Stephen Rudman: Good morning and good afternoon. My name is Stephen Rudman. I work with the Ashmore, New York-based client team. Welcome to today's webinar, thank you for joining. 

Today's webinar is ‘Frontier and Small EM: Strength Despite Uncertainties’. For those of you who follow our Frontier Markets Equity Strategy, you can see we've really had a super year-to-date performance, 14%-15%, not only substantially outperforming its benchmark, but moreover outperforming almost all asset classes this year-to-date. That's also following similar types of performances over the last 12-24 months and beyond. So, we're very excited to speak about Frontier Markets and small Emerging Markets (EM).

Today, we have Andy Brudenell, who's the lead Portfolio Manager for the Frontier Markets Equity Strategy, and Gustavo Medeiros, who is our Global Head of Research. And what they're going to discuss is that even in uncertain times, there is opportunity, particularly in Frontier and small EM, to generate superior returns, and often in an environment which creates less correlation, but adds diversity for your portfolio and your asset allocation, and why we think it's a nice addition to anybody's broad diversified portfolio.

With that, I'm going to hand it over to Gustavo and Andy to get to the real meat of the issue. Gentlemen, the floor is yours, and as always, thank you.

Gustavo Medeiros: Thank you, Mr. Rudman. Thank you very much, everybody, for dialling in, and thanks, Andy, for joining. 

I think the first question is really about framing the Frontier universe. Because every time that I hear the word 'Frontier', what comes to my mind is something very different than what has structurally been in your portfolio over the last few decades, which features much more mainstream names and relatively large companies. Talk to us about the universe that you're investing in with your Frontier strategy, please.

Andy Brudenell: I think it's a really good point. As you say, it's misunderstood to some extent. These are large cap businesses that are operating in smaller Emerging Markets, and some select Frontier Markets, but these are large leading businesses in their countries where the sector they're operating in is generally, quite lowly penetrated, is generally quite a fast-growing market. Therefore, there's quite a lot of opportunity, particularly as competition can also tend to be a little bit less as well. So, there's an opportunity for real returns that I think often surprise people at just how high structurally they can be. 

To put some numbers around it, when we talk about large cap, the weighted average market cap of the fund, and of the universe generally, is about five times the size of the small-cap EM by market cap. That might surprise quite a few people. It's just that the companies are quite large, and generally have national reach, but the countries are perhaps less developed, or maybe the capital markets are less developed, which is slightly different from being small. So, I think that's quite important. 

In terms of returns, returns on equity (ROE) are in the high teens and have been structurally ahead of Emerging Markets for many years now. Dividend yield is also high and has been higher than EM, again, for many years.

Gustavo Medeiros: Very good, yes, I think that's an important angle. We're thinking about smaller EM countries, and, you know, some selected Frontier economies, but generally speaking, the companies that we invest in have a monopolistic presence there, or have a differential, or have a very large share of a specific sector. It's very, very interesting. I look at the $10 million market cap five times larger than the average small cap is like really the medium to large cap companies that we invest in.

Now, talk to us a little bit about the asset class. As a reminder, what are the regions and countries that the Frontier/Small EM universe is based on?

Andy Brudenell: Yes, so it's pretty diverse geographically and also economically, and I'll come onto that, but it's the likes of the Philippines, Vietnam, across the Gulf Cooperation Council (GCC), the Andean markets, Central Asia. Some of those markets are the beneficiaries of a continually expanding European Union (EU) region, so, quite diverse geographically, as you can tell, but also, they tend to be quite idiosyncratic. They have their own nuances. Generally, their destiny is mostly in their own hands. It's all about reform, both orthodox economic reform, but also just a lot of rules and regulation, and bureaucracy, and red tape that just needs to be updated for the modern world. That's all ongoing, but the good news is that it's within their own destiny to change. 

These countries also, therefore, tend to be quite less correlated with the rest of the world. Again, because there's much more of a domestic story, they tend to therefore also be in different stages of an economic cycle versus perhaps the wider world, but also among themselves, as well. 

Some are, as you know, in the sweet spot right now, there are some that are just coming out of recovery, there are some that perhaps have done pretty well and are maybe beginning to get a little tired. There's also some that have managed to, through reform, to move beyond being quite so cyclical and moving into more of a structural story. 

So, touching on what Stephen was saying in the beginning, that really gives us the ability to build a portfolio that can deal with whatever may be going on in the world, or whatever people's outlook may be about where the risks and opportunities may lie.

Gustavo Medeiros: Fantastic, yes.  I think the keywords here are these idiosyncratic stories and a lot of different idiosyncratic stories, different parts of the cycle leading to diversification, right?

Talk us a little bit about portfolio construction, and the themes that you like in the portfolio at the moment, because just as you went through the geographies, I thought about a few themes that could be interesting for the audience.

