Searching for greenshoots

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By:
Ben Edwards
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Heavily indebted and with puny domestic savings, Africa ought to offer attractions for interested foreign equity investors. Inflows have increased but local equity markets are thin and illiquid, privatizations halting and company research scanty. Funds with an Africa label feel obliged to buy something Africa-related. Have they always chosen wisely?

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Africa is starved of equity finance. Decades of officially sponsored aid and debt programmes have left most countries south of the Sahara geared to the hilt. In many cases this debt burden has crippled economic activity.

The mobilization of scarce domestic savings has been problematic. Negative real interest rates have resulted in poor savings ratios and these have been compounded by financial systems incapable of allocating credit efficiently. Local banks, teetering over chronically weak loan portfolios, soak up much of the available resources in high intermediation costs.

For foreign investors, so active in the economic success stories of south-east Asia and Latin America, Africa is almost virgin territory. There have been no significant net foreign investment inflows for years.

Among portfolio investors, emerging market specialists have been uncharacteristically timid about the continent. According to a recent survey by Micropal, a Boston-based fund monitoring consultancy, global emerging market funds held just 0.3% of their assets in African investments by the fourth quarter of 1993. Strip out Morocco and South Africa, and this drops to 0.1%.

This is changing. Towards the end of 1993, institutional money was pouring into emerging capital markets, both directly and through managed funds. Following the upturn in the US interest rate cycle signalled in early February, these markets have collapsed and the flow has virtually dried up, but at their peak some of the managed money found its way to Africa. The sums are not insignificant. The four largest Africa funds – Alliance Capital's Southern Africa fund, Morgan Stanley's Africa fund, Fleming's New South Africa fund and Emerging Markets Management's Africa fund – have between them raised over $400 million. Much of this is yet to be invested and several more funds are in the pipeline.

What will they find to invest in? The short answer is very little. Excluding the Johannesburg Stock Exchange (JSE), sub-Saharan Africa's 12 stock markets have a combined market capitalization of just $12 billion.

Even this grossly overstates stock readily available to fund managers. Not only are Africa's markets shallow, they are also highly illiquid. For example, Africa's most recently established stock exchange, in the Zambian capital Lusaka, has recorded just three trades since it opened in January. Elsewhere, activity has hardly been frenetic. Miles Morland of London-based Blakeney Management estimates that turnover on all sub-Saharan stock exchanges last year totalled a little over $300 million.

Africa_May_1994-Hay-340.pngAnd exchange activity is concentrated on just a handful of stocks. According to a recent research note by Michel ZhuParris of Morgan Stanley, Africa's newly emerging exchanges between them had just 12 liquid stocks with market capitalizations greater than $100 million. Of these, seven trade in Morocco. "The most common feature on the ground," says Michael Power, recently recruited by Baring Asset Management to put together an Africa fund, "is that there are a significantly larger number of buyers than sellers." Liquidity problems will be exacerbated as foreign investors compete ever more fiercely with domestic buyers of stock.

In some southern African states there are signs that this is already happening. “There has been tremendous foreign interest in the Zimbabwe Stock Exchange since restrictions were lifted," says Brian Igoe, managing director of local fund manager Ketay. "The stock index stood at around 1500 in July 1993. It has since peaked at 3840 and is wobbling around there now.”

But the prospect of better returns on equity investments has also attracted domestic money. "It is not just foreign investors driving the exchange's performance," argues Igoe. "Domestically, there has been a very high interest rate regime. Short-term money has yielded as much as 40%. This is now down to 28% and falling. This is flushing all the institutional money out of the money market and into the stock exchange."

Africa fund managers say that one strategy will be to sit on large cash positions and wait for stock to materialize. They may be in for a long haul. Privatization programmes, which in Latin America and the Far East have provided foreign investors with many of the classic emerging market plays, have generally been halting and piecemeal in Africa.

''African governments have sold off only a small share of their assets," writes the World Bank in a recent policy report. "The value of privatizations in Nigeria between 1988 and 1992 was less than 1% of that in Argentina, Malaysia, or Mexico, even after adjusting for Nigeria's smaller GDP."

