Old Mutual Investment Group SA (OMIGSA) says that South African investors should look further afield to their country’s neighbours for growth and diversification if they are looking to invest in equities this year. With the South African equity market hovering around all-time highs and bonds offering historically low yields going into 2013, African equities could offer a smart option, according to Cavan Osborne, portfolio manager at Old Mutual Investment Group SA (OMIGSA).
“Although the risks remain relatively high and we would never advocate putting all (or even a majority) of an equity portfolio in African equities, the prospects for several African markets like Nigeria, Egypt and Kenya are looking bright this year, in terms of both economic growth and company earnings,” said Osborne at a press conference this week. “Prices can be relatively attractive and correlations to the FTSE/JSE All Share Index are low, making African equities an option to consider for investors who are looking for good diversification and can handle the risk.”
Perhaps the most important benefit offered by African equities is their historically low correlation to the local equity market and to developed markets, stressed Osborne. “At a time when all equity markets are demonstrating significantly higher correlations due to the increasingly globalised nature of investing, this is a significant benefit,” he said. “The FTSE/JSE All Share Index has correlations of between 20% and 30% with Nigeria, Morocco, Egypt and Kenya. These are quite low compared with the JSE’s nearly 80% against the US S&P 500, around 70% against the MSCI World Index and over 90% against the MSCI Emerging Markets Index. So investors are unlikely to get better diversification qualities within the equity asset class in other geographies outside Africa.”
Economic growth prospects are an important consideration, Osborne said. “Global Insights is forecasting sub-Saharan Africa to grow at 5.2% in 2013, which is much stronger than the developed world but not quite as fast as Asian emerging markets at 5.9% or China at 7.8%. Yet certain African countries are forecast to have similar growth rates to China this year – Angola 8.2%, Ghana 7.7%, Nigeria 6.9%, and Mozambique 6.8%, for example.”
A growth story
Over the next 20 years, Africa, with its current youthful 1 billion population, also offers the best population dynamics in the world, Osborne pointed out. Its projected growth rate of 23% is more than double the world average of 11%, while China is expected to grow at o¬nly 3%. “Companies targeting this consumer growth and able to introduce products from other markets should be able to capitalise o¬n these trends and grow faster than many in the developed world,” he observed.
However, he did point out some disadvantages. Poor company disclosure and low share liquidity, often found o¬n African stock exchanges, do represent higher risk for investors, he cautioned. “As a portfolio manager you must really do your homework, conducting in-depth analysis of the country, the industry and the business and going the extra mile to speak with people o¬n the ground to find out about any related-party transactions – often not officially disclosed – and possible changes in legislation or in the business environment that could impact company operations.”
Other risks are related to politics and exchange rates, Osborne continued. “While African regimes are more stable and investor-friendly these days, o¬ne must be aware of the special, and often complex, interrelationships between governments, companies and foreign investors that exist o¬n the continent. Often there are special legal or regulatory provisions that can change and consequently destroy value. Corruption and favouritism also have roles to play. Meanwhile, exchange rates are more volatile than those in the developed world. In the short-term this can cause big swings in values – for example, last year both Malawi and Sudan experienced 50% depreciations of their currencies literally overnight.”
OMIGSA’s exposure to Africa
Osborne mitigates these risks in managing the Old Mutual African Frontiers Fund by limiting portfolio exposure to a maximum of 5% per stock and 30% per country, while also conducting meticulous equity analyses that build in a margin of safety to account for these risks. He also ensures that the portfolio is widely diversified across countries, sectors and shares.
Currently the fund’s highest exposure countries are Nigeria (at the 30% limit), Egypt (25.1%) and Kenya (14.4%), with 9% in South Africa, 4.4% in Morocco and a smattering of investments in Sierra Leone, Equatorial Guinea and Namibia, among others. “We see good opportunities predominantly in Nigeria, Egypt and Kenya, plus these countries offer larger and more liquid stock exchanges,” Osborne said. “Nigerian and Egyptian stocks returned over 40% last year in US dollars, (despite o¬ngoing jitters over Egypt’s elections and public unrest) and Kenya returned over 25%. This helped the African Frontiers Fund to return 32.7% in 2012, despite a poor performance from Morocco (down nearly 15%).”
The fund is also well diversified across sectors, spread across banks, mobile telecoms, beverages, financial services and food producers, among others. O¬ne company that Osborne has identified as a potentially good bet is Egypt’s Oriental Weavers, the world’s largest carpet manufacturer with a 20% market share, whose largest customer is IKEA. “Although European exports may be down, there is big local demand for carpets thanks to a boom in the Egyptian housing market, where homes are sold with concrete floors,” he noted. “The company benefits from export subsidies, and is trading o¬n an attractive price/earnings ratio of 5 times and a dividend yield of 6%.”
An interesting Kenyan stock in which Osborne has invested is Safaricom, the country’s largest cell phone operator. Explained Osborne: “Kenya now has the lowest calling rates in Africa thanks to a price war, so there’s low risk of further price drops. It is 10% owned by the Kenyan government, which means there is little likelihood of a damaging change in policy, and it is 45% owned by Vodafone, introducing excellent corporate governance and disclosure. The company was also the first to introduce a cell phone money transfer service called Mpesa, which has proven spectacularly successful.”
A final attractive opportunity for Osborne is Nestle Nigeria, the Nigerian operations of the global consumer food and beverage group. “Only two products – Milo and Maggi spices – currently make up 90% of their sales,” said Osborne. “So there is huge potential in the large Nigerian market of over 160 million people to leverage many of Nestle’s other products (think chocolates, Nescafe, KitKat, Nestea, Purina pet foods, etc) off of their existing distribution network. Importantly, Nigerians have brand loyalty tendencies. Existing import protection also favours local production, and the group has an established base. So although the stock appears expensive o¬n a price-earnings ratio of 25 times, its opportunity for fast growth is very real.”
Osborne added that these three stocks are representative of the opportunities available to investors in African equity markets in 2013. “African equities can act as good diversifiers in a portfolio, while also offering superior growth opportunities for companies through more rapid population growth, o¬ngoing socio-economic upliftment and new product penetration. However, African equities are more risky than those in developed countries, and there will certainly be hiccups along the way, so it is important to ensure you have diversified exposure across the continent, and an even more diversified total portfolio. Diversification is o¬ne of the keys to successful investing in 2013.”