the local burger chain for to meet their fast food craving.  However, there are always exceptions and even in this sector, there are many strong Frontier Markets companies that are steadily growing.  One such example is Oman’s A’Saffa Foods, one of the major poultry producers in Frontier Markets that exports to a vast swathe of the markets we cover.  The company produces hormone-free, human chicken, something that the wealthier you are, the more you are likely to care about.  Their success is borne out in their financials; low debt, 35% average EPS growth over the last 5 years and a consistent 14-16% ROIC over the past 5-10 years.  The wealthier the middle class in Frontier Markets becomes, the more meat they will demand.  Poultry is far and away the preferred meat in Frontier Markets.


We hope these examples have illustrated how a successful investment manager should think about investing, and this is what you should look for in a Frontier Markets investment manager.  A firm that pays attention to valuation, but thinks of it in a wider context.  Avoid large AUM managers who are gathering assets, or those trying strategies that are unlikely to be successful given the unique characteristics of Frontier Markets.  There is a lot of great returns to be made regardless of the wider global economic environment, and a prudent approach will allow you to capitalize on the unique drivers of this market.

As always, if you have any questions, please let us know.




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