Andy Brudenell: Yes, so there are a number, and that's what makes it quite interesting, and quite a good opportunity. 

One story I have spoken about in the past is the friend-shoring story as the world changes in terms of trade and politics. Vietnam's quite well-placed in that environment, for example, there's financial inclusion happening through digitisation. Now, financial inclusion's been going on for some time in these markets, but as the technology evolves, that ability to leapfrog older technologies, and really begin to reach out to more of the unbanked populations, and some quite large populations, is really quite attractive. That's also happening in Egypt, and in Kenya, and Kazakhstan, and all sorts of other markets that we look at. 

There's also that economic reform story through becoming more orthodox, then the authorities have perhaps been in the past, and there are plenty of opportunities there as well, so, they're in the early stages of a recovery, be it Pakistan, or Kenya, or Egypt, and various others. So, we're playing all of these thematics.

Then there's also a structural growth story, where we've really seen the markets, and there's a couple of countries, particularly in the GCC, move away from being quite cyclical, commodity-driven markets. That’s great, of course, as it means they’ve got a strong balance sheet, but really, they've matured in the last few years to begin to work on reforms on visa work applications, the ability for people to stay longer, to own property and to own businesses. So, these are all big incentives to move assets and families and start a business in these countries. As a result, these countries are beginning to see population growth, in Saudi Arabia, but also in the United Arab Emirates (UAE), in particular. You're seeing population growth, but you're seeing white-collar population growth. And that growth brings skills, it brings money, and therefore, it needs services able to cope with this. So, we have a number of exposures to some of the infrastructure boom going on in Saudi, but also within UAE. There's much more demand for better roads, bigger roads, for better technology, for better education, because these people are not coming, it's not a flash in the pan. They really are moving here to the region, and they need better schools, and they need better healthcare, they need more clinics available to look after themselves, and their families, and their employees. 

So, we have a number of exposures across the region, but as I say, particularly in UAE, addressing the opportunity set in terms of homes and housing, but also, more interestingly perhaps, in terms of paid-for education, higher levels of medical care, clinic availability, doctor availability, etc. It's been fascinating for us to see that actually work and play through over the last few years, and you've really begun to see a lot more businesses and people perhaps seeing some headlines about big names appearing in region, and as I say, they're not coming for a visit like maybe they used to. They're really coming to invest long-term and put roots down. Those domestic reforms that perhaps were lacking in the past have really encouraged that and made that possible. This is a really good example of what I said earlier about a lot of these countries have the ability to make these changes, and have that destiny in their own hands, because they can make these sorts of reforms. That's a really interesting change that we've seen in recent years, and orthodox macroeconomic policies that we're seeing in the likes of Egypt and other places is another example of that.

There's a lot more to go, and there are structural stories, they need to build in there, but the GCC is one area where they've taken some of the other thematics I've mentioned, and they've moved past that, and now are into a new phase. And we have exposure to all of this within the portfolio.

Gustavo Medeiros: Yes, that's a very important point. What amazes me about the GCC, in particular, is how, you know, 10 years ago, you'd go to Dubai, and you'd see a lot of people that had come to Dubai to stay two or three years. But a lot of people today are considering buying a home there. It really has become a mega platform for services and for businesses, and is just getting more and more connected globally

Andy Brudenell: And yes, geopolitically as well, they're taking responsibility for the region, working with various partners, and  as other parts of the world see trauma and issues, you're seeing assets coming to the region, because people feel those assets are going to be left alone. Compared to parts of Asia where that's been a problem, you're beginning to see them move to the Middle East as an opportunity to start afresh, and be left alone to build a business. And as I say, when their kids get there, they're not staying only two or three years.

One of the businesses that we own in the education sector is really focused on building out a lot more capacity in the high school and college area, because whereas before the schools were needed for primary-school-age kids, which used to be the sweet spot for those people with younger families, that’s changing now. That’s clearly a structural area that’s playing out there, and that’s a great investment opportunity for us.

Gustavo Medeiros: Yes, and not a lot of people might know, and you know very well, that we've been investing in healthcare facilities across the region, as well, in partnership with King's College through our special situation business, so, there's quite a lot of opportunity there. 

But it's also interesting because you mentioned economic reforms in Egypt. I think it is a good example of how the GCC is really dealing with the problems in the region. Egypt has been implementing tough structural reforms for the best part of the last 8-10 years. But because of structural problems on the balance of payments and post-Ukraine invasion by Russia, the spike in food prices meant the balance of payments became a problem again. 

There were some slippages in terms of monetary policy that also caused over-appreciation of the pound, but then Egypt announced this massive deal with the UAE to transform the Egyptian economy, and it is already transforming the ability of Egypt to repay. That leads to lower capital controls. You pointed out this Monday that Egypt and Kenya were treated as special in the index, right? And that's changing because of the removal of capital controls from the structures.

