Looking back on the first quarter of 2010, we have again seen evidence that fundamentals eventually will overcome. Given that global financial markets are more of a psychological beast than an academic exercise and while the result of bi-polar investor sentiment provides for extreme valuation points for both buyers and sellers, solvency and sanity can go a long way in this brave world of frontier markets. In hindsight, we are delighted that we were able to recognise the value that was created as a result of recent dislocation of perception versus fundamentals. Unfortunately, not many investors have benefitted from these opportunities and I guess it is fair to say that we did our fair share of trying to convince them!
March 2010 also saw the first anniversary of both the African Lions and the Arab Falcons funds. They returned 35.9% and 22.8% respectively over the period. During Q1 we generally saw strong performance across our markets, most of them ranging between 5 and 12% year-to-date. Nigeria and Kenya made a strong comeback of around 25% each since the beginning of the year. Dubai seems to back in the game with a recovery of just under 16% in March.
The good news for investors is that there is much more upside to come. The long term trend of value creation for investors in Africa, the Middle East and Eurasia has only begun if you consider that, going forward, more and more businesses will find their way onto the local stock exchanges, the listed companies will see increased capitalization as more invesors enter the markets. The increase of bond issuance will contribute to increasingly functional local and regional markets which in turn will attract more foreign investment. There are several African countries that don’t even have a stock exchange yet so there are still many early entry opportunities yet to be revealed in the years to come.
The positive fundamentals are here to stay for a while, they are made up of economic drivers we can understand and believe in. The secular growth in internal demand comes on the back of positive demographics. The strong macro economics and healthy fiscal situations allow for governments and authorities to focus on pragmatic issues such growth, business and how to create a middle class that can carry this growth further into the future. Are there problems? Of course there are but in the eyes of those who govern the developed world, these are often the kind of problems they would happily swap for those of how to keep an ageing population with expensive habits happy while trying to sort out public debt issues.
If you have been reading our weekly and monthly updates, you have probably noticed that there are always plenty of stories to be told within our region of focus. I hope they help you better understand the opportunities and put them in right context. We have a local presence across the region and we are telling you the stories as we see them from this perspective.
We thought it would be a good idea for the cover letter to focus on a specific development every week by featuring a story that caught our attention and plays a role in our investment strategy. This week’s topic again takes us to Dubai. The recent turmoil and sentiment in this place has created a series of undervalued investment opportunities. This week, John Bates, our Head of Fixed Income, prvides us with a focus on the DIFC.
The Dubai International Finance Centre (DIFC) is Dubai’s “onshore” financial centre. We view DIFC as an integral element to the strategic growth of the UAE as a whole as one of the key global financial hubs in the region.
The recent “standstill” in debt payments which was shortly followed by a UAE bailout program for certain corporate entities drove DIFC’s Sukuk (Islamic Bond) valuations down by a staggering 50%. While the bonds have effectively recovered half of that fall, we believe the bonds remain laggards in relative value terms. Trading at 75/76 cents on the dollar, the DIFC floating rate note now yields 13.5%. Before Dubai’s debt standstill the yield was consistently around 6%.
Apart from the strategic value the DIFC represents for Dubai as a place for business in the world, a major catalyst for the continued recovery of these bonds is the potential for a merger of Dubai’s financial enterprises. There seems to be talk suggesting that consolidating a number of related Dubai entities with DIFC is under strong consideration.
Thinking further, the possibility of Abu Dhabi and Dubai Combining their financial centres shouldn’t be that remote either. On paper this would make total sense as it seems awfully complicated to have two major exchanges in the UAE. Considering that other countries in the region and elsewhere have only one. In addition, following the Abu Dhabi-led support plan for Dubai it makes sense that the 2 centres be merged. The DIFC is ultimately owned by Bourse Dubai and Bourse Dubai ultimately owns Dubai Financial Markets (DFM) and Nasdaq Dubai, so it would make sense to merge these entities too.
From a bondholder’s perspective such consolidation steps would be clearly positive – either via the triggering of a change of ownership clause, or indeed via the fact that DIFC could end up ultimately being owned by the Abu Dhabi sovereign, potential for strong upside would seem promising. All of this could take over a year to come to fruition, but we expect to see news flow pushing the bonds higher over the coming months.
Despite the lack of clarity coming out of the authorities in Dubai and UAE as a whole, we view DIFC as a government-related entity, as it’s failure to honour its debt would be viewed by the market as tantamount to a default by the UAE.
Recent events pertaining specifically to the Dubai real estate sector have taught us that transparency cannot always be relied upon, yet support is probable and is now proven. We believe that investment to the region will pick up in 2010 as, partly as a result of the re-pricing of risk particularly in Dubai, and that a more professional operating environment will draw investment once again.
For more colour on DIFC please refer to our analysis card at the end of the Silk Road Income fund’s monthly update.
With kind regards from the Silk Invest team.
The Monthly updates can be found on our website, www.silkinvest.com
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