Investment Insights Podcast: Frontier Markets Still Attractive

Stuart Quint, Investment Insights PodcastStuart P. Quint, CFA, Senior Investment Manager & International Strategist

On this week’s podcast (recorded June 2, 2016), Stuart weighs in on frontier markets and how this space is still an attractive area for investors.

Quick take:

  • Today’s frontier markets closer to yesterday’s higher-growth emerging markets.
  • Frontier markets are different and may offer potentially higher growth prospects relative to re-emerging markets.
  • Frontier markets can offer potential positive benefits in portfolio diversification.
Source: MSCI, Blackrock

Source: MSCI, Blackrock

Source: MSCI, Blackrock

Source: MSCI, Blackrock

Frontier markets still offer investors the potential for higher returns and lower correlation within broadly diversified portfolios. Although emerging and frontier markets both offer younger populations and higher economic growth potential relative to developed markets, there are also key differences that currently favor frontier markets.

Frontier markets include a variety of countries that, in many cases, are more tied to domestic factors as opposed to global growth. Countries in Sub-Saharan Africa, such as Kenya and Nigeria, and in South Asia, such as Vietnam and Bangladesh, offer potential investment opportunities. Several of these markets are enacting structural reform and attracting foreign direct investment to improve economic growth prospects. While depressed oil prices have an impact on growth in Middle East economies, such as Oman and Qatar, these countries also boast higher incomes and strong population growth rates.

Source: MSCI, Blackrock

Source: MSCI, Blackrock

Source: MSCI, Blackrock

Source: MSCI, Blackrock

In contrast, emerging markets are more of a mixed bag. The larger BRICK economies (Brazil, Russia, India, China, South Korea) within emerging markets contain a spectrum of moderate growth to stagnation along with banking sectors hobbled by large and rising bad credit. Depressed commodity prices directly hurt Brazil and Russia, while a capacity glut in basic materials impacts bank loans in China and India. The question of “whither the BRICKs” is vital to the direction of emerging markets given they comprise over half of the index.[1]

Investing in frontier markets provides more exposure to domestic growth sectors whereas emerging markets are more geared toward industries influenced by global commodity exports. Domestic sectors account for three out of every four dollars in frontier markets, while they comprise only one out of every two dollars in emerging markets. Industry sectors related to global trends (in many cases commodities) comprise nearly half of emerging market companies but only a quarter of frontier markets.[2]

Frontier markets only comprise less than 3% of the world’s total market capitalization.[3]  Coupled with potentially faster growth relative to the developed world, further structural reform could propel further growth in capital markets.

Superior population growth is one supportive factor. Median population growth of 1.5% in Frontier markets exceeds growth in both developed and emerging markets.

2014 Median Compound Annual Population Growth
Frontier Markets 1.5%
Developed Markets 0.7%
Emerging Markets 0.9%

Source: World Bank and Brinker Capital

A growing variety of funds and ETFs have come to market and allowed greater access to investing in frontier markets in recent years. Nonetheless, frontier markets continue to offer potential benefits to diversifying investment portfolios. Even over the last five years, frontier markets still show lower correlation to broad equity indices (and even lower relative to emerging markets).

Please click here to listen to the full recording.

[1] BRICK comprises 54% of the MSCI Emerging Markets Free Index.  Source: MSCI and Blackrock.
[2] MSCI, Blackrock, and Brinker Capital
[3] Bloomberg and Brinker Capital

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, a Registered Investment Advisor.

Monthly Market and Economic Outlook: May 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

In April we saw a reversal of some of what occurred in the first quarter. U.S. large cap equities were positive on the month (S&P 500 Index gained +1.0%); however, U.S. mid and small cap stocks experienced declines of -0.9% and -2.6% respectively. International developed equity markets continued to outperform U.S. markets (MSCI EAFE gained +4.2%), led by strong gains in Europe. The Euro strengthened 4.5% against the dollar during the month. Emerging markets led developed markets (MSCI EM gained +7.7%), helped by double-digit gains in China and Brazil. In the real assets space, crude oil soared +25% in April after an -11% decline in the first quarter, while REITs experienced modest declines.

Global sovereign yields moved higher in April. The yield on the 10-year Treasury climbed 11 basis points and as a result the Barclays Aggregate Index fell -0.4%. While investment-grade credit was negative on the month, high-yield credit gained +1.2% as spreads tightened. Municipal bonds underperformed taxable bonds during the month.

Our outlook remains biased in favor of the positives, but recognizing risks remain. We feel we have entered the second half of the business cycle, but remain optimistic regarding the global macro backdrop and risk assets over the intermediate-term. As a result, our strategic portfolios are positioned with a modest overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.

  • Global monetary policy accommodation: Despite the Federal Reserve heading toward monetary policy normalization, the ECB and the Bank of Japan have both executed bold easing measures in an attempt to support their economies.
  • U.S. growth stable and inflation tame: Despite a soft patch in the first quarter, U.S. economic growth remains solidly in positive territory and the labor market has markedly improved. Reported inflation measures and inflation expectations are moving higher but remain below the Fed’s target.
  • U.S. companies remain in solid shape: U.S. companies are beginning to put cash to work through capex, hiring and M&A. Earnings growth outside of the energy sector is positive, and margins have been resilient.
  • Less uncertainty in Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year; however, Congress will still need to address the debt ceiling before the fall. Government spending has shifted to a contributor to GDP growth in 2015 after years of fiscal drag.

