Stephen Charangwa, Silk Invest’s fixed income portfolio manager, provides us with an update on the Kenyan bond market and tells us why rising demand for African bonds could become a great alternative to a weakening trend in donor funding.
On the Frequent Asked Questions we get from investors is:
‘How do you hedge the risk of frontier market currencies?”
It is only natural that this topic always comes up because to most investors the frontier market countries are unknown territory. The fact that they have their own currency makes them even more exotic.
We thought you may find it useful if we shared a bit of perspective on the frontier market currencies.
First of all, we don’t believe it makes much sense to hedge frontier currencies. There are a few reasons for this:
The cost of hedging would eat up much of the upside potential. These markets aren’t as efficient nor are they quite as liquid as the more developed markets, this makes hedging expensive. In some cases, there simply isn’t enough of an infrastructure in place to do so.
We also believe there is a better way to deal with frontier market currency risk: Diversification.
Have a look at the chart below, this is a simulation over 10 years. What it shows is that, even by equally weighing the exchange rates of 6 frontier market currencies against the US$. The overall impact is only slightly negative. However, add an average yield to maturity of 10% to the basket and the individual currency risk will be overly compensated for. This is not unrealistic because these are the kinds of yields that can be found in today’s local currency frontier markets.
Source: Various sources; Silk Invest. 6 currencies have been used for the backtest
Each currency is driven by its own fundamentals and has its own supply/demand cycles. Predicting the trajectory of currencies is not easy but we do believe that it makes sense to apply a Purchasing Power Parity (PPP)* method to determine medium and long term value of a monetary unit. Even though making currency calls is not really a part of our investment methodology, this relative valuation does help us when it comes to making asset allocation decisions.
Source: World Bank; Silk Invest
Each currency is a world of its own. Listen to the short podcast below with Tammy Tang, who is attending the Investment Management Program at the London Business School. She has been doing some work with us by taking a closer look at what drives frontier market currencies. In this episode we cover some of the fundamental factors that affect the Kenyan Shilling, The Moroccan Dirham and the Nigerian Naira.
An Arrtist’s impression of the business district of Konza City, a planned technology district in Nairobi
Kenya has a strong reputation for being ahead of the curve when it comes to applying technological innovation to business.
It is not for nothing that’s many refer to this east African nation as the ‘Silicon Savanna’. Kenya is rising very fast as the technological powerhouse of Africa!
There seems to be a different, more creative attitude towards dealing with problems amongst the Kenyans. Maybe it is something in the water, but there is a new generation of entrepreneurs who come up with the most amazing ideas as solutions.
This ‘can do’ environment is rapidly transforming Kenya’s society. Technology has not only made financial services widely available across all levels of society via mobile phones, it has also facilitated a more efficient access to capital for the entrepreneurs that make up most of the Kenyan economy. Today there is a space where small businesses can truly create products and services that have a positively disruptive impact.
There are many examples of how this creativity is being put to work, ranging from how it allows education to find its way to more people online to those who are trying to turn the unused parts of television frequency with into high-speed Internet access around the country.
Adele Gikonyo and Baldwin Berges of Silk Invest, along with some investors, meet with the members of the management team at Equity Bank
Adding to all this innovation, Equity Bank further builds on its reputation of a game changer by partnering with Google to release BebaPay for the public transport system.
Just as it did with telephone banking, the objective is to reduce the use of cash by paying for public transport with a pre-paid card that can even be charged with a mobile phone.
This would allow not only to lower the cost of transport through efficiency, but it will provide thousands of small entrepreneurs in the transportation sector with more visibility on how their vehicles are performing while making tax collection by the government more efficient. Furthermore, BebaPay will have a positive effect on commuting passengers because it will keep public transportation more affordable and better funded.
Adele Gikonyo, Sub-Saharah Equity Analyst at Silk Invest
The system will work by using a commuter card that can be charged by a mobile phone. What especially caught our attention is that Google chose Kenya as Africa’s launchpad for the payment solution. This may well have to do with the fact that mobile banking is already so widespread that the adoption of this new system will prove to be seamless.
