By Michael Levy
Barings’ EMEA & Global Frontier Markets Equities Team
- Frontier equities disproportionately affected by the recent fall in the oil price
- We identify potential beneficiaries of the decline, in oil exporters as well as importers
- Asset class continues to offer long-term growth potential, at a lower valuation point
Brent Crude Oil Down 31.6%
Since the 18th June, oil prices have fallen sharply, thanks to a combination of excess supply, slowing demand and strength in the US dollar. The spot price for Brent crude oil has dropped by 31.6%, the largest decline since 2008.
In turn, this has had an effect on sentiment towards frontier and emerging equity markets, with the MSCI Frontier Markets Index almost 8% lower in US dollar terms, compared to a 5.5% fall in the MSCI Emerging Markets Index. By contrast, the MSCI World Index – a proxy for developed equities – has remained flat.
Put simply, we believe the disproportionate effect of the decline in the oil price on frontier markets is not justified. It is our assessment that the return on equity for companies in the frontier markets universe should remain in excess of 18%, well ahead of emerging markets as a whole.
As can be seen from the table below, this long-term growth potential is now available to investors at a significantly lower entry point after the recent sell-off.
Once you get past the headline level, the situation is more nuanced, as you would expect. One of the key characteristics of the frontier universe is the fact that it is heterogeneous. Countries and companies are driven by different factors. Here too, however, we see opportunities emerging from recent developments.
Many frontier market countries are net oil importers, for example, and their economies should benefit from the oil price fall. With lower fuel costs and a stronger economic environment, we particularly like Sri Lanka, Bangladesh and Kenya.
Two of our favourite companies here remain well placed, in our view, to benefit from an increase in consumer spending power and lower costs. The first is Marico Bangladesh, producer of Parachute coconut hair oil and other health and beauty products. The second is Kenya’s East African Breweries, the largest alcoholic beverage company in East Africa.
Net oil exporters face some near-term challenges. Even here, however, fuel subsidies in Nigeria, for example, could mean that input prices move lower, raising profits for well-placed companies.
While our overweight position in Saudi Arabia has detracted value in the short term, we believe the decline seen in share prices here is not justified.
Baring Frontier Markets Fund
A young and growing population, and the rise of the middle class, creates an attractive environment for healthcare, leisure and education companies, which are not so reliant on high oil prices and continue to offer excellent long-term growth opportunities, in our view.
One Saudi Arabian company we particularly like, Al Tayyar Travel Group, is a direct beneficiary of lower oil prices and the expansion of the infrastructure and airports around Mecca and Medina.
Even though many of these markets are at an early stage of their evolution, what experiences such as the recent decline in the oil price show is that the investment universe already has breadth. Idiosyncratic stock selection and understanding the drivers of companies in these early stage markets are absolutely critical to success.
Michael Levy is an investment manager in Barings’ EMEA and Global Frontier Markets Equities Team. He is lead manager of the Baring Frontier Markets Fund and the Baring Russia Fund. He joined Barings in July 2012 after 17 years at AllianceBernstein where he held a number of equity portfolio management and research roles.