“We believe frontier markets provide an inefficient landscape from which alpha can be extracted,” said Cleaver, lead portfolio manager of the recently-launched VAM Frontier Markets fund.
“They offer the attraction of high rates of growth and return on capital and they are still trading at a discount to both emerging and developed markets.”
Cleaver also co-manages the VAM Emerging Markets Growth Fund and is lead portfolio manger on Driehaus frontier markets and small cap growth strategy funds, which are employed by VAM Funds.
Driehaus Capital, a US-based boutique investment adviser, is a partner of VAM Funds and investment manager of the frontier fund.
Alpha from frontier markets?
Cleaver favours countries that have a large population, favorable demographics, and are marketshare gainers or lowcost producers.
“Two countries in Asia that fit these criteria, where we have sizable overweight positions, are Vietnam and Bangladesh.”
He believes Vietnam will benefit significantly from the urbanisation and an influx of foreign direct investment in the coming years. The consumer market in the country, population 89 million, is still nascent. Cleaver said the first McDonalds restaurant only opened in March.
Infrastructure plays are also attractive. The Vietnamese government will continue to build out infrastructure as urbanisation picks up. He points to companies such as Ha Tien Cement.
Bangladesh, by comparison, is well positioned as a textile producer, he said. The country is located near large export markets like China and India. In addition, as China’s working age population peaks, a migration of its textile manufacturing business to Bangladesh is likely.
Bata Shoes Bangladesh is an example of the companies he sees benefiting. It has strong brand recognition and is shifting toward branded apparel.
Betting on Indian banks, industrials
Looking at emerging markets, Cleaver sees opportunities for stock selection in both Indian and Chinese markets.
The optimism over India comes from investor expectations of government reform due to the majority mandate won by the Narendra Modi-led government and the measures taken by the country’s central bank.
“As economic growth rates bottom out and the reform agenda takes hold, we see numerous opportunities within the market, which is one of the deepest stock markets in EM.”
“We favor companies that are geared to a cyclical pickup in the economy, namely banks and industrials. Thematically, financial inclusion will be a big part of Prime Minister Modi’s agenda.”
The rural population in India has limited access to financial services, and Modi’s National Day address included a plan to provide a bank account for every household.
His fund owns a stake in SKS, a microfinance institution, which he sees as a prime beneficiary of Modi’s financial inclusion policy.
Cleaver believes SKS is poised to grow its loan book at 40% per annum in the coming years, and generate a return on assets of around 4%.
Another attractive small company is Wonderla Holidays, a company headquartered in Bangalore and operating theme parks in several cities within India.
“As incomes grow, families will seek entertainment and spend more money on things like amusement parks.”
China energy, internet sector
China’s reforms may be a bit more challenging to execute, given the buildup of credit, but the authorities continue to deftly balance the fine line between growth and reform, Cleaver believes.
He favours companies in the energy, internet and environmental services sectors.
Within energy, China Oilfield Services, the captive drilling and oilfield services arm of CNOOC is favoured.
“China Oilfield Services reported much stronger than expected results, as margins expanded and the company realised synergies across its various segments.
“CNOOC continues to target ambitious production growth, and this will create no shortage of drilling activity for China Oilfield Services, which is already running near full utilisation and further expanding its fleet of rigs.”
In the environmental services industry, the fund manager likes CT Environmental, which is involved in centralised wastewater treatment for industrial parks.
In the internet sector, he likes leading companies within specific verticals like search and flash sales, that have the scale and to address the growing mobile device market, which is driven by the domestic takeup in smart phones.
EMs versus Frontier?
Cleaver sees a positive long-term trajectory for both emerging and frontier markets, even though setbacks in reform agendas could pose a challenge.
EM equities are cheap relative to other asset classes, Cleaver added. The primary risk is economic reforms, which may lead to a slowdown in growth or involve difficult political decisions, such as removing subsidies.
In view of the likely US rate hike, there is risk of renewed pressure on currencies and interest rates for those countries that have failed to press forward with reforms or address their deficits, he said.
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By investing in both EM and FM, investors may realise correlation benefits, Cleaver said.
This was the case in 2013, when FM performed strongly while EM generally struggled, and more recently as FM has taken a bit of a pause, EM has performed better.
