Barely seven years after the IMF and World Bank gave 30 African nations a fresh start by wiping out more than $100bn (€72.4bn)of their debt, African countries returned to the bond market in a big way in 2013. New and repeat issuers floated 11 sovereign deals, raising $10.9bn in fresh cash, with six issues from sub-Saharan nations, according to Dealogic.
The swoon in emerging markets early in 2014 has not broken the momentum. African bond managers expect Kenya to come to market as early as Q2 with a $1.5bn debut that could be priced to yield near 7%. Angola is expected to offer a $1bn bond in the second half of the year, and Tanzania is said to be readying a $1bn deal as well. Capitalising on the issuance, specialist managers are preparing for, or are in the early stages of marketing new African debt funds that will invest in African eurobonds, local-currency government debt, or a mix of the two. And a German financial data provider’s new indices on African local-currency bonds and T-bills are also helping these fixed-income markets to develop.
Foreign capital fled from emerging economies in 2013, but the year-long African sovereign binge reflects institutional investors’ conclusion that the prospect of GDP growth in key issuing nations topping 6% GDP growth is realistic. African Eurobond sales took place before and after May’s Federal Reserve-inspired ‘taper tantrum’. While rates rose in H2 2013, the main reasons African eurobond issuers paid more to borrow had to do with country-specific financial stress. In just a year, investing in debt from Africa has transformed from picking among a few headline deals in order to window-dress emerging-market portfolios to selecting the best credits from among a series of individual investment cases.
This is no longer about ‘Africa’ – it is about individual nations, their governance, political and legal institutions and financial framework, and their progress with fiscal, monetary and development policy. Global investors are using rigorous credit evaluation and clear risk controls to allocate capital to the countries that are most effectively creating and implementing strategies to capitalise on the natural and human resources underlying their respective growth stories. And while recent controversy around Nigeria’s central bank governor again raised the spectre of lax governance and ingrained corruption, key investors believe African countries are, in the main, taking the necessary steps towards transparent policymaking and financial management.
While sovereign issuance is increasing, there are clouds on the horizon. Just a few years after it became the first sub-Saharan nation to issue a sovereign bond, Ghana’s debt-to-GDP ratio rose above 50%, and in 2013 the World Bank’s International Finance Corporation pumped in nearly $390m to cover water and energy infrastructure costs and support the country’s agribusiness and financial sectors. Investors are wary of fiscal potholes appearing in countries that just a few years ago needed debt relief to survive. Ghana was a big borrower in 2013, selling its second eurobond, a $1bn 10-year issue at 7.875%, in July. A recent report from Standard & Poor’s noted that a rapid growth rate does not always translate into a good sovereign credit rating – and the backup in Ghana bond yields to 10% shows that investors will penalise countries that wind up in fiscal straits despite large debt capital inflows.
Ghana’s fall from grace illustrates the importance of constantly monitoring issuers’ central bank policy and operations, governments’ budgeting, debt management and commodity policies, and the legal framework supporting private and public-private investment in critical infrastructure projects.
Ghana simply cannot keep issuing sovereign bonds, says Kevin Daly, senior portfolio manager for emerging markets at Aberdeen Asset Management. “The market is slowly waking to the fact,” he says.
Aberdeen, which manages $11.5bn in emerging market debt and has been one of the largest holders of Ghana’s 2007 debut bond, sold its position in 2009 and 2010, and plans to look seriously at new sovereign issuers this year. The core issue is that Ghana has become a “bad story”, Daly says. The country hiked public-sector wages, sending money into consumption rather than infrastructure and swelling the fiscal deficit. Meanwhile, Ghana’s growth rate slowed and is now projected to be less than 5% through to 2017, down from a peak of 14% in 2011. With the country’s maiden 10-year sovereign trading as high as 10%, says Daly, “it’s questionable how much appetite there is for another billion-dollar issue”.
Upcoming African eurobond issues are likely to be large. Countries sell issues of $500m or more in order to get into market benchmarks such as the JP Morgan EMBI index series. When Rwanda borrowed only $400m in April 2013, saying that was all the country needed for power and airport projects and a conference centre, its fiscal restraint was applauded but it does now mean that its eurobond is less liquid in the secondary market than larger, benchmark issues.
However, less-frequent issuance of large benchmark deals brings large sums into treasuries when smaller issues targeted to specific development objectives might be more efficient from a capital-markets and financial management perspective, says Jeremy Brewin, head of the emerging market debt team at ING Investment Management. For example, it means that there is no yield curve to speak of in African sovereign eurobonds. This, in turn, means that these bonds are most useful as opportunistic alpha sources based on particular growth stories.
