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On the evening of April 17, 2024, members of CFA Society, Chicago gathered in “The Vault” to unlock the hidden treasure of opportunities in the frontier markets. Nick Padgett, CFA, Managing Director and Founder of Frontaura Capital LLC, revealed the trail of his treasure hunt into the frontier world. 

Burkina Faso, Côte d’Ivoire, Togo. Only a few of us sitting here in the Land of Opportunity would have fathomed these were the names of real countries, much less about the investment opportunities that exist in these countries. As we were to learn, these countries not only exist, but also are prominent in at least one universe, the universe of Frontaura’s investable assets.

Based on who you ask, the definition of a frontier market may change. Padgett’s definition: 

Frontier markets are stock markets, categorized by country, that leading index providers typically do not classify as either “developed markets” or “emerging markets.” Frontier countries are home to 33% of world’s population. When measured by purchasing power parity, frontier countries form 16% of the world economy. However, when measured by market capitalization, these countries form only 1.4% of the global market capitalization. Frontier countries are the world’s fastest growing economies. Frontaura’s target investments are mostly companies with PE ratio of under 6, and would be considered value investments. However, as Padgett showed us, in the frontier markets, it is possible to get growth and value together in the same company.

Frontaura’s journey off the beaten path has its roots in personal travels of the founder, Nick Padgett. In 2003, Padgett – a Dartmouth MBA graduate, former technology analyst, CFO and CFA charter holder – decided to take a break and travel the world. Padgett and his wife travelled 65 countries in a span of 18 months. After returning to the US, Padgett wanted to return to the investment world. He found the frontier countries to be full of opportunity, only that it appeared too good to be true. To see it for himself, Padgett travelled to Ghana and was blown away by what he saw. Sonatel – a leading mobile operator in French-speaking West Africa – was paying a hefty dividend of 8.8%! Moreover, it wasn’t unusual for companies over there to pay a dividend of this kind. With less competition, these companies had most of the playing field for themselves and they generated good cashflows. The icing on the cake was their low valuations. Padgett had found his way back to the investment world. Frontaura, with a global mandate to invest in frontier countries, was born on November 1, 2007.

Currently, Frontaura has AUM of USD 146 million. In the past, the AUM of Frontaura portfolio has been in the range of $85 (COVID low) to $175 million (October 2014). The size of the fund is small by design as Padgett thinks it fits the markets. He is focused on getting a good return on investment rather than setting goals for AUM growth. 

One of the ingredients of Frontaura’s recipe for success is its lean and mean operations. Only three people – all three of them CFA chaterholders – handle the investment operations, Frontaura outsources all non-investment functions of the operation to third party vendors. The delegation of noncore activities coupled with availability of technology in the form of online conferences help keep actual site visits to a minimum. Padgett prefers to take one or two trips to a country before he starts investing. This gives him the context necessary to visualize the reality after reading about it from far away.

Investing in frontier markets comes with a unique set of challenges. The set includes exposure to market risk as well as country-specific risks such as political instability, regulatory changes, economic volatility and currency fluctuations. Frontaura actively manages market risk by diversifying its portfolio across multiple countries and sectors. For country specific risks, Frontaura selects countries based on macro-driven factors which help it avoid markets with the highest valuations and worst macro situations. With valuation being a major source of return, the risk of incorrect securities valuation is significant. Frontaura selects only securities trading at a discount to intrinsic value, providing a margin of safety. It also avoids complexities in valuation by opting for relatively simple businesses that it is confident in valuing. Another major risk is currency risk – devaluation and shutting down of the market with a small window left to exit. Frontaura accounts for projected devaluations based on the inflation differentials between USD and the country’s currency. 

The deck of slides Padgett presented compared the performance of S&P 500, MSCI EAFE, MSCE EM and MSCI FM from 2002 to March 2024, along with Frontaura’s performance from 2008. The charts show 4 up cycles and 3 down cycles for the frontier market during these 22 years. The bear cycle from 2014 to 2020 was particularly harsh for the frontier market funds. During this period, AUM of six large FM funds collectively dropped from $6.6 billion to $0.75 billion, an 89% decline. Two of the funds closed after losing more than 95% of their assets. This was the only period during which S&P 500 had a clear and emphatic lead over all indices with emerging markets trailing behind all others. With the majority of foreign institutional money having left the frontier markets, the recovery began with the S&P 500 leading the charts for most of the period of April 2020 to October 2022. Starting November 2022, as global markets switched from a recession narrative to a soft landing, all indices are on the rise. Frontaura has maintained superior performance for a majority of the time starting November 2022. Overall, during the 22 years between 2002 to 2024, frontier markets led for 6 years and Emerging Markets led for the next 13 years. The S&P 500 was worst for the first decade and only in 2021, it took the lead as China hurt Emerging Market returns. 

Padgett also compared the valuations for the four indices above with Frontaura’s valuations. The comparison was for the period of 2008 to 2024, and based on PE, PB, Dividend yield and ROE. For the most part, S&P 500 has been the most expensive, whereas, frontier Markets are the least expensive among the indices. Frontaura valuations have been the most attractive for this entire period of 16 years. 

Padgett takes a systematic approach with his investment process. He described the unique valuation method used in his analysis. Frontaura combines the four metrics of PE, PB, dividend yield and ROE to form a composite metric called Quality Value Score (QVS). Padgett found QVS to be highly predictive of forward 2-year performance. He ran the regression of future 2-year returns as predicted by QVS against the actual returns of Frontaura portfolio for the period of March 2010 to March 2024 and found it to be a good fit while being highly statistically significant (F score 149, t-statistic 12).  March 2026 QVS predicted return for Frontaura portfolio is at 39%, which is to say, if past relationships hold, the current portfolio held by Frontaura is predicted to give a return of 39% over the next two years.

Padgett used his analysis to make the point that when done right, frontier markets can provide a good return on investments. Frontaura is one of the most successful frontier market funds. The portfolio offers high returns on capital at low valuations, is diversified across 6 sectors and 24 countries in the frontier Market. Evidently, the source of Frontaura’s returns is its manager’s value investing approach using both top down and bottom-up analysis, country and company selection, risk management and active management. 

When asked to identify the source of Frontaura’s portfolio returns, Padgett explained, there are two answers, one pre COVID and one post. Prior to COVID, the biggest source of return was PE multiple exploitation. The second source was the dividend yield and the third was earning’s growth. Post COVID, earnings growth has become the primary source of returns. COVID sell off brought a lot of companies within Frontaura’s buy range. As a result, post COVID Frontaura portfolio has a growth view which it did not have prior to COVID. Inflation plays a critical role too, Padgett added. Inflation is incorporated into Frontaura’s basic value approach by forecasting free cash flow by year, projecting exchange rate with the assumption that exchange rate is going to be devalued by the differential of US and the local inflation of the country. Essentially, the source of return depends on the kind of opportunities the markets present. 

With Frontaura, Padgett has created a novel investment model. Currently, Frontaura is invested in public equities of 19 countries in frontier markets. The remaining frontier markets, about 80 countries, with their public, private and debt markets, still remain a treasure trove locked in a vault. The time is ripe to unlock them, include them and integrate them to create an egalitarian global economy.