Where programmes have succeeded in transferring state assets to the private sector, usually only the smaller, non-strategic concerns have been privatized. Strategic companies, such as extractive industries, utilities and agricultural marketing corporations, have usually been retained because of their perceived economic importance.

Demand for surrogates

There are encouraging signs that this is changing. The partial flotation in Accra and London of the Ghanaian government's holding in Ashanti Goldfields will value the gold producer at $1.67 billion. Unfortunately, the experience of international investors in Zambia, impatient with the government's prevarications in the privatization of Zambia Consolidated Copper Mine, remains more typical. Ultimately, listed equities can only provide part of the solution. "For these emerging market funds, the African stock exchanges are a route, but they are not the only one," says Colin Goodwin, president of Meridien BIAO, which controls an extensive network of commercial banks in 20 African states. "The amount of money these funds have to invest cannot be absorbed by the stock exchanges." One of the solutions, says Goodwin, will be to buy ''African-related stocks" elsewhere.

Marianne Hay, portfolio manager of Morgan Stanley's $230 million Africa fund, has done just this. "Our initial strategy is to invest between 10% and 20% in the non-African exchange-listed securities of companies that have their revenues sourced in Africa," she says. "But this is only a transitional investment – an initial investment in liquidity. As the domestic markets develop, we will have very few non-African listed companies in our portfolio."

A second strategy has been to peddle a South Africa fund under another name. Although many stocks on the JSE are notoriously illiquid, with a market capitalization of $150 billion the exchange ranks as one of the 10 largest equity markets worldwide. Mark Breedon, manager of Alliance's $8o million southern Africa fund, candidly admits a heavy bias towards South African stocks. Just 1.5% of the $48 million he has invested so far has been placed elsewhere.

Other portfolio managers have found their hands tied. For those US funds which have chosen a public listing, accessing stock exchanges outside South Africa has meant finding custodian services that satisfy stringent Securities and Exchange Commission (SEC) capital adequacy regulations. Breedon has custodian arrangements with Bank of South Africa in Botswana, Namibia and Zimbabwe. At Morgan Stanley, Hay has yet to arrange any local custody outside South Africa. One of the reasons for the delay, she says, is that Standard Bank is acting as an adviser to her fund. Under SEC regulations, advisers are prohibited from acting as custodians as well.

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Hay is now negotiating with Barclays Bank to provide the necessary arrangements through sub-custodians, but gaining exemptions from SEC capital requirements will prove a long and tedious process. Hay hopes to have custody arrangements in place in Tunisia within the next three months. Elsewhere, she says, the wait before she is permitted to invest may be a year or longer.

Hay has found an alternative way of diversifying her Africa holdings for the meantime. So far, she has invested over $80 million in debt instruments. Opportunities are limited. According to recent estimates provided by the World Bank, just $40 billion of sub-Saharan Africa's $156 billion in external long-term debt outstanding at the end of 1993 was held with private creditors. "There can be no market for government-to-government [Paris Club) or aid-type debt," says Nfor Susungi, the African Development Bank's resident director in London. "Theoretically it is possible, but it is most unlikely. It wouldn't go down too well either in francophone Africa or in Paris if the French government was to be seen selling what amount to political loans to third parties at 10 cents to the dollar." Hay's investments have raised a few eyebrows. Besides holdings in South African corporate and sovereign instruments, she has bought Algerian and Moroccan debt, and has invested in a non-performing loan to Côte d’Ivoire. In Nigeria, where the military regime has reneged on its structural adjustment programme and fixed exchange and interest rates at unrealistic levels, Hay has invested in par bonds.

"No investments in our portfolio have been real horror stones, she maintains. “In the last few weeks, African debt – like all emerging market debt – has suffered. We have seen Moroccan debt down from 8o cents in the Dollar to 64. But the fixed income element of our portfolio has fallen less far than other emerging debt markets." Nevertheless, since launch the net asset value of Morgan Stanley's Africa Fund has fallen by some 15%, even though 30% of it remains in cash.

