Emerging from the storm
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Who would have thought that the fastest-growing economies would one day be African? Yet the Economist Intelligence Unit forecasts that 15 out of the 20 fastest growing countries in 2009 will be in that region. Indeed, while most of the developed world has slipped into recession and growth has slowed in developing countries, Africa has bucked the global trend.
Ayo Salami, the manager of Duet’s newly launched African Opportunities fund, sees enormous potential on the continent, despite pressure on Africa’s small stockmarkets, falling commodity and oil prices, and diminishing foreign investment. Duet, an alternative asset manager, has just bought up the assets in New Star’s high-profile Heart of Africa fund, intended to invest in the boom of the region’s frontier markets. Troubled New Star said it had to wind up the fund because of reduced liquidity in the sub-Saharan markets.
Salami, who is also the chief investment officer on the Duet Victoire Africa index fund, says that as African countries grow, income per head grows and a new middle class emerges.
He says the political environment has improved and there have also been in-depth institutional reforms. For example, more African countries now have an independent monetary policy committee that sets interest rates and sound money policies.
Michael Power, a South Africa-based global strategist at Investec Asset Management, says: “In 2008, the capital tide flowed out of Africa’s financial markets and given the events of last year, this is hardly surprising.” He adds that the declines reflect a rise in risk aversion globally and “echo the idea that stockmarkets are forward-looking, discounting mechanisms that pay particular attention to growth prospects as they materialise in the profit outlook for companies”.
He says Africa’s share prices have fallen more than subsequent operational performance would tend to warrant. But there is also a correlation between GDP growth and stockmarket performance, although not an absolute one.
The stockmarket capitalisation of sub-Saharan Africa may still be less than that of a single giant such as Shell, Power admits. But he says one should also ask if Shell is going to grow faster than Africa.
Those African countries that depend on their commodities have been particularly hit by the crisis as the global demand for their goods declined, says Christopher Hartland-Peel, an African equity researcher at Exotix. But he stresses that “the bottom has been seen”.
While prices for commodities and oil have plummeted, he adds, soft commodity prices have been more resistant in the first place. “Demand for tea, cocoa and agriculture produce has been stable; prices for metals and oil will recover as the world economy recovers.”
Hartland-Peel also observes that many African economies, which used to rely on their commodities exports, are switching to a more domestically-orientated economic model. “These countries are growing from a very low level – there are considerable opportunities.”
“The continent’s demographics are the key implications,” Salami argues. “Half of the African population is under 35 years old. Europe and Japan, for example, have ageing populations.”
“We don’t like export companies and we don’t like mining companies because the demand for their products depends on Western economies. We’ve also got a negative view on banks and financials because we expect rising loan loss levels,” Salami says.
“But this [approach] changes as the economy changes. I can see a time when the demand for mining and natural resources will rise again.” When China’s economy takes off, he will “restructure the portfolio and take advantage of these conditions”.
“Investing in larger markets like Egypt is relatively simple, but we invest in esoteric markets like Botswana, Namibia and Uganda that others consider as too small. However, this is where we see the opportunity to add value for our investors.”
He says Duet’s philosophy is to “enable investors access to products and regions of the world where efficient models are not yet in place”.
For now, the newly appointed fund manager is looking for companies that are investing in infrastructure projects and those that meet domestic consumer demand: breweries, food companies, telecoms and cement.
Despite the financial crisis, domestically oriented sectors have tended to continue “business as usual.”
Power says Africa’s middle class “is on the move, although not as impressive as in China.” The global strategist likes what he calls “the BBC”: brewing, banking and cement. “These three sectors, and perhaps the telecoms sector, tend to grow more than the economy itself because of demographic changes.”
Nick Price, the manager of the Fidelity Emerging Europe, Middle East and Africa Fund, says that the African consumer is “under-served”.
In terms of geographical asset allocation, he favours South Africa. But he also points to Nigeria and Zimbabwe as possible investment opportunities. Yes, Zimbabwe. “Things look like they are improving. Zimbabwe is getting rid of its [hyper-inflationary] currency and everything is paid in US dollar and South African rand.
“Nigeria has grown by 7% over the past couple of years. One would think that this was driven by oil but it was actually telecommunications and the financial sector – domestic-related segments.” He says that the largest manufacturer of soap, PZ Cussons, has grown by 20% per year. Nigeria, like other African countries, is coming from a very low level. “The Nigerian demand for foam mattresses is up by 20% to 30%.” As per head income rises, people are replacing their straw mattresses. Beer consumption is growing at 10%. For example, Heineken has a large stake in Nigerian breweries, a stock that trades at 10 times earnings and pays an 11% dividend. He says such businesses grow at exorbitant rates because “African consumers have not been serviced properly”.
