By: Varshan Maharaj, fund manager of the Allan Gray Frontier Markets Equity Fund

According to Varshan Maharaj, fund manager of the Allan Gray Frontier Markets Equity Fund, the earnings of companies in frontier markets such as Nigeria, the Philippines and Vietnam, have fared better than expected given these challenging conditions.

“There continues to be a large disparity in valuation multiples between companies in the frontier universe and comparable companies in developed markets, presenting attractive investment opportunities,” says Maharaj.

He says that the holdings in the Allan Gray Frontier Markets Equity Fund have high profitability and attractive valuations represented by the weighted average five-year return on equity of 27% and the forward price-to-earnings ratio of 4.7 times. During the second quarter of 2023, the Fund returned 6.1% in US dollars and the MSCI Frontier Emerging Markets Index returned 2.0% in US dollars.

What is driving the performance of the companies in the frontier universe?

Over the last quarter Nigeria experienced economic policy reform.

“While these changes are encouraging, they have not yet materially improved the quantity and exchange rate at which invested funds can be repatriated from Nigeria. Furthermore, the higher fuel price is reducing consumers’ disposable income, and many businesses, such as the mobile network operators, have a significant portion of their operating and capital expenditures either denominated in or linked to the US dollar. Near-term earnings of these companies are likely to come under significant pressure,” explains Maharaj.

In the Philippines, Maharaj points to the LT Group, a company with a large stake in Philip Morris’s business and the Philippine National Bank as well as interests in several other consumer-focused businesses.

“LT Group trades on 4.3 times earnings and 0.5 times book value despite having good growth prospects. The Philippines also has a different risk profile from overweight markets,” says Maharaj.

The frontier market Vietnam, however, is seeing many high-quality businesses selling off significantly. Maharaj says that the earnings of many of these companies have come under pressure in 2023 due to a variety of factors. These include weaker domestic growth, and hence demand from their trading partners; government reforms, especially in the real estate sector; and significantly higher borrowing costs. Many of these challenges are cyclical in nature rather than structural.

“While we are underweight Vietnam, we are searching for opportunities among these names,” says Maharaj, concluding that for long-term investors, frontier markets, while complex, can present considerable reward, if patience is matched with the skill to navigate these dynamic landscapes.