Lines of fire

12/05/2009 | Stephen Cranston

Recent confidence in Africa’s assets proved misplaced – as the markets’ dramatic fall demonstrated. But some investors remain loyal

Recent confidence in Africa’s assets proved misplaced – as the markets’ dramatic fall demonstrated. But some investors remain loyal.

For years, Africa was a continent off the radar of most international money managers. Instead, it was the preserve of highly specialized private equity funds – and a handful of low-key regional investors.
By 2005 that had changed. As an increasing number of countries began putting their fiscal houses in order and stabilized politically, mainstream investors – often in droves – discovered for the first time an attractive risk-return trade-off across the continent. “The far-reaching and pervasive changes in sovereign governance on the continent changed the way many African economies operate,” notes Roelof Horne, manager at the Investec Africa Fund.
Africa also appeared to be somewhat insulated by what many believed were its more tenuous financial linkages to the rest of the world; and some optimistic bankers and investors even suggested it would be immune from global financial turmoil.
In 2007 a slew of funds launched to cash in on the rebounding sentiment. Among them were South African based Investec, Stanlib and Coronation funds (Stanlib also launched a fund in Europe under the Standard Bank brand), as well as the high-profile New Star Heart of Africa Fund in London.
Fund managers also looked to set up Africa debt funds, even though supply was limited: as most African sovereigns had restructured their debt, only Ghana and Gabon were issuing Eurobonds. But faith in African banks and corporates meant that some established names could issue debt. For example, Nigeria’s Guaranteed Trust Bank issued a five-year Eurobond fixed at 8.5% – despite Nigeria’s vastly overcrowded banking sector.

Confidence misplaced
But this overconfidence in African assets was naive and, it turns out, short-lived, analysts say. Stuart Culverhouse, chief economist at Exotix, a boutique investment bank, notes that even if there had been no direct impact from the US housing crisis, Africa was always in the firing line because of the crisis’ impact on capital flows and commodity prices, as well as the inevitable fallout on stock markets.
The price to earnings ratios of African markets, according to Stephane Bwakira, manager of the Standard Bank Africa Fund, has fallen from 20 to seven times earnings over the past 12 months. His fund has lost two-thirds of its value in this period.
It has not been alone. New Star’s Heart of Africa Fund was down 52% by February 2009 from its launch in November 2007. Withdrawals had been so heavy – it proved impossible to sell the underlying shares fast enough to meet withdrawals – that it suspended dealing in December. On April 6, New Star sold the remaining assets in the fund to London-based alternative manager the Duet Group. They will be used to form the core of the Duet African Opportunities Fund.
John Green, head of Investec’s global distribution, says it is essential
to have a core of loyal investors in such a specialized fund, focused on illiquid markets. “We are lucky that the loyal institutional client base – who did not come into the fund just because it’s a hot sector – have been loyal to us. We do not target the typical mutual fund investor, and we have only monthly trading.”
So Africa has pleased neither investors looking for high corporate stories nor those looking for low correlations with world equities. But this does not mean that neither will return.
Mark Mobius, executive chairman of Templeton Asset Management, says the fallout of a major global crisis is necessarily universal, so it’s hardly surprising that disparate and uncorrelated markets are feeling the shock.
“But when looking at frontier markets such as Africa, we have found the correlation with developed markets to be very low over the long term, and we expect that to continue.” About 40% of Templeton’s Frontier Market Fund is invested in Africa.

Bearing the brunt
For now, Africa is feeling the brunt of the world economic crisis. A sharp fall in copper prices slammed Zambia’s economy and upended its currency, the kwacha; a collapse in diamond sales hit Botswana – particularly as key mines such as Jwaneng were closed for several months.
Botswana, once among Africa’s most stable economies, is likely to slow sharply – as much as 7% of GDP this year. A decline in tourism has had a sharp impact on the Mauritian economy; although the island nation’s banking shares are down a modest 4% in the year to date, tourism is down 47%.
The fall in the oil price was one of the main reasons that Angola shelved plans to set up a stock exchange. Enabling legislation for the bourse was passed in 2005. In February 2006 Antonio Cruz Lima, the industry minister, announced that a stock exchange would open by the third quarter of that year with 10 companies with an expected market capitalization of $6 billion.
But by last August, cabinet heavyweight Aguinaldo Jaime announced that setting up a stock market would be a “problem for the next government”. Angola is now one of just three SADC (Southern African Development Community) countries without stock exchanges, the others being Tanzania and the Democratic Republic of Congo (DRC). John Mackie, head of Stanlib Africa in Johannesburg, says only a clear and unambiguous commitment to the privatization of state assets could have salvaged the initiative.

On the upside
But Standard Bank Africa Fund’s Bwakira believes the fall in commodity prices is easily overstated. Services and agriculture still account for over 50% of the continent’s GDP. The focus of the fund has moved towards domestically driven shares rather than those tied to the global economy. The region’s top 10 include three cell phone companies, Mobinil in Egypt, Safaricom in Kenya (which just two years ago bought the largest IPO – initial public offering – in African history) and Celtel in Zambia.
John Mackie of Stanlib says that there are limited ways for an investor to play Africa’s primary consumer theme – food and food security – but the fund owns Zambeef, as well as Illovo Sugar. Separately, he estimates that Nigerian banks are trading at 60% of book value – while in Botswana they can still trade at six or seven times.
Nigeria’s financial sector represents a dark spot among regional markets, having been hit hard by risk aversion and waning confidence. Investors failed to meet their margin calls, leading to a spiral down in shares that saw the market lose over 70% of its value from its peak, 40% in the first quarter of 2009 alone. The banking sector is down by 90%.
But Mobius notes that African per capita income is still on the rise and with it greater consumer exposure to credit and the money economy, which in turn should lead to a higher demand for durable goods and quality clothing. Across the continent defensive consumer shares, such as cell phones, breweries and food, have fared better than financials.
The IMF predicts a 3% increase in Africa’s GDP in 2009, followed by a more robust pick-up in growth the year after.
Mobius says that the trend towards improved infrastructure and the growth in local consumer markets as people move up the economic ladder will continue, even if commodity prices stay depressed. The top African picks in his Frontier Market Fund include MTN (the largest mobile phone business in the Africa and Middle East region), British American Tobacco Kenya and East African Breweries.
Investec’s Horne is a big investor in Benue Cement Company (BCC) in Nigeria. The market has been open for a year, but BCC’s sales have not been affected by competition from imports, because of the devaluation of the naira, the high cost of road transport and limited rail links in Africa’s most populous country.
Horne believes that as continued industrialization and urbanization drive real estate development and much needed new infrastructure, demand for cement in Nigeria will increase even if the overall economy slows.

Structural drivers
But there are other structural drivers of Africa’s growth dynamic, key among them governance reform. Culverhouse says that improvements in governance will on balance endure, even through the bad times. “If it was froth in the good times, and governments revert to bad habits, then Africa will be in trouble. But if it keeps its nerve, with some help from rich donors the region will get through it.”
Will investors recover their confidence too? That depends partly on how exposure to Africa is managed, notes Mobius. One way, of course, is to invest through a broader based fund, such as the Templeton Frontier Market Fund (there are not yet any frontier market index funds).
But at the end of the day, frontier markets will only appeal to investors with a longer time horizon – and an appetite for risk. Such cannot be said for New Star’s investors, who rushed for the exit at the first sign of trouble.

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