Andy Brudenell: Yes, so the MSCI and the indices monitor how easy it is for foreign capital to move out of any market. You can't have a market in the index if foreigners can't get money in and out, obviously. Egypt and Kenya were put on watch for this, and put on hold because of these capital control issues. Nigeria was removed completely. But yes, we've seen that positive turnaround. 

Early stages, but as you say, yes, a good indication. Some countries were unfortunate as they were beginning to make changes and COVID followed by the Ukraine conflict was a lot to deal with. But this is why we quite like the investible asset class that we have here, the addressable market. Suddenly, inflation was high, commodity prices were high, and rates needed to go up.  And food inflation was high, and that puts a lot of pressure on countries that import food and import energy and perhaps have economies that'll struggle if interest rates change a large amount. And so, yes, that's tough for some of the markets in our universe, but we don't have to be invested there, and there are plenty of other markets that we were invested in that actually benefit from some of this. A lot of the financial institutions around the world, particularly in the Middle East, where they've got a dollar peg, they don't have the currency worry, and they can make a nice margin on lending, and lending and demand have remained very strong throughout the region. There'll be those countries of course, that export energy, so, they do very nicely out of that, and there are those who export food, and of course, they'll also do very nicely out of that.

So, there's always that opportunity for scenarios where it seems bad for some countries, but good for others, and I think the mix of markets that I've run through in our investible universe, means we can build a portfolio that can generally cope with some of this, without coming under threat from one particular event that may happen globally.

Gustavo Medeiros: Very good, and opportunities too, right? I think the image that we want to leave here, in terms of how the portfolio is built and positioned, is we have diverse sources of very healthy structural growth, like countries in Asia, like the Philippines, like Vietnam, that are very dynamic, that have their own vectors of growth, and then structural growth in the Middle East, but also, this tremendous upside once we're starting to get reforms and turnarounds that actually allow for much more in-depth allocation from foreigners, and typically, you can buy these assets extremely cheap. So, being active there really pays off. Talk us a little bit about your investment process, so how do we select individual stocks to invest in?

Andy Brudenell: Yes, absolutely. We've talked a lot so far about the big picture, macro, and top-down environment to get a sense of what the asset class looks like and what the bigger picture thematics are. But in actual fact, day-to-day, we're very much focused on the bottom-up fundamentals. 

We've got to find good businesses with good management teams. We want to understand the business model: what kind of competitive advantage does it have? What's the management team like? Do they understand the opportunity set here? Do they think about the allocation of capital in the same way that we do? Do they understand the cost of capital and what that really means? Are they good at disclosing what they're up to, and are they reasonably transparent? That's all quite important. 

Our starting point is we need to meet the management teams. We need to understand the business, and very much focus on that bottom-up. Then, if we get a sense of what the theme may be within that business, with a business model that we understand and like, there are some competitive advantages. There's either already quite high returns above cost of capital, or the potential for it. The management team is good and open, and we think we can trust that they're going to think about capital the way that we do. Then we're like: okay, that's great, but now, what neighbourhood are they in?" What's the operating environment and in what environment are they operating in? 

This is the macro top-down, we call it the top-down overlay, where we say, "Okay, this business does look interesting, and the management team looks good, and the stock looks cheap. Okay, great. All right, where are we? What's going on with macroeconomics? Where are we in the cycle? What's regulation like? What's monetary policy like? What's fiscal policy like? Who's the government? How stable is politics, generally? What's the central bank like? Do we think they know what they're doing?” etc. 

Obviously, we do invest sometimes if the price is right, where the management team and the business model looks amazing, but the neighbourhood is bad. But everything has a price, so, sometimes, we're like, " These guys know how to operate, they've been operating in this environment all their lives, so, maybe there's an opportunity there." We do sometimes buy in that scenario. Obviously, the dream scenario is a great management team, with a good business in an environment that's really conducive for growth and investment. And then sometimes equally, it may be that the business is more or less okay, the management team is fine, but even they can't mess this up, because the macro environment is so amazing or because it’s also mispriced we just need to have some exposure. 

That’s the process, but generally, bottom-up fundamentals, build conviction around the team and the business, and then hopefully find a top-down overlay that also gets us excited. Then those will be the places and the businesses that I'll be allocating most of the portfolio to.

Gustavo Medeiros: So, at the end of the day, it's very similar to our Global Equity and EM Equity investment processes, where we have discounted cash flow models that we look at with an upside, downside, base case scenario for each of the individual companies that we're monitoring, and overlaying it with a global top-down analysis. In your case, you look at much more idiosyncratic stories. So, you're always bringing up the Philippines, and the Vietnams, or the investment in GCC, which we not necessarily are going to be, or I'm not going to bring up very often.

