Managing African Equity Portfolios in a Challenging Environment

The Annus Horibilis 
In a year that felt like an annus horribilis for global investing and where most asset classes from commodities to bonds and equities declined, African equity markets were not spared the rout  in 2015. 

Market returns in US dollars for 2015 

Source: Bloomberg 

The MSCI Emerging and Frontier Markets Index for Africa excluding South Africa fell 22.1% in 2015, although the two largest and most liquid markets fared worse, with Nigeria and Egypt declining 23.9% and 28.3% respectively.  Brent crude oil fell by more than a third from 55.8 to 35.8 USD per barrel over the period and this negatively impacted Nigeria, which is the only net oil exporting country in Africa that has a listed equity market.   

In an environment where the US dollar strengthened against most currencies and the Euro declined 10.2% over 2015, we have seen many African currencies weaken in a similar fashion to what are considered “commodity” currencies (e.g. the Australian dollar, South African rand and Russian rouble).  The effective currency weakness for the Africa ex SA Index was about 8.9% over the year.  This relative strength was due to the managed nature of especially the Nigerian naira and Egyptian pound.  We expect these to be allowed to weaken during 2016 which should result in just over ten percent further weakness for the basket and bring it in line with most major Emerging Market currencies over the last year. 

… it not all doom and gloom 
Lower tax revenues from mining, oil and other commodities have constrained African government budgets.  Higher domestic interest rates in many African countries are a result of imported inflation due to the weaker currencies as well as increased government borrowing needs.  But it is not all doom and gloom.  Foreign direct investment (FDI) into Africa remained constant in 2014, despite a 16% decline in global FDI from 2013.  And 2015 is expected to have been a record year for FDI into Africa ($55 billion) and should have exceeded development assistance (aid) for the first time.  The type of FDI into Africa has also moved away from extractive or primary industries.  In 2014, 43% of the greenfield investments were in the services sector, with 33% in manufacturing and only 24% into primary sectors.  This shows a significant move away from the primary or mining sectors of the economy, where the existing investment makes up 31% of the total.    

Africa is also expected to be one of the fastest growing regions in the world over the next five years. 

GDP growth 

Source: IMF, October 2015 

… macroeconomic and political stability
Despite problems in some smaller countries like Burundi, South Sudan and the Central African Republic, we have seen many positive improvements on the political front.  We had a very successful change in government in Nigeria, the continent’s most populous country.  Across the continent, citizens are starting to vote into power those candidates that display a clear agenda to fight corruption.  Nigeria’s new president, Muhammadu Buhari, made it clear in his inauguration speech that corruption will not be tolerated.  In October, Nigeria’s former oil minister Diezani Alison-Madueke was arrested in London and President Buhari has also ordered the arrest of the former national security adviser, accusing him of stealing about $2 billion through phantom arms contracts for jets, helicopters and ammunition for the army to fight the jihadist Boko Haram group which were never delivered.   

In Tanzania, newly elected President John Magufuli has taken a very strong stance against corruption. Within one month of his inauguration, he suspended the head of the Tanzanian Revenue Authority and 5 other tax officials pending an investigation into claims of corruption.  (If you want to see the impact he has had on the national discourse, take a look at #WhatWouldMagufuliDo on Twitter for some humorous thoughts on saving money).   As part of President Obama’s visit to Kenya in July, a comprehensive anti-corruption plan was drawn up and is to be implemented with the help of the United States. 

September saw Kellogg, the world’s largest cereal maker, invest $450m in a joint venture with the African arm of Singapore’s Tolaram Group.  Kellogg said it intends to develop snacks and breakfast items for the West African market through the joint venture.  Clearly real economy investors have a positive long-term view on the region. 

… unprecedented flows out of “riskier” assets 
Investors became more and more risk averse during 2015 as the world’s focus was drawn to the possible implications of a slowing and changing Chinese economy on developed and developing nations and geopolitical tensions increased, especially in the Levant and the Middle East.  We have seen unprecedented flows out of “riskier” assets like emerging market and frontier market funds that accelerated in the second half of the year.  The more than 10% redemption in emerging market funds since oil prices started falling in September 2014 is now more than redemption that took place during the financial crisis of 2008 when the world was in recession.   Frontier market funds have also seen more than 8% of their assets sold by investors.  Because both emerging market and frontier market funds are invested in African equities they have been net sellers on the continent.  We have also seen redemptions from Africa-focused funds and the closure of some others. 

So, although the macroeconomic and political fundamentals of the continent have not deteriorated significantly and growth is expected to continue, the selling by funds that have had to liquidate positions has weighed heavily on equity markets across Africa.  The nature of the selloff has been indiscriminate and companies that offer significant value, or that have lower risk profiles, have seen their share prices tumble too.   

… sell-off offer opportunities for braver investors 
Active fund managers in Africa, such as Ashburton, add value for their investors by understanding the companies and their operating environments and selecting shares that they believe do not fully reflect the companies’ future earnings and cash flows.  When selling is indiscriminate this may result in fund managers underperforming the market as a whole as “cheap” shares become even cheaper.  In addition, because the selloff has been driven by global investor sentiment rather than high valuations in domestic markets, most fund managers will have remained fully invested during the market weakness and were thus not able to cushion the decline by holding cash. 

Although 2015 has been very difficult for African fund managers, the good news for investors is that the selloff has resulted in a large number of significantly under-priced opportunities.  Once global investor sentiment improves and the value opportunities on the continent start to attract investors we could see a significant rally.  Maybe, just maybe, 2016 could be that annus mirabilis that African investors are waiting for. 

Author’s Profile 
Paul Clark started his investment career with Standard Corporate and Merchant Bank’s Asset Management division where he served as a research analyst and specialist unit trust fund manager for 2 years. He subsequently joined HSBC Equities South Africa as an equities analyst where he researched South African-based industrial resources companies with global operations for 5 years.

Paul joined the African Alliance Group in April 2004 as Head of Research with responsibility for the overall African research product of the Group as well as developing research in new countries where the Group opened businesses. He was instrumental in the launch of the Africa Pioneer Fund in June

2007, and was the lead portfolio manager on the fund from its inception to December 2011.

Paul joined Ashburton in South Africa in January 2012 to set up and manage an Africa Fund for the FirstRand Group. Paul holds a Bachelor of Engineering (Chemical) degree from the University of Stellenbosch as well as a Bachelor of Commerce (Accounting) degree from the University of the Witwatersrand, and is a CFA charter holder.