When it comes to frontier investing, smaller, it seems, is better.
Boutique firms that specialize in uncovering great investment opportunities in the world’s most far-flung, developing markets say their modest size is the key to success.
Smaller firms are more nimble and as a result, they can quickly respond to new developments taking place on the ground in frontier markets such as Qatar, Nigeria and Bangladesh.
“This structure allows us to learn what makes that country’s economy tick, and that’s how you get the best returns,” says Nick Padgett, the 44-year old co-founder of the Chicago-based Frontaura Capital, a $35-million hedge fund that invests in frontier markets.
It’s a strategy that is paying off for investors, which in Frontaura’s case includes large institutions, high-net-worth investors and family offices. Padgett’s fund — which invests in listed public equities and is currently 40 percent allocated to Sub-Saharan Africa, 25 percent to the Middle East, 14 percent to South Asia and the remainder to Eastern Europe — is up 35 percent since inception, compared to a drop of 39 percent by the MSCI Frontier Net Dividend Index from November 2007 through September 2010.
That translates to 10.9 percent annualized returns for Frontaura, compared to minus 15.6 for the index over the same period.
Padgett, a former equities analyst who started the frontier fund to leverage rising consumption by the growing middle class in developing markets around the world, recently spoke to Institutional Investor contributor Tracy Tjaden about new opportunities in frontier investing, what makes valuations in Africa so irresistible and why smaller is better.
Institutional Investor: Why are you so bullish on Africa?
Nick Padgett: We really like the valuations in sub-Saharan Africa. Most people will invest in Kenya because its capital markets are the most developed — it’s the easiest way to enter East Africa. And as a result, those are the highest valuations.
We own nothing in Kenya, but we do have positions in Tanzania and Uganda. Tanzania banks, for example, have great valuations but the execution of the trades is really difficult.
Tell me more about your investing strategy.
We have 33 companies in our portfolio right now across 21 countries. We avoid the BRICs and major emerging markets — why would you want to compete in countries everyone else is in? When you think about why emerging markets are so volatile, half the time it’s not what’s happening in the country, but rather what’s happening on the global trading desks in Hong Kong, Singapore, London...
How do you actually pick stocks?
We don’t follow any kind of index. Our strategy is based on our own research and really early on in the business, my partner and I had logged over 400 company visits.
We use fundamental research and follow a bottom-up investing style. That means individual stock selection based on internally developed investing themes — and we only buy stocks when they’re at a discount.
What sectors look the best right now?
We like the mobile phone industry, not so much to invest in but as a proxy to track growth in the consumer sector. It’s one area where you can really chart this massive growth of the middle class.
