The Overall Economic Situation
African markets have had a challenging few years despite promising GDP growth in many countries. The collapse in commodity prices has adversely affected commodity exporting jurisdictions. The strong US Dollar and on-going fears about the Federal Reserve increasing interest rates have also put the continent on edge. To cap it all off, China – Africa’s biggest trading partner – suffered severe market volatility in 2015 and 2016 which was strongly felt on the continent.
This is invariably leading to disappointing performance in African public equity markets. It is also forcing a number of economies – particularly those that are commodity dependent – to diversify. Market participants at Fund Forum, however, recognised any diversification and shift away from commodities will be a long-term process. Other commodity-dependent economies have been forced to take drastic action as their budget and trade deficits deteriorated. In January 2016, Nigeria implemented capital controls in an attempt to nullify further depreciation of the Naira following the oil price fall.
Equity and Fixed Income Funds
In terms of equity funds in Africa, returns have obviously disappointed. Unwelcome regulatory intervention in Kenya – which saw the government disregard Central Bank advice and impose a cap on interest rates on loans and deposits – caused bank shares to fall in value. Those equity funds with exposure to Kenyan banking stocks obviously felt the pain.
Many investors were oversold Africa initially and have not been impressed by the performance of fund managers focused on the region. Investors need to be properly educated about the challenges of investing into African markets.
Many of the markets are not hugely liquid, and this can cause a problem for daily dealing fund managers. Cobus Visagie, co-founder and managing director at Africa Merchant Capital, highlighted his firm had a 90-day redemption period, for example. This can reduce the need to gate in the event of mass redemptions. Managers highlight investors needed to adopt a long-termist approach towards public equities in Africa.
However, there are some daily dealing UCITS managers focused on Africa, and this does raise a few questions about whether firms would be able to honour redemptions if positions were found to be highly illiquid. Launching a US ’40 Act fund with African exposure is not viable. “The liquidity restrictions limit the opportunity sets,” said Malick Badje, director and head of investment solutions at Silk Invest. The US Securities and Exchange Commission (SEC) is now introducing rules which tighten up liquidity requirements at mutual funds in what is a further dis-incentive for 40’ Act funds to invest in Africa. In addition, future UCITS Directives may toughen up on the eligibility criteria for assets that may be held in UCITS portfolios.
Some service providers are also occasionally reluctant to provide depositary activities to a UCITS with a dedicated Africa-focus, particularly in some of the higher risk markets. UCITS V makes the depositary wholly liable for any lost, stolen or otherwise impaired assets in sub-custody. Given some African markets may not have suitably robust insolvency law, custody law or legal concepts around trade finality, the risk may be too great for depositaries to take.
Operating a nimble fund management business in these illiquid markets is important, and enables firms to buy into or extricate themselves from positions over time without drawing too much attention to their trading strategies. “Africa can be a difficult place to invest a large amount of money,” said Alexander Trotter, partner at Newmarket Asset Management. Most firms tend not to run in excess of $250 million when transacting in such markets.
Fixed income has been a bright spot for some African markets. Yields on bonds in a number of African markets are high, in what is a welcome respite from the traditionally low or negative interest rate landscape in developed markets. Ghana, for example, sold $750 million of bonds yielding 9.5% in what turned out to be an oversubscribed issuance. However, trading in local currencies does have its obvious FX risks. Some markets such as Nigeria have introduced capital controls so managers may be unable to get their US Dollars out of the country if they are trading Naira. All of these risks need to be properly weighed up before entering African currency markets.
Alternatives
Africa-focused private equity has also struggled. Private equity managers have been flooding into Africa – attracted by macroeconomic fundamentals such as a rapidly growing middle class and marked improvements in political governance. Private equity giants including Blackstone, Carlyle and KKR have all made the jump into Africa. Again, the limited liquidity and depth of attractive acquisition targets in many of the markets has made it hard for private equity managers to execute deals. However, many do believe Africa is a region which requires a long term approach. This should fit well with the investment time horizons of private equity.
Venture capital (VC) firms are increasingly looking to African markets, attracted in part by the the continent’s ready embrace and history of positive technological disruption, of which the mobile phone revolution in the 2000s is the most obvious. A number of western investors have, however, been disappointed by the lack of Unicorns – start-ups with a valuation of more than $1 billion – in Africa.
Mbwana Ally, managing partner at Savannah Fund, acknowledged there were VC opportunities in Africa albeit not Unicorns. He said a comparable company in Africa would typically be valued around $100 million. Firms also need to be mindful that VC in Africa is not the same as Europe or North America. While VC firms in the latter tend to invest into new jumpstart companies, African VC may focus more on organisations which are small but which have been in business for several years.