However, risks facing the economy and markets remain, including:

  • Timing/impact of Fed tightening: The Fed has set the stage to commence rate hikes later this year. Both the timing of the first rate increase, and the subsequent path of rates is uncertain, which could lead to increased market volatility.
  • Slower global growth: While growth in the U.S. is solid, growth outside the U.S. is decidedly weaker. It remains to be seen whether central bank policies can spur sustainable growth in Europe and Japan. Growth in emerging economies has slowed as well.
  • Geopolitical risks: Issues in the Middle East, Greece and Russia, could cause short-term volatility.

While valuations have moved above long-term averages and investor sentiment is neutral, the trend is still positive and the macro backdrop leans favorable, so we remain positive on equities. The ECB’s actions, combined with signs of economic improvement, have us more positive in the short-term regarding international developed equities, but we need to see follow-through with structural reforms. We expect U.S. interest rates to normalize, but remain range-bound and the yield curve to flatten. Fed policy will drive short-term rates higher, but long-term yields should be held down by demand for long duration safe assets and relative value versus other developed sovereign bonds.

As we operate without the liquidity provided by the Fed and move through the second half of the business cycle, we expect higher levels of market volatility. This volatility should lead to more opportunity for active management across asset classes. Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class Outlook Comments
U.S. Equity + Quality bias
Intl Equity + Neutral vs. U.S.
Fixed Income +/- HY favorable after ST dislocation
Absolute Return + Benefit from higher volatility
Real Assets +/- Favor global natural resources
Private Equity + Later in cycle

Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

Monthly Market and Economic Outlook: November 2014

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

After a pullback that began in mid-September, the equity markets bounced back sharply in the last two weeks of October. The equity markets shrugged off the end of the Fed’s quantitative easing program and slower economic growth outside of the U.S., viewing the weakness as a buying opportunity. After being down -7% during the correction, the S&P 500 ended the month at a new high. Utilities and healthcare were the top performing sectors, while energy and materials were negative on the month. Small caps bounced back even harder than large caps with the Russell 2000 gaining +6.6% in October, yet small caps have not yet eclipsed their July highs. Year to date through October, mid cap value has been the best performing style, gaining +11.9% due to the strong performance of REITs and utilities.

International equity markets were mixed in October. Developed markets, including Europe and Japan, were generally negative, while emerging markets ended the month in positive territory, led by strong performance in India and China. The U.S. exhibited further strength versus both developed and emerging market currencies. International equity markets have significantly lagged the U.S. markets so far this year; the spread between the S&P 500 Index and MSCI ACWI ex USA Index is 1200 basis points through October.

During the equity market sell-off U.S. Treasury yields declined. The yield on the 10-year note fell almost 50 basis points to a low of 2.14% on October 15, then moved slightly higher to end the month at 2.35%. It was a good month for the fixed income asset class, with all sectors posting positive returns led by corporate credit. High-yield credit spreads widened out 100 basis points in the equity market sell-off, but recaptured 75% of that move in the last two weeks of October. High-yield spreads still remain 100 basis points wider than the low reached in June, and the fundamental backdrop is positive. Municipal bonds had another solid month, benefiting from a continued supply/demand imbalance and improving credit fundamentals.

Our macro outlook has not changed. When weighing the positives and the risks, we continue to believe the balance is shifted even more in favor of the positives over the intermediate-term and the global macro backdrop is constructive for risk assets. As a result our strategic portfolios are positioned with an overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.

  • Global monetary policy remains accommodative: Even with QE complete, Fed policy is still accommodative. U.S. short-term interest rates should remain near-zero until mid-2015 if inflation remains contained. The ECB stands ready to take even more aggressive action to support the European economy, and the Bank of Japan expanded its already aggressive easing program.
  • Pickup in U.S. growth: Economic growth in the U.S. has picked up. Companies are starting to spend on hiring and capital expenditures. Both manufacturing and service PMIs remain in expansion territory. Housing has been weaker, but consumer and CEO confidence are elevated.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that flush with cash. M&A deal activity has picked up this year. Earnings growth has been ahead of expectations and margins have been resilient.
  • Less uncertainty in Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year. Fiscal drag will not have a major impact on growth this year, and the budget deficit has also declined significantly. Government spending will again become a contributor to GDP growth in 2015.

Risks facing the economy and markets remain, including:

  • Fed’s withdrawal of stimulus: Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, tapering was gradual and the economy is on more solid footing this time. Should inflation measures pick up, market participants will quickly shift to concern over the timing of the Fed’s first interest rate hike. However, the core Personal Consumption Expenditure Price (PCE) Index, the Fed’s preferred inflation measure, is up only +1.4% over the last 12 months and we have not yet seen the improvement in the labor market translate into a level of wage growth that is worrisome.
  • Global growth: While growth in the U.S. has picked up recently, concerns remain surrounding growth in continental Europe, Japan and some emerging markets. Both the OECD and IMF have downgraded their forecasts for global growth.
  • Geopolitical risks: The events in the Middle East and Ukraine, as well as Ebola fears could have a transitory impact on markets.

