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East Capital frontier market fund

The fund house believes its experience investing in the relationship-based cultures of Eastern Europe has direct application to frontier market investing, said Tim Umberger, senior adviser.

In mid-December, the firm intends to launch a global frontier market fund covering countries defined by the MSCI Frontier Market Index, although the firm will not adhere closely to the benchmark, Umberger said.

Compared to emerging markets, frontier markets have higher GDP growth, stronger corporate earnings and discounted valuations, he said.

Frontier markets are also relatively less exposed to huge macro events such as a US interest rate hike and a strengthening dollar.

As an example, he said Eastern European markets remained relatively stable during the global market volatility in October.

“Correlation between frontier markets and other markets is much lower than emerging-to-developed and developed-to-developed. So it makes sense to have some frontier market diversification in a portfolio.”

The firm also wants to get in early. Umberger estimated that $1.5trn is invested in emerging markets while only $20bn is in frontier markets.

“We want to be in places where there’s a bit less competition. Emerging markets have a lot of global guys with 20 years track record, but in frontier markets there are not many other managers with a longer track record than ours.”

The firm looks for companies that can outperform because of strong management.

Markets where Umberger sees the biggest opportunities are in Africa, specifically Nigeria, which he roughly equates to Russia, and Kenya, which has a loose equivalency to Turkey.

“Africa is much different than 30 years ago when technology transfer took a long time. Now with everyone online, you can find companies that have leapfrogged a couple stages and are as advanced as other companies in the world.”

In the Middle East, Saudi Arabia is opening to foreign investors next year and the fund will have an off-index position in the country. In Asia, he singled out Vietnam as attractive.

Applying core skills

Stockholm-based East Capital has 95% of assets in Eastern Europe, which includes Russia. However, Umberger believes his firm is well-postioned to invest globally because frontier markets require a certain set of skills the firm has developed over the past 15 years.

Frontier markets tend to have relationship-based cultures that require going beyond data when evaluating investments.

Building strong personal relationship with all stakeholders, not just management, is crucial, he said.

“After a certain number of years you learn who to do business with. If you work in one place in Eastern Europe, you meet similar guys in different places or you meet their friends. It develops into a large network and that makes it easier to judge corporate governance risk.

“You also need to be very active in pushing for better corporate governance, fighting for minority shareholders in terms of pushing for higher dividends or nominating independent board members.”

Liquidity managers

The key risk factor in the firm’s Eastern European investments has been liquidity, which is what investors often ask about, Umberger said. Generally, investments tend to be in larger, more liquid assets and the investment team uses internal tools such as a liquidity filter to size up how liquid the assets actually are.

“As an investment manager, you need two-three ways of getting out of a position. We don’t rely on the fact that market liquidity will be there.”

He said a compliance team “makes sure we can get out of x amount of the portfolio in x amount of days”.

“We also have an internal trading team that has been trading illiquid assets for 15 years. [Managing] liquidity is where we could have an edge in frontier markets.”

Umberger said since the firm started investing in Eastern Europe 15 years ago, when risk in those markets was far higher than today, it has never had a fund closed for redemption.

“We’ve always had liquidity. We’ve had investments crash and burn but were always able to pay the money out.”

Part of the Mark Allen Group.