AFMC held up well during February showing limited downside capture as developed markets started to slide, but the collapse in the oil price starting on 6 March was a turning point and resulted in a rapid increase in cross-market correlations as well as indiscriminate and violent selling across our markets, thus impacting most of AFMC's exposures quite severely. The fund has limited exposure to oil companies (circa 3.0%), but not insignificant exposures to Georgia, Kazakhstan, UAE and Saudi Arabia, all of which are have been either directly or indirectly impacted by the oil price decline, at least in terms of sentiment, and thus all witnessed large drops. A range of other positions we have, operating in peripheral markets and exhibiting low liquidity, also saw heavy selling pressure as a result of the violent swing to risk-off mode – names such as ASA International, Addiko and NLB, for example. Markets are not operating efficiently and are struggling to price the risks to the outlook whilst placing a huge premium on liquidity – the result has been excessive mark-downs of robust businesses in our space.
While activity in frontier markets is sure to be impacted, we are currently of the view that the economic impact of Covid-19 should be more moderate for frontiers than for US and European economies given the following:
- the much smaller contribution of services, and larger contribution of subsistence and self-employed/sole-trader activities, to economic output;
- lower levels of debt generally speaking, so any temporary shut-down is less likely to strain balance sheets;
- warmer climates that lower transmission of coronavirus;
- lower population densities, which also lowers transmission;
- the demographic skew to young people (who are more resistant to covid-19);
- the fact that epidemics and national public health issues are not new to frontier markets (TB, HIV, cholera, etc) and people and businesses are well used to disruptions (health, natural disasters, etc);
- and of course that these economies have more limited trading relationships with US/Europe, which are likely to fall into recession
Europe and US are resorting to further monetary stimulus, which should be supportive of frontier markets currencies and lower interest rates across the region. Already Egypt has cut interest rates by 300bps this month.
With regard to the oil price, the decline is a huge boost to spending power as well as FX reserves across many frontier markets, a very material positive too. Pakistan imports almost all its oil consumption, for instance, and the saving could be as much as 2-3% of GDP, which is very significant.
Looking past the initial panic, the outlook for frontiers vs developed seems significantly better in relative terms today, yet frontier markets have sold off as hard as, or harder than, developed markets since this virus came to light. In our view the relative case for frontier markets has improved, not worsened.