Despite levels of investor sentiment that have moved back towards optimism territory and valuations that are close to long-term averages, we remain positive on equities for the reasons previously stated. In addition, seasonality and the election cycle are in our favor. The fourth quarter tends to be bullish for equities, as well as the 12-month period following mid-term elections.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class Outlook Favored Sub-Asset Classes
U.S. Equity + Large caps growth
Intl Equity + Emerging and frontier markets, small cap
Fixed Income - Global high-yield credit
Absolute Return + Closed-end funds, global macro
Real Assets +/- Natural resources equities
Private Equity + Diversified

Source: Brinker Capital

Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

 

Monthly Market and Economic Outlook: September 2014

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

After a mild 4% pull-back from July 24 through August 7, the equity markets continued to grind higher while global bond yields fell. The S&P 500 Index gained 4% in August and crossed the 2000 level for the first time. Markets shook off elevated geopolitical tensions in Ukraine and the Middle East, and focused on stronger earnings from U.S. companies, better U.S. macroeconomic data, and the anticipation that central banks globally will remain supportive.

In the U.S., small cap stocks outpaced large caps in August, but large caps have a lead of more than 800 basis points on small caps year-to-date. Growth was ahead of value in August. In both large cap and small cap, growth has closed the gap and now lags value by only 50 basis points year-to-date; however, mid cap value still has a significant advantage over mid cap growth due to the very strong performance of REITs so far this year.

Developed international equity markets meaningfully lagged the U.S. in August, in part due to weaker currencies. Europe was slightly positive, but Japan declined more than -2%. Year-to-date, U.S. equities are almost 700 basis points ahead of the MSCI EAFE Index. However, emerging market equities posted another solid month and, after a very weak start to the year, are now ahead of U.S. equities. Brazil and India have each rallied more than 25% so far this year, while China has lagged with a gain of only 8%.

Global fixed income rallied along with equities in August. The yield on the 10-year U.S. Treasury Note fell 22 basis points to 2.34%, which still looks attractive relative to yields in the rest of the world.

Magnotta_Client_Newsletter_9.8.14

All fixed income sectors positive for the month, led by credit and Treasuries. After high yield spreads widened in July and the asset class experienced significant redemptions, investors saw relative value and moved back into high yield in mid-August. The sector gained 1.6% for the month, and spreads still remain 40 basis points above the low reached in June.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds, and as a result our strategic portfolios, are positioned with a modest overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.

  • Global monetary policy remains accommodative: Even as we approach the end of quantitative easing, U.S. short-term interest rates should remain near-zero until 2015 if inflation remains contained. The ECB has taken more aggressive action to support the European economy by lowering interest rates even further and announcing the purchases of covered bonds and asset-backed securities. The Bank of Japan continues its aggressive easing program.
  • Pickup in U.S. Growth: U.S. economic growth rebounded in the second quarter. Capital spending appears to be recovering. The improvement in the labor market continues and job openings are surging. Leading economic indicators suggest the recovery has momentum.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. M&A deal activity has picked up this year. Earnings growth has been ahead of expectations and margins have been resilient.
  • Less Drag from Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year. Fiscal drag will not have a major impact on growth this year, and the budget deficit has also declined significantly.

Risks facing the economy and markets remain, including:

  • Fed’s Withdrawal of Stimulus: Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, tapering is more gradual and the economy appears to be on more solid footing this time. Should inflation pick up, market participants will quickly shift to concern over the timing of the Fed’s first interest rate hike. However, the core Personal Consumption Expenditure Price (PCE) Index, the Fed’s preferred inflation measure, is up only +1.5% over the last 12 months and we have not yet seen the improvement in the labor market translate into a level of wage growth that is worrisome.
  • Election Year/Seasonality: While we noted there has been some progress in Washington, we could see market volatility pick up in the next two months in response to the mid-term elections. In addition, September tends to be a weaker month for the equity markets.
  • Geopolitical Risks: The events in the Middle East and Ukraine could have a transitory impact on markets.

Risk assets should continue to perform over the intermediate term as we expect continued economic growth; however, we see the potential for increased volatility and a shallow correction as markets digest the end of the Federal Reserve’s quantitative easing program. Economic data, especially inflation data, will be watched closely for signs that could lead the Fed to tighten monetary policy earlier than expected. Equity market valuations look elevated, but not overly rich relative to history, and maybe even reasonable when considering the level of interest rates and inflation. Investor sentiment, while down from excessive optimism territory, is still elevated, but the market trend remains positive. In addition, credit conditions still provide a positive backdrop for the markets.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Magnotta_Client_Newsletter_9.8.14_2

 

 

Source: Brinker Capital

Brinker Capital, Inc., a Registered Investment Advisor. Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.