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Picking the best low-hanging fruit where few others look -- for cents on the dollar

Why now might be the right time to invest
(or invest more) in Africa

At present, an estimated 22 million people move to Africa’s cities each year. By 2050, the urban population in Africa will be over 1.3 billion, or nearly as much as the entire population of the continent today.

As they did in Asia over the past 50 or so years, these trends offer enormous opportunities for businesses and investors. At African Lions Fund, our goal is to benefit from some of them.

In spite of a number of short-term challenges, such as high inflation, debt distress, and foreign exchange shortages that are afflicting some of the countries in our frontier Africa investment universe, these long-term demographic trends have not changed.

Moreover 2022 proved that a carefully selected portfolio of the best companies in frontier markets in sub-Sahara Africa can offer investors a rare safeharbour of non-correlation with the rest of the current global financial markets storm.

2022 was one of the worst years I’ve seen in my career for financial markets worldwide. Nearly every asset class suffered significant losses, especially the more “crowded trades,” led by high-flying US tech stocks. Supposedly safe US government bonds, the foundation on which the entire modern financial system is built, suffered their worst losses in nearly a century.

The world’s largest asset manager, BlackRock’s, latest investment return map shows that unless you invested in Commodities (+22%) or stashed your Cash under a rock (+1.3%), you would have lost money in 2022. There were losses on all other asset classes, such as:

  • Infrastructure -0.2%
  • High yield bonds -12.7%
  • European stocks -14.5%
  • Developed markets bonds -17.5%
  • US Stocks -19.5%
  • Emerging market stocks -19.7%
  • REITs -23.6%

On the other hand, by strategically choosing to be in the right place, deliberately avoiding the overpriced asset classes that had been pumped up to ridiculous valuations, combined with a sound stock-picking strategy, the African Lions Fund was left unscathed. It gained 3.7% in 2022.

While +3.7% is not something you might brag about, it makes a big difference when the S&P 500 is down 19% in the same period.

In other words, had you invested $25,000 in the S&P 500 in January 2022, you would have lost almost $5,000 by December.

But with that same money put in the African Lions Fund, you would have preserved your initial investment, plus banked a modest gain of just under $1,000.

We are living through uncharted macro-economic waters

US Federal Reserve Historical Interest Rate Hikes

Last year, more than a decade of insanely loose monetary policy finally ended in an inflation explosion. Spooked, the Fed (and other major central banks) raised interest rates at the fastest rate ever for a new rate cycle.

And I don’t think they’re done yet. By any objective measure, the Fed is still behind the curve. Real interest rates, after adjusting for inflation, remain negative, and the purchasing power of people’s savings is evaporating.

In this context, African economies are somewhat unusual. While inflation rates, for the most part, are high and, in some cases, also spiraling out of control, so are interest rates. Thus, real interest rates remain positive in many African economies. This signals that investment capital remains scarce, and — by extension — healthy returns on that capital are still possible to find.

You would think that investors’ natural instinct would be to flock to places with much better investment prospects. But as I’ve written before, it’s difficult for most people to go against prevailing market psychology. Most investors are spooked, and they fear uncharted waters even more than before.

Common reasons why investors are staying on the sidelines when it comes to African investments

One of the questions I have been asked over and over again since I started the African Lions Fund in the second half of 2020 is, “I am expecting a market crash. Won’t African markets just crash, too? Isn’t it better I wait to invest, until after that?”

Or a variation thereon, “I am making too much money in crypto/uranium/coal/oil & gas/something else. Once I take my profits on that, I might be interested.”

And also, “I am expecting the US dollar to rocket. Frontier and emerging markets always tank when that happens. So, I want to wait for that to pass.”

There was an element of all three last year:

  1. financial markets did finally crash in the face of higher interest rates;
  2. many energy stocks did do very well, (though crypto went the other way); and
  3. the US Dollar has, until a recent bout of weakness, been extremely strong.

And yet, the African Lions Fund held its own and saw a decent gain.

I can understand, however, why many investors are reluctant to stick their toes in the water. Africa is a huge continent with 54 countries, some of which are as different as day and night. Having boots on the ground is definitely what separates us from the rest.

Indeed, even against its peer group of Africa-focused funds, African Lions Fund has been an outlier. Just over a year ago, I wrote about six listed investment funds you can easily buy that give you some exposure to Africa. Back then, African Lions Fund was slowly but steadily outperforming them. By end of November last year, the Fund was way ahead of the rest.

African Lions Fund, S&P African Frontier BMI, and six-listed African -focused funds comparison

African Lions Fund is also the only (unlisted) Frontier Africa Fund that delivered a positive return in 2022

In 2022, according to the league tables published each month by specialist industry magazine, Africa Global Funds, losses of 20%+ were commonplace in African Lions Fund’s peer group (funds with no Middle East or North Africa exposure).

The one exception is the Stanlib Africa Equity Fund which was up about 7%, but with only US$1.5 million left under management, it appears to be in the process of being wound up.

