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African markets should continue to outperform

04 September 2013 Johan Steyn, Prescient Investment Management

But it would be unreasonable to expect 50% a year going forward.

Although they have valuation levels similar to their counterparts in South Africa and the developed world, African markets offer superior prospects for growth.

Johan Steyn, Portfolio Manager at Prescient Investment Management, acknowledges the high performance of African markets over the past 18 months, but says this is likely to continue, albeit at lower levels of growth. Prescient Africa Equity Fund was the number one performing fund across all unit trust funds in South Africa in 2012, delivering a return of 48.5%.

“Africa has higher expected GDP growth rates compared with most regions. This will mostly be consumer driven growth, accompanied by lower levels of government debt as well as the benefits of positive demographics. African economies are getting stronger and more robust and their markets offer superior growth prospects.

“Much of the recent strong performance by African markets has been driven by international inflows from investors wanting to access the direct consumer growth story.”

So much so, he argues, that some sectors could be at risk of a sell-off. Steyn cites the Nigerian consumer sector, which has undergone a strong re-rating year-to-date. Stocks have become more expensive and there’s the growing risk of increased volatility going forward, especially given the increased likelihood of slower monetary stimulus by the US Fed.

As global interest rates trend upwards, there is a risk of a reversal of the international portfolio flows we’ve seen recently. The sectors that benefitted the most from these flows are at risk of being hit the hardest.

That said, in other sectors like financials, valuations are much lower. While financial shares have also performed well over the last 12 months, this has been accompanied by strong earnings delivery, so there hasn’t been a re-rating in the sector.

“While there is still value in African markets, recent very high levels of performance are probably not sustainable. Although there has been some earnings delivery, which we expect will continue, it would be unreasonable to expect 50% a year going forward.

“However, over time, higher growth and positive demographics should drive growth and performance in excess of that delivered by developed economies.

“High volatility is characteristic of African markets, which are often regarded as a high risk allocation. As a result, we expect high returns but are cognisant of the risk of a sell-off in consumer focused stocks given that a lot of medium- to long-term optimism is already priced in. The failure of those expectations to materialise is likely to prompt some consolidation in the sector. Africa is also not without political risk and this will also result in bouts of volatility.

“On the other hand, valuations on financials are not as stretched, making it possible to access the consumer growth story indirectly. Banks have massive potential to grow and are well placed to benefit as other sectors develop. As economies grow and sectors develop, there is a sustainable growth in bankable credit demand.”

Steyn says that Prescient follows an approach similar to the MSCI when selecting its African investable universe, looking at size or free float market capitalisation and liquidity. In terms of the number of counters that meet size and liquidity requirements, there are currently six markets to invest in: Nigeria, Kenya, Mauritius, Morocco, Tunisia and Egypt. Zimbabwe and Ghana are on the periphery.

He is most optimistic about Kenya where he says valuations are not as stretched as Nigeria, which has captured a lot of international flows. Nigeria’s appeal lies in its potential, but the country’s dependence on oil needs to be reduced by developing sectors such as agriculture and manufacturing, Steyn says.

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