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Investing in sub-Saharan Africa

‘Over the last four years…we’ve been negative on SA companies’: Danesh Ranchhod from Franklin Templeton Investments.

RYK VAN NIEKERK: Welcome to this Market Commentator podcast. It’s my weekly podcast where I speak to investment professionals. My name is Ryk van Niekerk and my guest today is Danesh Ranchhod. He is the vice-president and executive director at Franklin Templeton Investments, and he focuses primarily on companies in South Africa and sub-Saharan Africa. Danesh, thank you so much for joining me.

Emerging markets is currently a bit of a mixed bag. There’s a lot of liquidity around, and some of it flows to some markets and some of it doesn’t flow to other markets. Where do you think the market in Africa fits into this scenario?

DANESH RANCHHOD: Hi there, Ryk. Correct. Africa, and particularly South Africa, has on balance seen net outflows, and if we talk specifically to South Africa, it’s been over the last four or five years that we’ve seen net outflows on equities. Even on our fixed income and government bonds we’ve seen net outflows.

Within Africa, it’s a little bit of a mixed bag. But in sub-Saharan Africa, particularly, if you think about markets like Nigeria, they have seen outflows from foreigners, and even domestic investors within Nigeria have been allocating less to equities, and more of that exposure domestically has gone to fixed income. Foreigners currently are in a situation where they’re not able to repatriate money out of Nigeria, and that has made the willingness to allocate to Nigeria maybe all the more less.

And then parts of East Africa like Kenya have probably attracted the flows that would have gone to Nigeria. These have probably gone to Kenya, where structurally at a macro level they are in a better place. Also, fundamentally many of those companies are dealing with the Covid situation a lot better than we are seeing in parts of West Africa.

RYK VAN NIEKERK: Let’s talk about some of those markets and the performances of those markets. In South Africa we are seeing a very volatile sideways movement, for lack of a better term. What have been the performances of other African markets?

DANESH RANCHHOD: If we look at markets in sub-Saharan Africa, markets like Kenya year to date have been marginally up over the year.

I mean, most markets have rallied off the lows that we saw in March due to the first Covid panic, but Kenya has been marginally up.

If we look at markets like Nigeria – they are still below, down by about 5% to 6% in local currency and probably down 10%, 15% since the beginning of the year. We take it there.

There’s been a bit of a local rally in Nigeria, but that seems to have been stemmed, or paused with the recent protests. On balance, we see both markets are down from the start of the year, and there’s been some currency weakness that in dollar terms has probably added to that weakness as well.

RYK VAN NIEKERK: I see that Franklin Templeton has many emerging market funds, some of them looking at China, Eastern Europe and Asia. There’s an Asian fund, there is also a Brics fund, a Latin American fund – but there’s not an African fund. Why not?

DANESH RANCHHOD We used to have an Africa Fund. I think the fund was initially launched in 2012. There was a boom period in the early 2010s, and the Africa Fund grew in scale, and there was a lot of optimism about African markets, with various structural underlying factors like the demographic dividend. Politics was getting better, infrastructure investment was growing, and foreign investment was coming to these markets. That was relatively short lived and we saw the boom-and-bust cycle related to commodities. We saw currency depreciation come back in resources, slow policy reform start again, and the African theme just didn’t quite take off as many had expected.

One has to be selective when we do go into these markets. So the fund didn’t quite get the scale. We still continue to invest in Africa and we do that through the broader Frontier strategy.

It sort of lends diversification to a particular region or to a particular continent, and the Frontier strategy obviously invests across the world, across various frontier markets within Asia, within Eastern Europe – within that and Africa as well. Two years ago that fund was intentionally  merged into the Frontier strategy.

South Africa

RYK VAN NIEKERK: I’m looking at the fund fact sheets of various of these emerging-market funds, and the only South African company I can see among the top 10 holdings of these funds is Naspers. How many South African and African counters are included in these funds that may be not part of the top 10 holdings?

