In 2005, the former South African president, Thabo Mbeki, opened the doors for South African pension funds to invest 5% outside of our borders within the African continent. At the time, the limit on offshore investments was 15%, hence increasing ones non-SA portfolio allowance to 20% including the African allocation. A further increase to the offshore allowance was announced in the February 2018 budget speech. The African allowance was increased to 10% and the offshore allowance was increased from 25% to 30%. By definition, investors could effectively invest their full 40% non-South African SARB allowance in Africa.
Over the past decade, many investors have become increasingly bearish on the prospects of what South African risk assets can offer them in terms of real returns. Up until March this year, it was possible to generate real returns in the safe haven of cash, money market and income funds whilst yields exceeded inflation. This all changed in the past few months as the SARB cut interest rates by 3%, reducing the repo rate to 3.5%. Headline CPI last printed at the lower end of the 3% to 6% inflation band, well below the 4.5% inflation target sought by the SARB. Lower reported inflation combined with the low growth environment in SA could see interest rates held lower for longer.
So where does one find these real returns going forward? The South African listed equity market has morphed over the last decade into a reflection of international earnings rather than South African earnings. Based on the underlying earnings of the companies of the FTSE/JSE All Share Index, only 21% of the market is driven by South Africa, 26% by other emerging markets, 48% by the world’s developed markets and interestingly, only 3% by the rest of the African continent. This highlights the fact that one’s investments offshore have a greater overlap with our overall equity market than investing in our neighbours.
African markets are by no means homogenous, nor are they efficient. We do understand that the African market is a volatile space, but the African continent remains under researched, and if you know where to look, full of opportunity and potential. Many African markets still present frequent inefficiencies, presenting profitable investment opportunities especially in times of heightened volatility.
The general, perception around African investments is one of volatility and illiquidity. Most Regulation 28 portfolios have held very little direct exposure to Africa since the introduction of the 5% and then 10% allowance. The chart below illustrates how the African Equity market and eurobond market have outperformed the SA equity and bond markets in Rand terms since the inception of the FTSE JSE Capped SWIX (TR) in 2011.
African listed equities have experienced some very strong periods of outperformance over time (MSCI Africa ex-South Africa TR Index (ZAR) annualized 12% from November 2006 to November 2008, 31% annualized between December 2011 and December 2014, and almost 10% annualized from December 2016 to December 2019), but African markets do not go up in a straight line. While right now poses an attractive entry point into the asset class given current valuations and relatively resilient macro during COVID-19, investors need to have a long-term view and be able to handle some volatility along the way. In order to take advantage of the full opportunity in the inefficient African equity markets, the limited liquidity needs to be managed. This means limiting flows to at least monthly and incorporating the asset class in the long-term holdings portion of a strategy.
African eurobonds, on the other hand, have produced consistent returns for investors both in USD and Rand terms with minimal volatility. African eurobonds are denominated in hard currency (USD/Euros) and settled daily via the Euroclear market in Europe. With up to $500million a day of trade and outstanding issuance of over $100billion spread across 20 different African countries’ sovereigns, the African eurobond asset class offers a liquid, relatively low volatility access point to Africa. The Laurium Capital Africa USD Bond Prescient Fund is a daily traded unit trust which has generated 15.2% year to date (30 September 2020) and is currently yielding above 7% in US dollars. The Fund forms part of the 10% Africa allowance for Regulation 28 portfolios, offering investors a building block to diversify their portfolio and access additional international exposure.
African eurobonds offer significant diversification benefits to a South African multi-asset portfolio. As can be seen below the asset classes have low, if not negative, correlations to the likes of SA equity, bonds, cash and property. Based on historic performance, the inclusion of Africa most often results in lower overall volatility and higher returns over time.
There is a significant benefit of being a smaller, nimble boutique investment firm in Africa. Laurium Capital has developed what we call the ‘alpha’ narrative regarding investing in Africa. In essence, Africa’s markets are incredibly inefficient and, in this inefficiency, lies the prize. We are able to use our unique research and operational capabilities to fully capitalise on opportunities in the African markets. We have to be nimble and adaptable, which is something our larger competitors are unable to do. Our on-the-ground, deep research and tireless approach truly has made a high-yielding formula for investments into the great African opportunity.