What these big eurobonds have done is focus attention on the continent’s government debt markets. Hard-currency bonds require significant disclosure about financial conditions and economic plans that institutional investors require as part of ordinary due diligence, says Brewin, and that draws attention to the other components of African government debt – short-term bonds issued in local currencies, and Treasury bills. David Lashbrook, head of Africa investment strategies at Momentum Global Investment Management, notes that, of $340bn in African debt, half is issued by South Africa; of the rest, 80%, or $150bn, is high-yielding local-currency debt.
Some funds are not investing in local securities. ING’s Brewin says the Dutch manager also avoids local-currency bonds because, despite high yields, investors “are not compensated” for the capital and foreign exchange risks that come with local issues. “Unfortunately, most emerging central banks could engage in capital controls [if their countries faced severe economic stress]”, he reasons.
Similarly, Allianz Global Investors’ emerging debt team uses African eurobonds to “diversify idiosyncratic risk in large, index-based portfolios”, says Greg Saichin, CIO of global emerging market debt. Allianz is not currently managing a frontier debt fund.
“It’s impossible to hedge idiosyncratic risk in Africa,” says Saichin. “No one will sell protection to you – if someone does, it means there would be very high counterparty risk, so there would be no liquidity attached to that CDS.” AllianzGI capitalises on the “scarcity value” of African dollar sovereigns to capture above-average growth potential in certain African economies.
Meanwhile, there are specialist managers who do jump into the African local-currency risk pool. Mauritius-based MCB Capital Markets in February launched a fund that will invest solely in African local-currency government debt, using a new 12-country index designed and managed by Frankfurt-based Concerto Financial Solutions. The MCB fund focuses on the one to five-year range of the yield curve, which “typically allows the annual yield of a bond to offset any potential capital loss due to an interest rate rising environment”, says MCB portfolio manager Dean D’sa.
With $10m in seed capital under management, MCB wants to shake up Africa’s local-currency debt markets. “Local pension funds are a big player in these markets,” says D’sa. “But in some countries they still need to move from a hold-to-maturity investor to an available-for-trade investor.”
With the MCB one to five-year Africa Bond index offering a 10.2% average yield at an average duration of 2.4 years, however, that might be a tall order. “We are speaking to brokers and banks to ask for any bonds they are able to sell,” says D’sa. “We hope they see an opportunity.”
Concerto’s new African local debt indices provide a window on local yield curves. Most have significant gaps. Managers say Nigeria’s is the best developed, with 20-24% of its debt in the 1-3, 3-5 and 10-year-plus ranges, and about 16% in the 5-7 and 7-10-year ranges. Kenya has 20% or less in the 1-3 and 3-5-year ranges, almost nothing in the 5-7-year range, and more than 30% in maturities of 10 years or more. Troubled Ghana has more than 70% of its local currency debt in 1-3-year maturities, with an average yield of nearly 20%, the highest in the MCB Africa Bond Fund index.
MCB’s fund is designed for Africa’s markets. To offset liquidity risk, the fund carries a one-year lock-in and will hold up to 15% cash in hard-currency bonds. It’s also denominated in US dollars because forex hedging transactions ultimately settle back to dollars or euros, says D’sa. While the fund will aim to hold 0-20% of assets in each benchmark name, the manager can place up to 50% in a single benchmark country to “help protect investors in the event of an ‘African crisis’”, says D’sa.
Momentum’s African debt fund, launched in August 2013, shows why crisis protection is an essential feature. Momentum uses a multi-manager approach to tap both local-currency debt and dollar-based sovereigns, excluding South Africa. And when Nigeria’s president removed Lamido Sanusi as governor of the Central Bank, Lashbrook headed for safety, moving 90% of the fund’s assets into hard-currency bonds.
Such flights to safety show that the aftershocks of Sanusi’s allegation that the Nigerian state oil company embezzled $20bn of public funds could reverberate for some time. On the other hand, the fact that the country has foreign exchange reserves enough to cover the country’s total external debt by 500% suggests that this scandal need not derail Nigeria’s capital-market development.
Meanwhile, new African eurobond issues are in the queue. In addition to Kenya, Angola is expected to issue its first dollar sovereign this year, says Brewin. Its likely to be well received. “We’re comfortable with their ability to pay, and the competence of the central bank is higher than you’d think,” he says.
While yields will reflect individual situations, Saichin says African economies are moving in the right direction. “We are past the point of civil strife,” he says. “Now governments are setting up top-down processes to improve conditions.”