DANESH RANCHHOD: We have two strategies that invest in the African continent. The first one is the Global Emerging Market (GEM) strategy, which South Africa is mainly eligible for, because South Africa is an emerging market, and the rest of sub-Saharan Africa falls really into the Frontier market.

So you’re correct that the biggest holding within the GEM fund is Naspers. Over the last four years at a macro level we’ve been negative on SA, and at a bottom-up level we’ve been negative on SA companies. So we haven’t had much exposure to South African companies. We have one small retail holding within the GEM Fund. And then we have Naspers. We do have some investments in Kenya. As I said,  structurally we are generally a bit more positive about Kenya. And then the Frontier strategy invests in Nigeria, in Kenya, and some outlying markets within West Africa as well, and African companies.

Kenya

RYK VAN NIEKERK: Can you maybe expand on some of these non-South African investments?

DANESH RANCHHOD: Within Kenya we have exposure to the banks, we have exposure to a telco company, we have exposure to a brewing company. If we think about the banks at an underlying level, the Covid situation primarily would naturally increase the risk for banks from a perspective of credit losses that would evolve, given that many companies and individuals would be compromised and made vulnerable. But when we think about these banks and we think about the exposures that they have, and we try to understand exactly where these are and what has happened in previous cycles where they’ve gone through severe downturns, we think the Covid situation in Kenya seems to be more short lived.

We’ve seen a lot more economic activity pick up quite quickly in the third quarter. It’s also looking like [in] some of the banking exposures where they’ve given relief, we’ve seen payments start to come through and collections start to increase. At a bottom-up level the banks have exceptionally high profitability and they can absorb some of the credit losses that will be evolving over the next six to 12 months. We pair that with the ability of the banks to generate non-interest income, such as fees and commissions, and their partnerships with the telco companies to generate other types of fees and commissions, and loan and microlending arrangements. Those are doing quite well.

And then we couple that together with a top-down or high-level macro. As I mentioned, economic activity is picking up quicker than most would have expected.

Kenya seems to have an underlying structurally higher growth rate, and that seems to be a benefit to most of the companies that are operating over there.

And then the telco company that we quite admire and appreciate what they’ve done is Safaricom. This is a business that is less of a telco company and becoming more of a financial technology company, or a fintech platform most commonly known as M-Pesa. This business has essentially branched out from just basic mobile money transfers to a platform that has partnered with the banks to do credit lending. It’s also doing remittances, it does merchant payments. It’s looking at doing partnerships with Alipay and other international players to essentially do purchases at a global scale. So in Kenya we are quite positive on many of those companies that I spoke about.

In Nigeria we have some exposure to a high-quality bank, and on balance the bank has a net long-dollar book, and essentially hedges against some of the currency depreciation that we forecast over there. But we are still worried about other structural issues within that country.

RYK VAN NIEKERK: Do you have more investments, total investments, in South Africa, or do the investments in other African countries exceed what you have in South Africa?

DANESH RANCHHOD: If we include South Africa, if we include Naspers in the South Africa bucket, we would have a greater exposure to South Africa. But in reality we don’t really think of Naspers as a South African company, given its large exposure to Tencent and some of the other offshore businesses that totally eclipse the small investment that it has here in Takealot and Media24.

RYK VAN NIEKERK: So you have a lot more investments north of the Limpopo River than in South Africa – if you exclude Naspers.

DANESH RANCHHOD: Correct. If you just want to compare those to purely South African domestic companies, yes, that’s true.

Hope for SA?

RYK VAN NIEKERK: The local market in South Africa is actually quite an interesting market. It’s very much a stock-picker’s market at the moment. Most of the companies are going nowhere, and then there are selected companies that are doing really well. How does that compare to the markets you analyse, say, in southeast Asia or even Eastern Europe? Is the focus so much on yearly stock picking, or can you be more general and buy the market?

DANESH RANCHHOD: Ryk, I think I agree with you that it’s more of a stock-picking market. By nature Franklin Templeton is within their emerging markets division. We are pretty much a bottom-up company. So we try to understand company fundamentals and invest on that basis, although we do overlay the macro.

