More upside to the Africa story – economic growth, rising democracy, and now a liquid bond market
We all know the story – African economies are, in many cases, growing rapidly; investment opportunities abound; and a lot of smart money is flowing in from all over the world. At the same time, of course, we also know that investors need to be cautious in frontier markets. While there is growth potential, and people are making money, it's still a far from simple thing to start investing in Africa. However, that is changing. In this interview, Investec portfolio manager Antoon De Klerk explains how fixed income markets in African countries like Nigeria, Kenya, Ghana and others are developing, achieving new levels of sophistication, liquidity, accessibility, and investability. This is a crucial step in the development of Africa's economy – African nations' financial markets need to develop to the point where they offer people a measure of security and confidence. As that happens, investing in Africa becomes more and more accessible to everyone. – FD
GUGULETHU MFUPHI: According to Investec, international investor interest in African fixed income markets, outside of the established South African market has increased significantly over the past decade. Antoon de Klerk, Co-Portfolio Manager at Investec joins us now for more. Antoon, just looking at the increased interest: what's driving it?
ANTOON DE KLERK: I think primarily what's driving it is just the development of financial markets in Africa. The greater availability of fixed income investments, increased liquidities, and trading volumes going up: that's the primary driver. A secondary driver is the Africa 'good economic growth' story that has brought Africa to the front of global newspapers, but I think even before that…it's just the development of local bond markets – that's the really exciting part.
ALEC HOGG: We were talking to Peter Brooke a moment ago and he explained how Transnet went into the global market and issued a rand bond at 9.5 percent. Are there any other African countries that are issuing bonds in their own currencies?
ANTOON DE KLERK: That's a great question because that really marks a very mature financial market. It's almost the final step of financial maturity when global investors are willing to lend to you, in your own currency. Many African countries' issues local currency sovereign bonds and dollars and that's all very exciting: Mozambique this year, Tanzania, and Kenya's on the rise, and Rwanda – very exciting. Now however, that final step of being able to borrow in your own currency…that's been taken by relatively few. Nigeria is the other obvious example that has been included into the global benchmark of local currency sovereign bonds, and select other markets/international investors to look at, but more on an ad hoc/benchmark way.
GUGULETHU MFUPHI: Antoon, just looking at the two…does the one mitigate risk versus the other, and what about the rate of return on investment?
ANTOON DE KLERK: I'd say they're relatively attractive. Why is that? It's because the African bond market that we just discussed is relatively underexplored globally. When you look at the volatility of returns, which is obviously part of the risk return equation… Let's just look at the risk side of things and then we'll look at the reward side of things. On the risk side, the fact that Africa – especially the local bond market – is less correlated with what's happening globally; local bond markets are dominated by local players, local pension funds, and local banks etcetera. When you do see something tapering or the global news around tapering and you see South African bonds sell off at 150/200 basis points. You see all the more developed emerging markets really taking punishment, African bond markets and the local bond markets…they don't blink, so that lower correlation is very attractive. If you look at the reward side, the fact is that Africa, by and large, can only run inflation rates of high single to low double digits, so you have corresponding yields that look at ten percent plus. Clearly, if you have a lower correlation or low volatility with a ten percent plus return, that's very exciting. The final component of course, is the currency risk and this I'm almost loathe to say live, but there's a great myth about African currencies. It's that they always depreciate and that they're very highly correlated. That's just not true. Please have a look at the data. African currencies are extremely stable. I think it's because we're so used to the rand in South Africa, that we think this is the way African currencies move. The fact is that the rand, even amongst emerging markets, is a very volatile currency and if you look at other African currencies like the Naira, the Ugandan shilling, and the Zambian kwacha etcetera, those make for really stable return profiles.
ALEC HOGG: That ten percent that you mentioned a moment ago, is that in US dollars?
ANTOON DE KLERK: Yes, you have a common accounting currency. It doesn't say that African dollar bonds yield ten percent. I'm not saying that. I'm saying that the historical returns are associated with…if we were to say an asset class of African fixed investments have been around ten percent with a volatility of less than ten percent. You get the SANCI concept in the investment world of Sharpe Ratios, which is just a relationship between your historical returns and your historical volatility. The Sharpe Ratio, that relationship for African fixed income as an asset loss, is extremely attractive.
ALEC HOGG: How liquid is it? You've really whet my appetite here by saying there's a ten percent return available in US dollars. If I buy Mozambique, Kenya, Rwanda, and Nigerian bonds those countries are all going very strongly – the economic growth is going well. However, if I want to sell, how easily can I do so?
ANTOON DE KLERK: Liquidity of course, for any given investor, is relative to the size of the investment. Now, the fixed income market in Africa is segmented, both in terms of geographies…so you find extremely liquid markets in South Africa – we all know. Nigeria is very liquid, and if they're very liquid, you can do 50 million dollars of bonds per day as an individual investor – an individual house. The other markets are also relatively liquid. For example, Uganda is quite liquid. Kenya has some liquidity constraints. In Kenya, the issuance of bonds hasn't been benchmark bonds, but now we're taking a step into market specifics. The pocket of financial instruments in Africa fixed income markets – those are the most liquid and actually, in our opinion at this stage, the most attractive – is actually in your currency forwards. It is therefore a derivative product. Its interest rate prices are the local interest rates, so that's where you get around ten percent interest rates. You take very little to almost no duration risk because these are currency forward, so they price out typically 3, 6, 9, and 12 months. That is extremely liquid to the extent that I'd say there are at least six markets on the continent that you can easily trade 30 to 40 million dollars per day, for example Ghana, Nigeria, Uganda, and Kenya. Zambia is very liquid. Once you step into the secondary liquidity to your markets of, as you said, Rwanda and Mozambique etcetera, liquidity goes down a bit, but we've been trading these African currency forwards for our multi-billion dollar funds, globally, in very good size so there is liquidity. I don't actually want everybody to know about this.
ALEC HOGG: Very quickly Antoon, you've painted a very attractive picture, but we have had debt write-offs. We have had debt defaults in Africa and it wasn't that long ago. Just as a brief response to that, do you think that those days are over?
ANTOON DE KLERK: The most dangerous words in the investment world are 'this time it's different', isn't it? Do I think those days are over? I think…Africa isn't a country, so I think for select markets… Kenya never had debt write-offs, so clearly you won't see a recurrence of that happening. There are some worrying trends in select markets, and some signs of fiscal indiscipline, but I'm very happy to say that is the exception rather than the rule. African debt markets aren't outside of this rising democracy – the greater transparency. It's very much coincidental. It's very much a concurrent phenomenon of the bigger socio and macro institutional improvement, which we've seen. That doesn't mean we should not be aware of the risks. I'm concerned about the fiscal slippage in Ghana. We've seen in Zambia and in Kenya this year…they're missing their budget deficits, so it will be something that we'll take up with the Ministries of Finance when we go see them. However, this is not a continent, which is running ten percent fiscal deficits in every country year-on-year – no. Those days that we saw during civil war times, or in post-independence times: we have not seen those days recurring – no.
ALEC HOGG: That was Antoon De Klerk. Thanks Antoon for the insight. He is Co-Portfolio Manager at Investec.