Summary

• African markets rose for the fourth month with the MSCI EFM Africa ex SA index gaining 4.8% in July. Nigeria was once again the key driver with US dollar gains of 12.6%. Kenya and Egypt were also strong gaining 6.4% and 4.3%, respectively.  In the smaller markets, Mauritius gained 2.6% and Tunisia was 2.4% stronger.  Top contributor to the index was from its largest component, Egypt’s Commercial International Bank (CIB), that gained 6.4%.  US dollar weakness also contributed to the returns in the month.
• The largest contributor to the Fund’s underperformance relative to the index came from Egypt where its holding in CIB is roughly half that of the index.  In addition, the consumer sector in Egypt (where the Fund has exposure) was weaker and it is not included in the index.  The Fund slightly underperformed in Nigeria (10.8%) due to its oil and gas sector weighting that didn’t perform as strongly as the rest of the market.

Market update - What happened to the “Africa Rising” narrative?

Last month we looked at economic growth across the continent to see if there has been a change in the Africa Rising narrative.  The optimism for the continent that we saw during the first decade of this century seems to have waned and we weren’t sure that this was justified.  We concluded that by excluding the effects of the Arab Spring and oil price collapse from the growth numbers, most of the continent continued on an improved growth path.  Admittedly some large economies have faced difficulties in the recent past for specific and largely domestic reasons, but the future looks bright with GDP growth of over 5.5% per annum expected through to 2022 by the IMF (excluding South Africa and oil exporting countries).

Based on our visits and interactions with company management in many Africa countries we observe a continuing improvement in the operating environments to which businesses are exposed.  The following graph shows the latest analysis by the World Bank using data from their “Doing Business” project that “provides objective measures of business regulations for local firms in 190 economies”.  We use their “Distance to Frontier” measure which allows us to assess the level of improvement in the ease of doing business over time. 

Distance to frontier (percentage points, adjusted*)

^{Source: The World Bank and IFC, Doing Business 2017  *Adjusted to limit the effect of methodology change}

The graph clearly shows that our observations on the ground can be backed up by the World Bank’s detailed analysis.  The business environment has on aggregate continued to improve in line with the trend experienced earlier in the century. Mauritius is the easiest place to do business on the continent and is ranked 49^th out of 190 countries. After their recent difficulties, we should see improvements in Egypt and Nigeria in future releases.

Fund activity

The Fund gained for the six month in a row.  Most of the gains were in Nigeria where its banking shares gained 15.8% and outperformed those in the index (15.2%). The Fund is overweight banks and oil and gas in Nigeria and has very little exposure to the rest of the market.  In July, Nigeria’s oil and gas sector was not as strong as the rest of the market after a strong rally in June and this meant that the Fund slightly underperformed the index shares.  The top contributors to the Fund’s performance in the month were the Tier 1 Nigerian banks, Zenith Bank (22.3%) and Guarantee Trust Bank (16.4%).

Egypt’s Commercial International Bank (CIB) makes up 80% of the index’s weight in that country and it gained 6.4% in the month, driving the index returns.  The rest of the Egyptian market was generally weaker in July and this was the major contributor to the Fund’s relative underperformance in the month.  Two Egyptian consumer companies, Obour Land (-11.1%) and MM Group (-8.2%), were the largest detractors from the Fund’s performance in the month. The market gains in Morocco (1.9%), which has a high weighting in the index, also offset some of the Fund’s gains relative to the index.

Strategy

The Fund has maintained an exposure to Nigeria of 29% that is broadly in line with the index. As the different foreign exchange rates in Nigeria continue to converge and liquidity improves, we are constantly monitoring our exposure to the country. The Fund still has its largest exposure to Egypt, where we expect the Egyptian pound to gradually strengthen during the latter half of the year. Morocco remains the Fund’s largest underweight as we view the market as expensive.

Outlook

Looking forward, we believe that the Africa rising narrative that dominated discussions about the continent early in the century has not disappeared or even stalled. Infrastructure spending has not slowed, new railways are being built and commissioned across the continent; road networks are improving. For the first time, we expect a surplus of electricity generating power in many regions as new power stations come on line over the next few years. Of course, the favourable demographics on the continent have not changed and the continued urbanisation and growth of the middle class will continue. Even politics has improved, with a lot fewer Africans living under authoritarian regimes than six years ago.

The current environment is particularly favourable for equity investors. Not only is there the longer term potential of investing in companies that will benefit from the improving environment, but many shares have been sold down to discounted valuations as investment flows have dominated stock markets rather than valuations. This is especially true for value investors who normally invest in smaller companies where they see disconnects in valuations. The relatively under developed markets on the continent therefore provide immense opportunities for active managers to add alpha in these conditions.