Africa Equity Opportunities Fund - February 2019

Egypt was a strong performer in January, with Commercial International Bank in Egypt being the single largest contributor in January.

Summary

• African markets rallied strongly in aggregate and the Fund returned 6% year-to-date.
• The exception to the rallying African markets was Nigeria, which declined 5.9% ahead of the February elections. Nigerian banks were the biggest detractors for the Fund, declining 7.9% in aggregate. Despite overall Nigerian weakness, the Fund’s overweight Nigerian Oil and Gas position, which gained 14.8% and offset weakness in December, delivered strong outperformance in January.
• Kenya was one of the strongest performers, gaining 12.6% over the month and reversing the poor showing in December. Kenya’s Safaricom and Equity Bank, which were the two biggest detractors for The MSCI EFM Africa ex SA Index in December, reversed their losses and returned 8.5% and 18.6% respectively. Kenya also delivered outperformance for the Fund due to Centum gaining 17.4%, while the Fund’s Kenyan banking portfolio was up 14.3%.
• Egypt was also a strong performer in January, having gained 10.8%. Commercial International Bank in Egypt is the largest component in The MSCI EFM Africa ex SA Index and its 13.8% return was the single largest contributor in the month.

Fund activity and performance

Not many changes have been made to the portfolio’s exposure over the past month. After a strong rally in Egypt, the Fund’s exposure to some of the more expensive shares was reduced.  The weighting in Egypt was reduced by 1.5% over the month to end at 42.6%.  We also reduced our weighting in Mauritius’ New Mauritius Hotels to 2.0%. The proceeds were used to settle a small redemption. The Fund still has its largest exposure to Egypt, while Morocco remains the Fund’s largest underweight as we view the market as expensive.

Overall the Fund outperformed the MSCI EFM Africa ex South Africa benchmark by 2.9% and was the top performer for January in the peer group of comparable funds.

Outlook

With equity markets in Africa close to their five-year lows, growth has been continuing for many of the underlying businesses over that period, there is clearly impetus for significant future returns through active management and stock selection. Lower interest rates should provide further support for valuations, although central banks are being cautious. The current economic conditions should be positive for equity markets that will also start anticipating generally improved economic outlooks for the continent in 2019 and beyond.

Are Egypt’s stars aligning?

On 4 February 2019, the Executive Board of the IMF completed the fourth review of Egypt’s economic reform program, supported by an arrangement under the Extended Fund Facility (EFF) which was originally approved on 11 November 2016. The completion of the review has allowed the disbursement of the fifth US$2 billion tranche of the US$12 billion facility.

The reform program was initiated by a more freely floating currency in November 2016, which saw the Egyptian pound weaken by 50% in that month. Further reforms relating to the removal of subsidies had a dramatic inflationary impact, as did the introduction of value added tax (VAT). The most recent major reduction of fuel subsidies happened in June 2018. The full removal of subsidies on fuel will start in September 2019.

Inflation descending to reasonable levels

Consumer price inflation dropped significantly to 12.0% YoY in December 2018 after peaking at 17.7% in October 2018. The reduction in energy subsidies in June and a seasonal spike in food prices were the reasons for the increases from the middle of the year. A significant drop in the prices of fruits and vegetables, which slowed to 18.8% YoY in December, from 48.0% YoY in November had a material effect in the lower print. Core inflation increased slightly to 8.3% YoY in December.

Inflation is expected to trend down throughout 2019 and to end the year lower than the December 2018 reading. The average inflation forecast of 12-13% compares to the 21.6% average for 2018.

Economic growth

The Finance Minister says Egypt is currently expecting gross domestic product (GDP) growth of 5.6% in the fiscal year ending June, slightly lower than the Ministry’s previous target of 5.8%.  Full 2019 calendar year forecasts for GDP growth are currently 5.5%.

Foreign exchange reserves and currency

Egypt’s net foreign reserves rose slightly at the end of January after US$900m of foreign portfolio inflows (a reversal in the trend seen in the second half of 2018). The Egyptian pound gained slightly to about EGP/USD 17.6 in early February after remaining stable at EGP/USD 17.9 for most of 2018. This at a time when the country is ramping up production from its gas fields. Commercial International Bank’s (the largest private sector bank in Egypt) management expect a considerable increase in sustainable FX inflows during the year, resulting from a recovery in tourism, remittances, Suez Canal revenues, and the now fully-operational Zohr gas field.

Rate cut?

Although we have seen a declining inflation trend during 2018 and a strong foreign exchange position, the central bank has been cautious in a world where rates have been rising in developing countries and where global tensions and risks have also been rising. Although the current positive economic environment in Egypt would ordinarily imply rate cuts in the first half of 2019, we expect that these will be back ended into the later part of the year.

All in all a very positive environment for equities in Egypt this year.