Templeton explores new frontiers with USD250m fund

The Templeton Frontier Markets Fund was launched in October 2008 and aims to achieve long-term capital appreciation by investing principally in transferable equity securities of companies incorporated and/or having their principal business activities in the frontier markets countries across the market capitalisation spectrum.

According to the International Finance Corporation (IFC), Frontier Markets are developing markets that are more developed than ‘least developed countries’, but are still too small, or too risky or too illiquid to be formally classed as an Emerging Market economy. Generally, they have equity markets that are small, inaccessible, illiquid, but still investible. They are risky but have the potential to offer high potential and double-digit returns over the longer-term with low correlation with other markets – so when North America or the EU falls into recession, the potential to find positive returns in Frontier Markets remains. Economies can move between Emerging Market and Frontier status as if a country’s economy contracts, it can fall back to Frontier status.

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The fund has USD250m assets under management, is dollar-denominated, Luxembourg-domiciled and benchmarked against the Linked MSCI Frontier Emerging Markets Select Countries Capped Index-NR. Managed by Bassel Khatoun and Ahmed Awny, both based in the UAE, the managers aim to hold their investments for the medium- to long-term. Khatoun is head of research and director of portfolio management for Frontier Markets for Franklin Templeton and had been with Algebra Capital since 2007, which was founded in Dubai in 2006 and acquired by Franklin Templeton in 2011. Awny is head of investments and portfolio manager of the Templeton Frontier Market and has been with the fund manager since 2007 after spending three years working at local firms in Dubai.

Frontier markets are fastest growing

Frontier markets, the next emerging markets, are among the fastest growing and least tapped markets in the world, offering an opportunity to invest in companies that are poised for growth, are uncorrelated with both developed and emerging markets, offering diversification for an investment portfolio.

The Templeton group has a global presence and operates globally, with teams on the ground in or near to significant Frontier Markets.

The fund is at the top-end of expensiveness, charging an Initial Charge of 5.75% with an Ongoing Charge of 2.57%. It has offered 11.8% cumulative return over one-year against a benchmark return of 8.7% to the end of July 2023. Over three years to the same end-date, the Templeton Frontier Markets fund offered 44.8% against a benchmark return of 24.5%.

However, to illustrate the volatile nature of Frontier Markets, and taking into account the global impact of the Covid-19 pandemic, on a cumulative basis the fund only returned 9% over five years, beating its benchmark by 2.6 percentage points and over a decade retuned 14.1%, underperforming its benchmark by 18.9 percentage points.

On a discrete annualised basis over the past ten years the Templeton Frontier Markets fund outperformed its benchmark five times and underperformed its benchmark five times. The fund had an exceptional year in 2020/21 retuning 41% against a benchmark performance of 28.8%. This was its best year in the last decade. However, in 2013/14 the fund underperformed the benchmark by nearly 16 percentage points, returning 15.8% that year.

Its worst performance was 2021/22, obviously giving back some of the performance from the year previous, and retuning -8.1%, but still outperformed the benchmark by just shy of three percentage points.

Embedding philosophy of the fund

It’s hard to ascertain a trend working through the fund. Three bad years from 2017/18 to 2019/20 followed by three good years for the current team gives you a 50:50 chance of an above benchmark return, however the last three years of clear outperformance are encouraging, as it might indicate an ongoing trend, where Khatoun and Awny have embedded their philosophy into the fund in the 2017/18 to 2019/20 period and now the fund is behaving according to their investment strategy.

The fund managers are strong in their convictions, when compared to the benchmark. The fund’s biggest geographical overweight position was in Vietnam, with the fund holding 22.2% of assets in the south-east Asian country, compared to a 10.3% exposure of the index. The fund was slightly overweight the index in the Philippines. Given the managers are based in the UAE, understandably the fund is overweight the benchmark. Other notable overweight positions include Kazakhstan, Saudi Arabia, Georgia and Kuwait, and the fund is underweight in Morocco and Peru.

Khatoun is very bullish on the GCC (a trade bloc comprising Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates) and cites the demographic advantages the region has. He said: “In a world grappling with the challenges of falling birth rates and increasing dependency ratios, the demography of the GCC economies, particularly Saudi Arabia, is moving in the opposite direction. Rising birth rates, a falling dependency ratio, and social reforms are powerful combinations which have the potential to raise the potential growth rate of GCC economies.”

He cites Saudi Arabia, claiming that the region’s largest country is: “in the demographic sweet spot, with high and relatively stable births, and low and stable deaths,” with he believes Saudi Arabia expecting one of the fastest growth rates in the economically-active 25- to 64-year demographic in Emerging Markets, only pipped by the Philippines.

He said: “In sum, we see a positive backdrop for MENA equity markets in 2023. The region is not immune from risk, including the impact of rising interest rates on growth and, in turn, the demand for energy, as well as the impact of Russia’s war in Ukraine. Nevertheless, the connection between oil prices and the economic and market outlook for MENA is being steadily diluted thanks to economic diversification and a greater reliance on sovereign wealth funds to finance investment in the region.”

Frontier Markets offer great potential, but like emerging markets, the success of these countries depends heavily on commodity prices, particularly oil. They are also vulnerable to turbulent politics, as we’ve seen in the cases of Africa and South America. There are thrills to be had, sometimes in the same way that riding a rollercoaster offers, and it’s not the kind of fund or kind of market that you want a huge exposure to – probably no more that 3% to 5% of a total portfolio. However, the prospect of gaining exposure to some newer markets that could potentially offer some high levels of growth could be exciting.

Templeton Frontier Markets Fund top five holdings:

Source: Franklin Templeton / July 2023