Africa funds: continent of promise and peril
With deep inefficiencies and illiquid shares, Africa requires a longer-term commitment than most other markets
Financial advisers and pension fund trustees should reconsider their exposure to countries elsewhere in Africa now that pension fund members may increase their maximum allocation to this region to 10%.
With a range of highly inefficient markets and illiquid shares to choose from, there is still a strong case for active management of African frontier funds.
And 2017 was a particularly strong year for the continent. The Laurium Limpopo African Equity Fund, for example, provided a 48% return. Markets were coming off a low base, with a devaluation of about 50% in the Egyptian pound and the Nigerian naira in 2016.
"The positive trend continued in the first quarter of 2018," says Laurium fund manager Paul Robinson, "but it turned negative again in May as investors sold out of emerging and frontier markets."
He says the demands on MTN for extra tax payments by the Central Bank of Nigeria did not help: MTN Nigeria was the most keenly expected IPO of the year and it has been postponed indefinitely.
But Egypt has a strong IPO pipeline. Recently listed Obour Land is a favourite of most fund managers as it produces spreadable feta cheese, the staple source of protein in the mass market. And Cira, a property developer in Egypt that builds and manages schools — a hybrid of Balwin Properties and AdvTech — has added another option to the universe.
Fungai Tarirah, manager of the Sandton-based Rudiarius BCI Africa Equity Fund, says many African countries have put the right reforms in place. Egypt has dropped all subsidies except for butane — the main fuel used by the poor — and Kenya has built a single-gauge railway from Nairobi to the sea with Chinese help. "Even inflation has been coming down, though some investors are frustrated that it remains stubbornly at 11% in Nigeria," says Tarirah.
Undoubtedly, Africa requires a longer-term commitment than most other equity markets.
Some of the promising economies on the continent still have to open a bourse. Angola, for example, has a stock exchange building but no counters. The new president first needs to purge corruption and waste from state-owned enterprises.
Ethiopia is still taking baby steps towards a free market economy, but with more than 100-million people it has huge potential, without the legacy issues of, say, Nigeria.
Those who complain that SA small caps are often untradable should consider the obstacles faced by African frontier funds.
The JSE trades about $1.6bn daily, 10 times what the rest of Africa trades, even including the well-diversified Egyptian market, a hotspot of liquidity with about $50m of daily trading.
The African share universe is dominated by banks, which make up 45%-50% of most benchmarks. In contrast, there are very few tradable insurance shares.
"In some African markets trade is less than a $1m a day," says Mishnah Seth, manager of the Aluwani Africa Equity Fund. "So if you buy a share in Ivory Coast, for example, you need accept that you are married [to it] for life."
Some African champions have emerged, notably Safaricom, which is not only the dominant cellphone operator in Kenya but also pioneered the M-Pesa mobile money transfer system, a world first.
Nigerian banks are the largest single constituent of the index, and a few of these, such as Zenith and Guaranty Trust Bank, also feature prominently in some funds.
Peter Townshend, manager of the Sanlam Africa Equity Fund, does not like banking shares, which he considers to be low-quality businesses with low returns and high debts. The only exceptions would be top-rated Nigerian banks Stanbic IBTC and Guaranty Trust Bank.
The Sanlam fund is exceptionally concentrated, with the top 10 shares making up half the value. At present it has no banks, nor does it feature Safaricom.
The biggest point of disagreement between these funds is on specific countries at either end of the continent: managers either loathe or love Zimbabwe, and have equally strong views about Morocco.
Nick Ndiritu at Allan Gray has almost 26% in Zimbabwe, principally in the two largest shares, brewery Delta (now part of Anheuser-Busch InBev) and cellphone provider Econet, and it would be even higher than 26% if Allan Gray didn’t adjust the holding downwards to reflect fair value.
Godfrey Mwanza of the Absa Africa Equity Feeder Fund says that though he looks for cheap shares, he believes in fishing in the right pond where there is the right level of risk. An example would be KenGen, a renewable energy business in Kenya with a much stronger balance sheet than the state electricity generator.
Seth says that not only is Morocco overpriced, it also has the highest correlation to developed markets, especially Europe, and most clients want diversity from this fund.
Laurium has a half weighting in Morocco, which trades on a high multiple as it has a largely captive domestic investor base.
But Robinson considers supermarket group Label Vie to be good value even on a p:e of 19. It is the partner of the French Carrefour Group, and its margins are expanding faster than expected. Formal retailers account for just 15% of the Moroccan market. And Label Vie is one of the very few quality retailers listed on the African bourses.
There are some strong African consumer goods names, however, such as Eastern Tobacco, Egypt’s monopoly producer, in a country where there is no sign of a decline in smoking. Several multinationals have subsidiaries in Nigeria, such as Unilever, Nestlé, Heineken (through Nigerian Breweries) and Diageo (Guinness Nigeria). These shares command a premium price, but they have fallen back and are now on more radar screens.
But Paul Clark, head of Africa equities at Ashburton, says breweries have had a tough time recently. "All the talk a few years ago was on premiumisation," he says.
"The old SABMiller was launching brands such as Peroni in the market. Now the trend is towards value brands."
Clark says that in Nigeria, International Breweries, now part of AB InBev, has outgunned Heineken and Diageo in this sector.
Mwanza says there have been opportunities to almost double your money on Safaricom, which fell on speculation that the regulator would make it unbundle the M-Pesa businesses. But this turned out to be incorrect.
He says the other large African cellphone business, Senegal-based Sonatel, still has to prove it can make up for lost voice revenue in data and its fledgling mobile money business, but it is starting to make strides.
Fund managers have not managed the upward trend in the oil price well. Few oil and gas producers are listed on the continent, though London listings such as Tullow Oil would be permitted as its operations are in Africa. The easiest entry point has been Seplat Petroleum in Nigeria. It was hit not only by the low oil price 18 months ago but also by political tensions in the Niger Delta. Its pipelines are back online, and it has expanded its gas business.
Clark says that on an oil price of $60 a barrel the stock would trade on a forward multiple of four. "If you look on a five-to seven-year time frame, African markets have always returned at least in line with the JSE, but there is considerably more scope for active managers to add to that," says Clark.
Mwanza agrees, as there is limited "sell side" stockbroker coverage of African equities, and many multinational securities firms pay even less attention now than they did before the global financial crisis.