We’ve done some comparisons with Brazil at a macro level, at a high level, which compares a little more closely than the Asian peers, and a few things maybe stand out before I get into some of the bottom-up factors. We looked at Brazil back in 2016, when it went through somewhat of a similar inflection point that South Africa seems to be going through at the moment.

Read: How Brazil and SA measure up in the corruption stakes

Among some of the big reform changes that that country did do quite well was one that addressed the corruption issue, and it did it in a relatively short space of time. One in particular that people tend to remember is the big money-laundering scheme that was fronted by a car wash. I think it was called Lava Jato. Essentially the government did address that and essentially exposed a lot of executives and government officials; those government officials actually went to jail. They were arrested and sent to jail.

Brazil also essentially did a fiscal-consolidation move. They put a spending cap, a bill that essentially limited expenditure growth to the previous year’s inflation. They also did a big pension reform that extended the retirement age of public-sector workers. Much the same, they have a pension scheme that works on a defined-benefit basis, and it was just costing the government too much money. That was a big move.

So these were done very quickly and we can mirror some of the things that we think should happen in SA – and there’s been some movement.

I think Brazil comes up as a strong comparator when we think about where they were and what they did and what South Africa needs to do.

So we are following South Africa’s recent activity quite closely. What did happen in Brazil after doing those things is we did see fiscal consolidation, we did see GDP growth start to pick up, we saw private-sector and foreign investment start to increase within that country. Lo and behold, the debt stabilisation did take longer, but it does seem to be happening. So we think South Africa could be on a similar path if it does execute. The risk I think, as everyone says, is on the execution part.

RYK VAN NIEKERK: There is, as I  said earlier, a lot of liquidity in the market – and a lot of that money is flowing to emerging markets. That influences valuations greatly in several markets. How do you approach this scenario, because suddenly liquidity may affect valuations a lot more than profitability expectations?

DANESH RANCHHOD: Correct. Money flow is important and it’s hard predict money flow. But if we think about South Africa, that is exceptionally underweight with African domestics – South African foreigners are exceptionally underweight the SA domestic stocks. Recall the last Alexander Forbes Manager Watch Survey that looks at what SA institutions are invested in the SA equity market, I think it’s well below 40%, and probably the lowest it’s been over the last decade or longer.

Foreigners are obviously a lot less invested in our SA fixed income; it used to be 40% two, three years ago. Now it’s under 30%.

So you are correct that foreigners and locals themselves are quite under invested. And if some of these tailwinds that we see start to emerge, you could have a lot of money flowing into what is essentially a small asset pool, if we think about just the pure SA domestic stocks and if we exclude all the rand hedges and some of the mining stocks that are, on balance, at weight or overweight.

So we could possibly see a reform rally, and that may happen in the near- to medium term.

It looks like in the past sort of two, three weeks, we’ve seen SA domestic stocks start to move a little bit in the right direction. On balance, that may happen in the near to medium term, but long term rests very much on whether there’s longevity to the reform agenda that everyone is waiting for the government to implement.

RYK VAN NIEKERK: Thank you, Danesh. That was Danesh Ranchhod, the vice-president and executive director at Franklin Templeton Investments. He focuses primarily on companies in Africa.

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It’s extremely depressing that Sub-Saharan Africa, with a population almost equal to China and three times the US, should only have one significant company, Naspers, as a cornerstone. And that Naspers is only as large as it is now thanks to its fortunate early investment in Tencent.

What does this say about a continent with the world’s largest mineral resources, and sitting between the two largest economies, US and China?

We as a continent have let opportunity slide through our collective fingers whilst the rest of the world economies march on.

Sigh …

To study this, it is instructive to review what history of the last 30 years, the last 60 years or so and also the last 120 – 140 years. These periods tell us a lot about Africa, resources, exploitation, management and corruption.

End of comments.

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