The curious tale of Nigeria
with one of the worst-performing economies
and best-performing stock markets in 2020

Earlier this year, I wrote about the Global X MSCI Nigeria ETF (NGE) listed on the New York Stock Exchange. I said at the time it appeared good value and was worth a look. I don’t personally own it. I have traded it in the past for some client accounts I manage, but right now, I am on the sidelines.

It is an Exchange Traded Fund (ETF), and as such is supposed to trade at all times at the Net Asset Value (NAV) of the basket of stocks it owns, all of which are listed in Nigeria. Obviously, that means the underlying stocks are denominated in Nigerian Naira, and not US dollars. Instead, it currently trades at a whopping 26% discount to NAV. How can that be?

Right now, due to the low oil price, Nigeria, one of Africa’s largest oil exporters, and heavily reliant on sales of crude oil for earning foreign exchange, has a short supply of hard currency. To help conserve what they have and to avoid a balance of payments crisis, the Central Bank of Nigeria is rationing the amount of foreign exchange (mostly US dollars) it is selling to the Nigerian banks.

With a scarcity of foreign exchange in Nigeria, foreign investors selling Nigerian shares or earning dividends from Nigerian shares, such as the Nigerian ETF, are currently unable to sell the Naira they get for the US dollars they need to pay out their investors.

Due to these factors, the price of dollars in Nigeria, as you’d expect, has shot up beyond the official exchange rate and a thriving “parallel” or black market for dollars has developed.

While the official exchange rate is now USD1=Naira 377, in the parallel market you will need to pay as much as Naira 475 to buy a dollar (compared to 360 back in March, before the Covid-19 pandemic smashed oil prices, and cut Nigeria’s foreign currency earnings in half).

While the parallel market might work for business-people and travelers to Nigeria who can operate in the shadows, for foreign investment funds and asset managers, only official channels are applicable.

As such, there has developed a “backlog” of people in a queue to buy the limited amount of foreign exchange  being rationed out by the Central Bank of Nigeria. The queue is long, and the supply of dollars is scarce, so there is a long delay with repatriations of investment funds at present. It’s common to have to wait months.

What might solve the problem – though I don’t think such a solution is imminent – is for the Nigerian Central Bank to let the Naira devalue closer to the market rate observed in the unofficial, parallel market.

In that case, those inside Nigeria who spend in Naira but are currently hoarding US dollars, might come forward and sell them for the better price, thus bringing the dollar supply closer to equilibrium with demand. Until then, we are stuck with the current situation.

As a fund manager entrusted with my clients’ money in the African Lions Fund, given that I cannot guarantee that I will get our money out of Nigeria as things now stand, due to the hard currency shortages, I simply cannot entertain the thought of putting any money in.

This is however creating another problem for me. The benchmark index I use to calculate the “hurdle rate” that I must outperform to earn my performance fees from managing the African Lions Fund, the S&P Africa Frontier BMI Total Return Index, is heavily weighted to Nigeria. Six of the top ten stocks and over 46% of the entire index market capitalization is Nigerian.

And believe it or not, right now – in spite of the above situation – the Nigerian stock market is rallying hard. It is the best performing market in the world year to date!

So, I have the absurd situation where I cannot possibly risk my Fund’s capital in Nigeria, but Nigeria’s contribution to my benchmark means I am falling further and further behind my hurdle rate.

Some fund managers would simply dive in and ride the Nigerian market higher in order to get paid, regardless how reckless that might be. I am not one of them. I cannot take undue risks with my clients’ money, just so I don’t fall behind my benchmark and give myself a chance to get paid a performance fee.

The first hurdle in my proprietary “8Ms” investment process is “Macro,” which asks the question whether the macro environment in the country concerned is such that the level of risk to our investment from macroeconomic factors is acceptable. Right now, unfortunately, in Nigeria, it’s not.

I hope that changes. Given our long-term investment time horizon at African Lions Fund, I’m almost certain there will come a time when we will invest in Nigeria. But not right now, except perhaps a small indirect position via one of the Nigerian investments that trades OUTSIDE Nigeria. I am looking at several of them closely.

But I am resigned to the fact that barring extraordinary performance in other markets – of which I remain hopeful – I can forget about being paid performance fees for the immediate future, if the Nigerian market continues its run higher.

But, why on earth is the
Nigerian market going up so
strongly if the economy is in trouble?

Good question. I think it boils down to two things:

  1. Nigerian stocks were cheap, trading at multi-year lows before the recent rally.
  2. A giant wave of domestic liquidity suddenly got pushed into stocks, after exiting fixed income investments and cash, which now earn next to nothing. Nigerians are turning to stocks as an alternative.

In recent years the Nigerian Central Bank sold a special high-yield product to foreign and local institutional investors in a desperate search for liquidity. They were paying as much as 15% on 1-year “OMO Bills,” as the instruments were called.

As these matured, they stopped offering them. Instead, with the coronavirus pandemic slamming both the oil price, on which Nigeria relies for most of its foreign currency earnings, and the local economy, the Central Bank adopted a stance of cutting interest rates drastically in an attempt to stimulate the economy.

Recently, the Central Bank of Nigeria has pushed interest rates on 91-day paper down to just 0.34%, but inflation is running in the double digits. So, the real rate of return on short-term bills is MINUS 10%+.

In other words, keep your Naira in cash and, as things now stand, your purchasing power will completely disappear within 10 years. Perhaps not surprisingly, this has led Nigerian pension funds, asset managers, financial institutions, and financially savvy individuals to seek a safe haven. Some may have been able to buy hard currency, or gold, or real estate. But the other alternative suddenly became stocks.

Similar patterns have been observed in Zimbabwe, or Venezuela when their currencies collapsed in value. Money poured into stocks, and in local currency terms, the stock markets there soared, even as the currency became all but worthless in terms of US dollars.

Nigeria is not in such dire straits yet, and hopefully never gets there. But it could unfortunately get worse before it gets better. The oil price is not showing signs of a lasting resurgence yet and Nigerian government finances are very delicate. The economy is not growing. Per capita real GDP has been shrinking since 2015. Tax collections are also down, and government deficits are piling up.

In that respect Nigeria doesn’t sound too different from much of the world right now, including the United States. There, we also see a similar pattern. Stocks are soaring, despite the worst economic performance since the Great Depression.

The advantage the United States has, I suppose, is that it can print the world’s reserve currency, and for some reason, many people still prefer the dollar over hard assets. I think the time will come when that changes, but it’s a very slow-moving process.

Owning productive businesses that have large cash hoards and continue to make money in spite of the pandemic does make sense. At this point, perhaps what we are witnessing in stock markets is already a “flight to safety trade,” in the US as well, just as in Nigeria.

Maybe the market is pricing in a dollar devaluation (against hard assets). I don’t know.

Personally, I own a good amount of physical gold, just in case. I am investing the bulk of my own capital in markets that are in much healthier macro-economic shape – such as Tanzania, and other fast-growing African economies like Rwanda.

I might have trouble keeping up with my benchmark if Nigeria keeps rocketing higher, but I won’t mind too much if I still enjoy big share price gains, in the high-quality businesses I am buying in other markets that are less risky from a macroeconomic standpoint. There are thankfully still plenty of those in Sub-Saharan Africa.

For the first month, my African Lions Fund was up just over 0.6%. On my estimates it’s up another 2% or so in November thus far. Those kinds of returns are more than adequate, even if they are not in the same league as the Nigerian market’s 30%+ gains year to date.

Until next time,

Good Investing!

Tim Staermose
Founder
Globalvaluehunter.com
Africanlionsfund.com

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