2015 was a difficult year for most equity investors, particularly those focused on the developing world.
Return volatility is to be expected, however, and Acadian remains confident in the long-term potential of the frontier asset class. For 2016, we see a number of notable investment opportunities, particularly in the following three countries.
Pakistan's private sector is strengthening, driven by better governance, productive International Monetary Fund borrowing programs, and infrastructure renewal. Commercial and residential real estate is booming, improving the outlook for companies in sectors that will benefit from this activity. Additionally, Pakistan's status as a net oil importer has been another recent boost.
All of these factors are supporting strong company fundamentals, which far outpace the frontier asset class as a whole on the basis of growth, returns, margins and leverage. Despite this, the country still remains attractively valued at 8 times the price to earnings ratio. In addition, investors are focused on the potential for an MSCI upgrade, which could be a catalyst for further flows into this market.
On the negative side, we see downside risk around the potential for currency devaluation, reduction of IMF support, and renewed political disruption.
Overall, however, we see these risks as manageable. Pakistan has been politically stable for several years and has been strongly focused on addressing militancy and corruption. Most importantly, protections for international investors and regulation of the Pakistan stock exchange are among the strongest in the frontier asset class.
At 18 times P/E, Vietnam is not a value play. Active managers, however, will find a broad and liquid market by frontier standards, and one that in our view offers very attractive stock selection opportunities.
Structurally, this is an attractive country, led by a reform-oriented government that supports the private sector. Attractive characteristics include high productivity, low wages, and a young labor force.
The government is actively seeking to encourage development of the manufacturing sector, offering competitive terms on land and taxes. They have shown considerable progress in promoting private initiatives in this area over state owned enterprises. To this end, we favor a diversified approach to industrials in Vietnam.
We also see some economic catalysts in Vietnam that should help support corporate profitability. Vietnam's export-oriented economy should benefit disproportionately from the recently executed Trans-Pacific Partnership. Cyclical recovery is underway, evidenced by rising consumer confidence. GDP growth at 6.7 percent has exceeded expectations, driven by a booming real estate sector, low inflation, and rising consumption.
Risk in Vietnam lies around continuing to improve the alignment between shareholders and corporations, as many companies retain significant state ownership. We also see geopolitical risk in the ongoing regional tensions. Economically, the possibility of currency devaluation should not be ruled out, though given the generally strong economy, we don't see this as a major risk in the near term.
A major recent catalyst in Argentina is the election of the country's new president, Mauricio Macri. We see this event as offering significant momentum for change as Macri, a technocrat, has effectively been given a mandate to restructure the economy.
His election follows years of ill-conceived economic policies and capital controls that have stifled business activity. Macri's stated objective is to liberalize the country's external accounts and improve the operational environment. He has already devalued the currency and embarked on a gradual fiscal reduction plan. His cabinet is expected to include many individuals from the private sector, which should support continued corporate-friendly policies.
Looking to the longer-term, we believe there is strong potential to be realized from Argentina's robust infrastructure, high per-capita income, and well-educated workforce.
Whether Macri can succeed in his plans is of course uncertain — there is meaningful risk that inflation, budget shortfalls and limited financing options will delay or diminish his reforms. In any case, this is a long-term play and it will take some time for fundamentals to improve.
However, with the market trading at 8.5 times P/E, there are many stocks in this market that look attractive to us now, particularly those that have been distressed by past regulation and are poised to benefit from policy change.
Commentary by Asha Mehta, CFA, the lead portfolio manager on Acadian Asset Management's Frontier Markets strategy and a member of the team that manages Acadian's highly ranked Emerging Markets strategies. Prior to joining Acadian in 2007, she worked at Goldman Sachs, where she was an investment banker executing energy and power transactions in emerging markets.
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