Issue: June - Aug 2013
Editorials

OFFSHORE ALLOWANCE

Africa alert

SA pension funds are increasingly looking to invest in other parts of the continent. There are many opportunities, but they need to be carefully sifted.

To an ancient Roman philosopher is attributed the observation Semper aliquid novi Africam adferre (“Always something new from Africa”). Back then, Pliny was referring to the continent as a traditional source of hybrid animals. Today, the observation remains but in a different context. What’s now new about Africa is the suddenness with which it has become a favoured investment destination.

True, it’s stimulated as much by improved governance in many countries across the continent as by rapid urbanisation, a burgeoning middle class and exponential growth prospects (off a pitifully low base) that sparks huge infrastructure and consumer demand (not least for social services). It’s also fuelled by the confluence of two other events.

One is the super-cycle in the price of commodities, which Africa has in abundance: copper in Zambia and Democratic Republic of Congo; iron ore in Guinea and Sierra Leone; gas in Mozambique and Tanzania; oil in Kenya and Uganda. Light prospecting has turned to heavy exploitation, with the Chinese often in the forefront.

The other factor is the “search for yield” where returns offered by African economies far exceed the titbits in developed economies. Such is the enthusiasm for Africa, or the search for yield, that a recent $400m bond issue in Rwanda attracted orders worth nearly half of the country’s gdp. The yield on this 10-year paper was Libor plus 5%. No matter that Rwanda’s government continues to rely significantly on international aid.

It isn’t as though, in a blink, Africa has become low-risk. But for so long as quantitative easing continues in the US and Europe, their negligible interest rates suggest little risk that the swamp of liquidity will restrain the worldwide search for better yields. Since nobody can say when it might reverse, and it won’t for some time to come, Africa is on a firm footing.

But there is a warning bell. It was sounded in a recent report from Kofi Annan’s Africa Progress Panel that Africa has been parted from its resource wealth for a fraction of its true value. The problem arises from asymmetric information between African authorities and the companies with which they negotiate, allowing opportunities for corruption and plunder.

The report singled out, as an example, the unfairness of contracts for resource extraction in the Democratic Republic of Congo. At heart is the obscurity of transactions with companies in weaklyregulated markets.

The infatuation with African opportunities should be tempered by open eyes. This is particularly so for SA pension funds. Since the revised Regulation 28 allows them to invest 25% of their portfolios offshore and an additional 5% in other African countries – meaning that they could invest 30% in other African countries if they want – they really should be careful in how best to increase their African exposure. They can be blinded by the performance of African indices that in the past year have shot up by more than 50%, far exceeding the performance of the JSE.

The most common way for institutional investors to access equity exposure in a region is through local listed markets, point out Prasheen Singh and Rory Ord of RisCura. They note that these investors would look for markets with high liquidity, many listed companies and high standards of governance: “In many African markets, not all of these criteria can be met. At present there are 22 exchanges of which 17 are operational and only four (SA, Mauritius, Egypt and Morocco) are registered with the World Federation of Exchanges.”

Looking at the number of listed companies and value traded, the JSE is far ahead of the other exchanges (see graph). Some investors wanting exposure to the continent will continue to seek it through the JSE where companies such as Shoprite, MTN and Mr Price have rapidly growing African footprints.

However, Singh and Ord suggest, when the price of the SA market is compared to the lower p/e ratios of most African markets and given their growth prospects, investment of a small proportion of a fund’s portfolio in Africa ex-SA is definitely worth considering: “While this comes with additional risks, it brings more direct exposure to the growth potential of these economies.”

A new report from RisCura Fundamentals, Bright Africa, shows that (apart from SA) the majority of African stock exchanges do not closely represent the economic sectors contributing to their countries’ gdp. For example, Egypt shows an obvious skew towards financials which account for 29% of the exchange but contribute only 7% to gdp. In Kenya and Nigeria, the disconnect is more pronounced.

Ultimately, argue Singh and Ord, this demonstrates that broad exposure to the African growth story cannot be fully accessed without considering private equity in addition to listed markets: “While private equity has its own shortcomings, it has the great advantage of being able to access companies outside the limited confines of listed markets.”

Fortunately, Reg 28 now allows SA pension funds to invest up to 10% of their portfolios in private equity.

BRIGHT SPOT

Although at a relatively early stage, African Private Equity is growing.There’s a strong core of practitioners capable of managing institutional capital on the continent.

The Bright Africa report, produced from analysing  private-equity deals on the RisCura Fundamentals database, shows that on average private-equity deals in Africa are taking place at multiples 12% lower than the global average. This indicates that African deals are cheaper than those elsewhere.

But on average the multiples in Africa, excluding SA, are higher than the multiples on SA deals. This reflects higher growth potential on deals outside SA. Also, multiples in African private equity are generally lower than the multiples on Africa’s listed markets(expected for lower liquidity of private companies).

As more SA companies expand to the north, liquid exposure to Africa can increasingly be found through the JSE. Further afield, opportunities listed markets are less liquid and these markets are not representative of the respective countries economies.