Mark Mobius, the manager of the Templeton Frontier Markets fund, says he is still interested in raw material and mining. “However,” he adds, “ the African consumer is becoming more interesting to us. For example, we are interested in anything with retail sales or telephone services.”
Like most investors, Mobius’s biggest investments are also allocated in South Africa. “This is mainly because the choice of well-run companies is greater than in other countries. Liquidity is greater and valuation is better." He also has holdings in Kenya, Nigeria, Egypt and Tunisia but says that “South Africa has the greatest potential”.
Mobius says South Africa has a stable society, good infrastructure and a developed legal system, factors he considers when making decisions.
Emad Mostaque, who co-manages Pictet’s Middle East and North Africa fund, warns that “the sub-Saharan African equity markets are very illiquid”. Last year it seemed there was too much liquidity in too few stocks, he says. “Now a lot of money has been taken out.”
“Middle Eastern markets have only been accessible to investors for two to three years,” he says. Governments in the region have “liberalised the market and encouraged foreign direct investment”. In an effort to attract foreign investors they have created tax benefits and other incentives. “Some companies receive free land and resources are available at a reduced rate so that local companies can grow and create jobs.”
He continues that the region took advantage of high oil prices and paid off all debts when oil prices were high. “They can now invest in infrastructure.”
Sanjeev Gupta, the CEO of South Africa-based Sanlam Investments, is responsible for business in Africa and other emerging markets. “We do have a pan-Africa strategy, excluding South Africa. But investment opportunities vary from country to country.”
Gupta says there is now more optimism towards Africa from large corporations. Domestic flows are increasing, discretionary savings are increasing and governments are beginning to form pension schemes. “Funding is no longer a challenge but creating opportunities is,” he says.
“There are not enough companies listed on the stockmarket. [However,] there are very early signs of companies coming into equity markets as opposed to just raising debts.”
He says there is a shortage of readily available local investments in listed funds because to a large extent the main commercial activities – power, water, electricity, housing and telecoms – are controlled by governments.
“The public sector or government-owned companies are not listed [on the stockmarket]. Other companies, such as those operating in the financial or mining sector, don’t necessarily come into the local stock exchange markets to raise equity debt. Or they are owned by foreign multinationals.”
Mobius says: “There are well-run companies [in the region] that are just as good as companies in other countries, or even better.” He continues that “now we can find a lot of bargains, not only in Africa but also in lots of other emerging markets”.
Andrew Brown, a manager of the Aberdeen Emerging Markets fund, holds two companies listed in South Africa. The fund gains indirect exposure to other African countries through these companies, which have operations in sub-Saharan Africa. "For example, Massmart not only operates in South Africa where it is listed, but also in other countries like Nigeria, a country of 140m people – which makes it the largest consumer market in sub-Saharan Africa. The second company, Truworths, has operations in Botswana.” Brown says both companies have adopted a conservative expansion strategy. “Their cautious approach gives us confidence of longer-term source of growth.”
“I would like to get higher exposure to the sub-Saharan Africa but the problem is liquidity,” Brown says. “We found decent companies but haven’t found any that are good enough to include in the GEM fund.” Searching for investment opportunities, he has travelled repeatedly to Ghana, Kenya and Nigeria. “We meet companies several times before making a decision.”
Dirk Kubisch, a product specialist at Julius Baer Asset Management, says the Northern Africa fund invests in Egypt, Morocco, Tunisia and sub-Saharan Africa. It has smaller asset allocations in Kenya, Nigeria and Zambia
“We don’t use a defined sector approach but a combination of bottom- up stock selection and top-down macro analysis. Companies have to be strong as a stand-alone position.”
He focuses on market leadership, earnings growth and strong balance sheets. “On a stock level, we identify stocks that are placed with different themes.” He is now keen on the financial and telecommunication sectors. “Most people first think about commodities when they hear Africa, but there are a lot of other opportunities.”
Kubisch says some of the risks include currency risks and inflation. “I don’t hedge currencies because the cost is very high. Financial markets are not so developed, and one needs to have instruments. Interest rates are also generally high in developing countries.
“When investing in frontier markets, it is always a challenge to get stocks that are liquid enough. And there are not a lot of large caps in the region.”
“Investors traditionally regard high liquidity as a good thing,” says Power. “But Africa has shown this need not be so; its relatively illiquid frontier markets, although still mostly recording negative returns, significantly outperformed both developed and emerging markets in 2008.” He says those investors who have employed this approach alone have, when faced with the need for liquidity, often been forced to liquidate their deep-value yet illiquid stocks at “fire-sale prices”.