The dearth of investment opportunities has led some fund managers to contemplate unlisted securities for their portfolios. "I will definitely be considering private placements," says Baring's Power. "I want to keep them as a minor, though not insignificant part of my portfolio, say, 15%." Power will be looking to invest in companies he hopes will achieve a public listing at a later date. “Pre-listing institutional financing will catch on in Africa," he says.

Others are more sceptical. "We do consider pre-listings and unlisted stock," says Mark Mobius, the globetrotting president of Templeton Emerging Markets Fund who has just completed a whirlwind tour of Botswana, South Africa and Zimbabwe. "But we don't like them. Our experience is that they're not normally that cheap. You have to throw a lot more at them, and usually the due diligence is not there. Also, you're locked into the stock."

“A lot of people utterly mistrust unlisted deals for managed portfolios," adds another London-based fund manager. "There is no rigorous process of pricing the deals, and as a result net asset values are usually vilely overstated." In the secondary markets, shares in funds with large unlisted components often trade at large discounts to net asset value.

Foreign ignorance

The problems and complexities facing asset managers trying to run well-managed, high-performing and diversified Africa funds are immense. More than in any other market, the onus falls on the fund managers themselves to generate accurate and reliable research. As Morgan Stanley's ZhuParris notes, apart from the South Africans, one research house in Ghana and a brokerage in Zimbabwe, no local houses produce research on African firms.

Africa_May_1994-Susungi-340.pngForeign ignorance is compounded by inadequate auditing and disclosure standards in Africa. Even in the public sector, financial reporting standards can be lax. In late 1992, a World Bank survey of financial auditing practices among major public enterprises discovered that in only four of the 29 sub-Saharan countries reviewed were many firms audited annually. In 15 countries there were no regular annual audits at all.

Investors must also be alive to macroeconomic policy shifts, which can be violent and sometimes unpredictable. A further layer of complexity is added by individual countries' relationships with the IMF, which are often politically charged and unstable. Local exchange and interest rate policies can hinge on the political will to implement IMF-sponsored structural adjustment programmes. Perceptions change weekly, and there is little value in writing, as Morgan Stanley's ZhuParris did last October, that Nigeria "perseveres with its structural adjustment programme, launched in 1986." Considering what happened to that programme since 1986, that observation can hardly be a basis for an investment decision, suggest rivals.

Some British fund managers are now calling American professionalism into question. "I am totally underwhelmed by the American approach," says Power, who was interviewed by a number of US firms before joining Baring Asset Management. "On the whole, the British approach has been sanguine, circumspect and realistic. Fools rush in..."

This is probably a little unfair, or at least undiscriminating. John Niepold, a portfolio manager based in Arlington, Virginia, has been far from impulsive. Niepold works for Emerging Markets Management, a specialist in developing capital markets with $2.5 billion under management. Headed by Antoine van Agtmael, a former deputy director of the capital markets department at the IFC and founder of the IFC's Emerging Markets Data Base, the company is packed with talent.

In the five months since Niepold launched his fund in November, he has invested just 60% of the $30 million raised. ''I've bought stocks listed on exchanges in Morocco, Egypt, Botswana, Zimbabwe, Namibia and Ghana," he says. ''I've also accessed Mauritius via a London-listed country fund."

At the African Development Bank, Susungi refuses to be lured off the fence. ''I'm very worried about these American institutions," he says. "They tend to be very reactive. On the other hand, the British approach is always too cautious."

The question is partly one of professional expertise. “The US knows nothing about Africa," says Arnab Banerji, chief investment officer at Foreign & Colonial Emerging Markets. "There is far more expertise sloshing about London." Even in London, suitably qualified fund managers are thin on the ground.

Power is one of a rare breed. Born in Kenya and educated at school and university in the UK, he worked for several years at Anglo American, the South African mining giant. After honing his financial skills at Rothschild and Smith New Court in London, Power returned to Africa, where he ran a Kenyan venture capital fund for five years.

Power was also approached by Foreign & Colonial. But since Power's recruitment by Barings, Banerji has shelved his plans for an Africa fund, at least temporarily.