It will not only allow a Equity bank to diversify its revenue stream, but it will also further position the institution as a true solution provider in addition to being a bank.
It is refreshing to see that a bank can have a such a clearly recognisable and positive impact on its society for a change!
Listen to a short conversation with Adele Gikonyo, our equity analyst based in Nairobi. She provides some more perspective on BebaPay.
The frontier markets fixed income space opportunity is very much like what emerging markets had to offer more than a decade ago.
Stephen Charangwa and Daniel Broby
These are fairly unknown markets, explored only by few investors. If you can get over the lower levels of liquidity, the exotic nature of local currency and the (often misguided) perception of risk, there are handsome rewards for the intrepid asset allocator.
Listen to a short podcast with Daniel Broby, Silk Invest’s CIO and Stephen Charangwa, Frontier Fixed Income Portfolio Manager. They offer their perspective on these nascent and promising markets.
Hard currency denominated frontier fixed income offers a risk premium over emerging market debt. The risk premium is well over 600 basis points over US Treasuries
Frontier Markets currency offer attractive yield levels. A diversified allocation helps mitigate individual risk attributes for each currency
We are going to be on the road to speak about Investing in the new world, across frontier and emerging markets.
We’ll be in great company as we are going to be touring along with AK Asset Management, one of Turkeys leading asset managers. They will give us insights into investing in Turkish mid- and small caps as well as the growing segment of corporate bonds.
OFI Asset Management, a major French investment manager, will also join us in Paris, Luxembourg, Geneva and Zurich. OFI will speak about their strategy of combining BRICs with Africa and the Middle East.
Silk Invest will cover the frontier markets in more detail, speaking about the grand rising consumer opportunity and how to put it to work for your investments.
Listen to the audio trailer, it provides a preview of what we will be talking about:
Make sure to book your place as there are only 20 places per venue!
In this audio interview, Youssef Lahlou, Silk Invest’s Casablanca based equity analyst shares his views on the opportunities in Morocco now that its middle class is on the rise and its leading companies seek to expand across Africa.
How Morocco’s leading companies expand out to Africa.
The deepening relationship with the Middle East
How Morocco’s unique large-scale real estate development model is moving into foreign markets.
Food comes first. It is where everything starts and ends, if there is no food, there is nothing at all.
In this piece we take a closer at why this sector should be the focus of investors who seek to capture the opportunity of a rising global middle class.
When Warren Buffet explained his thinking behind his recent investment in Heinz, a global food heavyweight, it is based on the view that regardless of where the economy goes, food always tops the shopping list.
This is especially true for developing markets. In contrast to developed economies where we find a taller stack of needs, the behavior of consumers in developing economies lies closer to the base of the Maslow Pyramid. As can be seen on the chart below, households in developing economies spend a larger portion of disposable income on food than in more industrialized economies.
Percentage of Household Income spent on food products – click on the image to enlarge
That is why we believe that investors should focus on finding and investing in businesses that can benefit from the essential demand that makes up for most of the consumer’s share of wallet.
One of our colleagues in Silk Invest’s private equity team, that focuses on African consumer-facing food businesses, recently reminded us that the key to success is the ability to create capacity and then know how to manage it well.
Africans dedicate more share of wallet to food that other regions. Click on the image to enlarge.
Food is so basic that when it gets hard to come by, it can trigger revolutions. Let us not forget that the spark that lit the Arab Spring revolution a couple of years ago was all about an imbalance in the food supply in Tunisia. As long as civilization has been around, food security was always the number one priority. This is nothing new. And therefore It is not a big surprise that the food sector that is one of the most represented sectors on local stock market exchanges.
More investors seem to be realizing that food is the place to be. Just look at the graph below to see how frontier market foods companies performed over the past year…
Here is a selection of some of the major food companies in the frontier markets. Click on the image to enlarge
Investments in the food industry are a key component of Silk Invest’s Investment Strategy. We even have a private equity soley dedicated to the consumer-facing food sector in Africa.
For more information about our activities and our funds, please go to our products page