Power says that high liquidity often encourages investors with short-term horizons to trade the market. And taking short term positions makes the market more volatile.
“In less liquid markets, investors patiently buy positions for long-term investment,” he says. “Long-term investors don’t need to trade today.”
The global strategist says investors face issues such as availability of information and stocks and tradability of stocks. “Long-term investors are not afraid of investment heights and that profits that are not necessarily materialised tomorrow.
“One has to have a private equity mindset when investing in Africa, although this is not so much true for South Africa, Nigeria and Egypt.”
Power says: “The real art of investing in Africa’s emerging and frontier markets – an art only available to institutional investors with a longer-term time horizon – is to balance the more cyclical, shorter-term advantages that accrue to liquid emerging markets against the more structural, longer- term advantages that accrue to deep- value frontier markets.”
“Africa is full of Hotel Califonias,” Power says, referring to a 1976 song by the Eagles. “You can check out any time you like, but you can never leave!”
The promising candidates in Africa
Several African countries are promising candidates to become part of “a second generation of emerging market countries,” says David Nellor, the country representative of the International Monetary Fund (IMF) in Nigeria. “Today, macroeconomic performance in those African countries is as good as it was in Asia back in 1980. Or even better.”
The term “emerging market”, Nellor says, broadly refers to developing countries with stockmarkets that are beginning to demonstrate the features of mature stockmarkets in industrialised countries. “Emerging markets have been identified in all regions of the world. In Africa, only South Africa so far has been seen as an emerging market.”
Eight African countries are headed toward emerging market status when benchmarked against the founding members of the Association of Southeast Asian Nations, which were among the early emerging markets. The criteria set for Nellor’s research – growth, private sector-led growth, and investable markets – were met in Botswana, Ghana, Kenya, Mozambique, Nigeria, Tanzania, Uganda and Zambia.
“These countries have developing financial markets that are likely to attract institutional financial investors,” Nellor says. Together, they account for about 40% of the region’s population outside South Africa and almost 50% of its GDP. Despite the crisis, African countries will continue to grow, albeit at a slower rate, Nellor says. “And some countries will grow quite rapidly.”
The Nigeria-based IMF associate adds that access to capital markets is a key driver to high and sustainable private sector–led growth. And there is evidence mounting that financial flows are being translated into growth in financial intermediation in these countries. “They have improved their macroeconomic performance and established capital markets.” He adds that their governments have embraced market-led growth and “foreign investors are actively looking for opportunities on the continent”.
“A high GDP growth signals that there are opportunities for investors to buy into the country’s overall prospects or seek out opportunities by identifying undervaluation in specific sectors.” The search for yield, Nellor says, has encouraged investors to expand their investment horizons.
However, Africa’s aspiring emerging markets face a more complex and more integrated global environment than they did a quarter ago, Nellor warns.
For sustained growth, low inflation and sound macroeconomic policies, including a regulatory framework, are essential. “The environment for private sector investment is important. The public sector has to put quality infrastructure in place and invest in transportation, health and education.”
Sheltered from the financial storm
Remoteness paid. Weaker financial linkages with the rest of the world, once seen as a major stumbling block to Africa’s development, are proving to shelter the continent from the raging financial storm.
Christopher Hartland-Peel, an Africa equity researcher at Exotix, says African countries have been less integrated in the global financial network and there are few toxic assets on African balance sheets.
Michael Power, a global strategist at Investec Asset Management, says: “The lack of financial depth, typical of many African economies has not been a weakness but an advantage; it is more readily available cash that makes frontier Africa’s world go round, not so much the hard-to-get credit.”
“Unlike many of their Western counterparts, Africa’s banks have continued to expand lending, so shielding the African consumer from credit crunch afflicting the West.”
Hartland-Peel highlights that many African countries have a vibrant informal sector. And although much of the activity in the informal sector is unrecorded, micro entrepreneurs contribute to a country’s economic growth. “The informal economy is still strong. [Micro entrepreneurs] may not be part of the formal economy but they still buy things like cement and soap from companies in the formal sector.”
He says almost all these micro businesses are profitable and cautiously managed. “They are cautious about taking on debt and most of their investments are financed in retained earnings.”
Sanjeev Gupta, CEO of Sanlam Investments, says that money from the informal sector now flows into the formal sector as financial service providers offer savings accounts
and insurances.
“The Western perception of an African is a man with a mud hut and goat,” says Nick Price, the manager of Fidelity’s Emerging Europe, Middle East and Africa fund. “But in Lagos, the first thing one sees is mind boggling traffic. There are huge numbers of vehicles. Everywhere.
“But what is even more fascinating is, that every single one has been bought for cash. And this is almost exactly the opposite of what happened in the West.”