Of course, I am not satisfied with a low single-digit gain for the year for African Lions Fund. But given the number of headwinds we have faced, I’m glad it wasn’t worse. And I am very happy we trounced our competitors, proving that we add great value for our clients.

Overall, since its inception in October 2020, African Lions Fund is up 36.55%. And it’s ahead of the hurdle index, the S&P Africa Frontier BMI, by 14.65%. These numbers are after accounting for all fees and expenses, of course.

What can we look forward to in 2023?

I don’t think anyone truly has a clue what the markets will do this year. All I know is, 2022 was a very rough year for most investors, and it would be unusual for an even worse year to follow. Only 4 times in the last century have there been back-to-back declines in the major benchmark index of US stocks, the S&P 500.

It also appears the US Dollar may have peaked in the 3rd quarter of 2022. That may provide some respite for those, like us, operating in frontier markets.

But inflation remains high and Central banks around the world are still hiking interest rates. Macro headwinds remain.

To recap, when investing in listed companies, there are all sorts of risks.

  • Macroeconomic and political risks
  • Regulatory risks
  • Governance risks
  • Exchange rate risks
  • Industry/sector specific risks
  • Business model risks
  • Management and execution risk
  • Financial and balance sheet risks, to name but a few.

Africa has more than its fair share of the first four. But so does the rest of the world at present. And as I’m fond of saying, in Africa, you generally get paid proportionally more to take on these risks, than you currently do in developed markets, or the more mature emerging markets.

The last four risks highlighted above are universal for listed equity investments. But I would argue they can all be mitigated – and perhaps more easily even than in the developed markets – here, in Africa, where we deploy our capital.

That’s because we invest in easy-to-understand businesses, in relatively stable sectors, which still offer great growth potential in Africa Frontier markets. Banking, telecommunications, building materials, food, beverages, packaging, and branded, fast-moving consumer goods are not yet mature industries here. They are still growing fast. And the demographics mean that they will continue to do so.

Today, 1 in 8 people live in Africa. By 2050 that will be 1 in 4.
To me, that spells growth opportunities

According to UN population projections: “… sub-Saharan Africa is projected to have the largest growth of 1.2 billion by 2050, even more than population giant Asia.” If you recall, this is one of the core, long-term macro reasons that after a career spanning two and half decades in Asia, I moved my investing attention to Africa full-time in 2020.

Leading this demographic trend are the countries of Nigeria (projected to be the 3rd most populous country), Tanzania (stepping up to #15), and Kenya (projected #20). African Lions Fund has positioned our investments to be at the heart of this population explosion. Frankly, I think my initial forecast returns of doubling our capital every 5 to 10 years could prove conservative.

If you are still considering frontier African investments, you haven’t missed the boat – at least just yet.

Those who have invested in the African Lions Fund from day 1 are enjoying 36.6% gains.

But, for the most part the valuations on the biggest holdings we have are lower today than when we started. Profits have grown even more than company share prices. So, price earnings ratios are even lower today than in late 2020.

SSA Ex-SA Top 30 Companies PE & PB ratios

So, it’s anything but too late to invest.

As evidenced by their robust profit generation, the companies we own continue weathering the macro storms pretty well, and I expect some blockbuster earnings results come 2Q2023 when the numbers begin to come out.

Furthermore, I expect that, with time, other investors will inevitably begin to reward that performance with higher valuation multiples.

We remain true to our classic value investing strategy. As well as buying healthy, growing businesses that are well managed by ethical and competent people, we are trying to buy their stocks on valuation multiples that we believe have the potential to rise as the market better understands the fundamentals of the companies concerned, and / or the macro investing environment and sentiment improves.

I think we are at a low ebb on both the market’s understanding, and for macro conditions here in frontier Africa. As far as I am concerned, the only way is up.

And while we wait for that, we are also collecting fat dividend payouts. Currently we own six stocks that trade on indicative yields in double digits as high as 13%, and two other stocks are in high single digits.

But, while you haven’t missed the boat yet, at some point it will set sail. So, you might want to take advantage of the opportunity to still get in cheaply, on the frontier African markets, while it lasts.

Until next time,

Good Investing!

Tim Staermose
Founder, Global Value Hunter
& African Lions Fund Ltd.

Last year, more than a decade of insanely loose monetary policy finally ended in an inflation explosion. Spooked, the Fed (and other major central banks) raised interest rates at the fastest rate ever for a new rate cycle.

And I don’t think they’re done yet. By any objective measure, the Fed is still behind the curve. Real interest rates, after adjusting for inflation, remain negative, and the purchasing power of people’s savings is evaporating.

In this context, African economies are somewhat unusual. While inflation rates, for the most part, are high and, in some cases, also spiraling out of control, so are interest rates. Thus, real interest rates remain positive in many African economies. This signals that investment capital remains scarce, and — by extension — healthy returns on that capital are still possible to find.

You would think that investors’ natural instinct would be to flock to places with much better investment prospects. But as I’ve written before, it’s difficult for most people to go against prevailing market psychology. Most investors are spooked, and they fear uncharted waters even more than before.

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