June 7, 2018
Jonathan de La Pasture, Pan Africa Credit: Portfolio Manager
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Credit instruments in other African economies can be an attractive option for investors looking to diversify outside SA.
The prudential limits on offshore investments for funds under management by institutional investors have increased by five percentage points for all categories‚ including the allowance for investments in Africa.
Much has been written about the ‘Africa Rising’ story in the past few years. Since the financial crisis, growth in GDP across sub-Saharan Africa has been impressive compared with many regions across the world and particularly compared with growth rates in developed markets.
Size is not the only way to assess potential opportunity, although there are vast differences in the relative scale of the 54 countries on the continent. According to the IMF, Nigeria’s GDP in 2016 was US$406 billion – 37% larger than SA’s and nearly 10 times the size of its neighbour Ghana.
Across Africa there are oil exporters (Nigeria, Angola), oil importers (Kenya, Uganda, Tanzania), countries with broad-based economies (Egypt, Kenya) and those with little diversification in their economies (Angola). These categories are not static. The oil and gas finds being developed in Kenya, Uganda and Tanzania are reducing their dependence on oil imports. Changes in the oil price and climatic conditions will affect different countries in different ways. Political and economic shocks can never be ruled out. Africa is a highly dynamic investment environment.
Investing in Africa provides excellent opportunities for diversification – a key consideration for any investor. Despite the size and developed nature of the South African economy, significant benefits can be achieved by reducing overall exposure to this country. Allocating some money to Africa provides access to assets in economies which have a low level of correlation with SA.
The table below highlights the low levels of risk correlation among countries in Africa.
Investment opportunities in Africa
There are several ways to invest in other countries on the continent. Equity investing provides the investor with direct exposure to companies and financial institutions across Africa. While equity strategies have the potential to generate significant upside, they also expose the investor to a number of risks.
Many African stock exchanges are relatively small in global terms and are sometimes dominated by a few very large entities. As a result, liquidity can be limited, which can magnify changes in market sentiment caused either by wider country-specific factors (event risk) or by external developments. African equities will expose the investor to currency risk as the rand value of holdings will be affected by any moves in the local currency.
Another route to consider is alternative equity strategies. These tend to focus on either private equity or unlisted property, both of which have the potential to generate substantial returns. But they require a longer-term investment horizon.
Credit as an asset class
Credit, which refers to non-equity instruments such as either listed or unlisted, sovereign or corporate debt, occupies the middle ground between traditional equity investing and alternative equity strategies. Credit can be well suited to investors for whom capital preservation is an important factor or those looking for stable income.
Credit is a mature and liquid asset class. Globally, listed credit has experienced spread compression as a result of quantitative easing while unlisted credit yields have reduced due to a combination of bank liquidity and increased competition from non-bank lenders. Fortunately, in Africa these factors have had less impact. Yields for unlisted credit have actually increased across the continent, creating the potential for very attractive returns on a relative basis.
The same currency risk that applies to an equity strategy can also apply to a credit strategy. However, given the substantial hard currency credit markets available across the continent and their associated liquidity, these currency risks can be substantially mitigated. The main currency risk for South African investors into credit would be the risk of the US dollar weakening against the rand.
The investable credit universe
In fixed income markets, African nations other than SA have issued more than US$160 billion in eurobonds over the last decade. This issuance has been supported by investors seeking yield in an environment where global rates have been at historic lows. The Standard Bank Africa (ex-SA) Bond Index which tracks African eurobonds shows an investor in the asset class would have achieved annualised returns of 9.3% in US dollars over that period (source: Bloomberg).
Local currency African fixed income markets outside SA are much larger, with a total outstanding debt of over US$330 billion.
In the unlisted space, there are many active borrowers in the syndicated loan market across most of Africa’s larger economies. Although slightly lower than in 2016, overall volume in 2017 still totalled US$15 billion, excluding South African issues.
Credit investment strategies
STANLIB has investment strategies for all three of these credit classes: hard currency fixed income, local currency fixed income and unlisted credit.
The STANLIB Africa Fixed Income fund invests in a combination of US dollars and local currency denominated instruments, allowing the fund manager to take a view on undervalued countries and sectors or attractive local yields.
The STANLIB Credit Alternatives team invests in listed and unlisted credit across the continent. This strategy mainly targets attractively priced loans, typically arranged by regional and international banks for Africa’s highest quality borrowers.
When investing in African credit markets, it is essential to take a broad geo-political view across the continent. Political events and commodity prices can alter the relative attractiveness of different markets at different times.
This dynamic approach to investing requires a dedicated focus on the continent, strong attention to economic fundamentals and the capacity for rigorous bottom-up analysis, supported by the insight provided by STANLIB and Standard Bank’s extensive local presence across Africa.