It's interesting, I sit right in front of you, but I interact much more with the managers that are covering Brazil, Mexico, the Chinas of the world, but you have much more alpha. I think the track record of the product, and the track record of the asset class, shows quite a lot of inefficiencies in that space, because, as you pointed out, there are some very good, solid, large businesses in countries that are relatively under-covered by the universe, which gives you this edge, right?

Andy Brudenell: Yes.

Gustavo Medeiros:  So, I think that wraps it up in terms of the prepared questions that I had. I don't know if there is any questions from the audience, Steve, or any particular questions that you think we didn't cover?

Stephen Rudman: I think you've pretty much covered the stuff that has come from the audience, so, we're good. But if either of you can comment on the story that we've told over the years about portfolio completion. In other words, if you own broad EM, you don't own what's in Frontier, and to discuss not just the lack of correlation, but the reasons why if you're thinking of ACWI (All Country World Index) as your benchmark, then you're missing out on opportunity. 

Gustavo Medeiros: Yes. There is first a big picture point that I think is interesting, that this asset class massively outperforms the MSCI EM, right? Yes. So, there might be reasons why investors are not comfortable, say, with China, or with other parts of EM, but then you can actually get exposure to a lot of countries that are effectively EM, they're just smaller EM countries, and you actually get higher ROE, higher-dividend yield. The returns have been much, much higher akin to developed world markets over the last three to five years. And those were driven, which is a particularly important fact, by sales and earnings expansions, because the multiples have been relatively unchanged over the last three to five years. 

So, there are different ways that you can discuss the asset allocation, but I think that you could think about it as, "Oh, I don't have exposure to EM, or I have an underweight in EM, and I'd rather use this portfolio, this structure, to get my EM exposure." Or as you said, Stephen, I think it's fair to say that it could be seen as a completion play.

Andy Brudenell: I think that's all correct. You know, it covers a lot of countries, not too concentrated in any one place, lots of interesting ideas that are idiosyncratic to themselves, and partly because of that, there's quite a low correlation, which also, therefore, is even if each market might be quite volatile in and of itself, if you have a diversified portfolio like we always do, and it's uncorrelated, you find that the volatility is lower, as well. The data is there for years now, coming up to two decades of faster growth, cheaper, higher yield, higher returns, lower volatility, and it can really add by smoothing out your returns, and as Stephen mentioned, yes, completing the portfolio. That's kind of how we think about it.

Gustavo Medeiros: And just one thought that crossed my mind, because for two years, in our fixed-income recommendation and our outlook, we've been recommending a barbell between high-quality investment grade and distressed countries that have been priced to default, or have defaulted, and have a lot of upside if they do their own idiosyncratic structural reforms. That's exactly what you get in equity land, like in your portfolio, right? Because we're talking about Andeans, which are mostly investment grade in Latin America, we're talking about high-quality, Middle Eastern mostly.

We're talking about, the Asian part of the market, which is, again, high quality. Most of that is investment grade in nature. Eastern European countries that are playing for Europe, the same, and with a barbell with the distressed stories that can actually have structural reform that really lead to a massive re-rating. If you can buy the same asset of the currency 50% cheaper, and then the currency has a 20, 30% upside, that will itself is going to be a big tailwind, right? These recommendations worked very well in fixed income, and not surprisingly, in the equity space, it's also working very, very well, because this structural growth is quality, and on a very diversified basis, and thanks to our active management being the ability of buying these distressed stories at the right timing.

So, yes, I think that's why quite a lot of us that understand Emerging Markets like this strategy a lot, even if they're underrepresented by the overall broad asset allocation community. A bit misunderstood, I'd say, despite our efforts. We did a webinar about 18 months ago. 

Andy Brudenell: It's difficult, there's a lot to take in, but yes, hopefully, what we've spoken about helps in getting people comfortable with what we think is a really interesting space.

Stephen Rudman: Agreed. Well, gentlemen, both, thank you, as always. Hopefully it does do just that, gets us down the road to get more people more comfortable. 

That said, if there are follow-up questions or if anybody out there wants to have a further dialogue, please reach out to your Ashmore representative. We're happy to connect the dots here. It would be our pleasure. In the meantime, feel free to share this document with others. To all that attended today, thank you so much. Obviously, we appreciate your time, we appreciate your trust, we appreciate your business. And finally, and again, Andy, Gustavo, thank you. We appreciate your efforts, and Andy, keep those numbers coming. The clients and the shareholders love it, so, again, truly appreciate it. Thanks, gents.

Andy Brudenell: Great. Thank you very much.

 

Gustavo Medeiros: Thank you, bye-bye.