Adventis Africa Enhanced Income Strategy

SEPTEMBER 2020

STRATEGY COMMENTARY

The strategy returned -0.36% for the third quarter. Renewed coronavirus concerns at the end of Q3 20 motivated risk-off selling, tripping the strong gains achieved over the previous 3 months.

Africa’s fight against COVID-19 remains resilient, as the continent’s younger demographic may assist in a quicker COVID-19 recovery. At the end of September, the total number of confirmed active cases on the African continent continued its decline to 219,190, a 7.49% decrease month-on-month. On the other hand, infections continue to rise globally, with the UK reimplementing partial lockdown restrictions as the European continent prepares for a second wave of cases, reigniting the prospect of subdued demand and a slower growth recovery.

The subdued global risk appetite has resulted in a risk-off environment to end Q3 20. The JP Morgan EMBI Global Index posted a return of -2.53% for September with a year-to-date maintaining in positive territory at 0.37%. African debt capital markets reversed the gains made recently, as the SBAFSO (Standard Bank African Bond Index) recorded a -3.99% negative return for the month with a -4.51% year-to-date.

The Adventis income strategy maintained its strategic asset allocation to diversified exposure across countries, sectors, and credit ratings. short maturity positioning of the strategy will allow for re-investment at significantly enhanced levels presented by the current environment.

The Adventis Income strategy has a running yield of 10.79%, lower than the Q2 20 yield of 11.55% with a quarter end closing cash position of 9.60%. The duration of the strategy increased from Q2 20, ending September at 2.03 years. The strategy returned -0.36% for the third quarter versus a cash benchmark USD 3-month Libor +3.0% of 0.83%. USD Cash exposure increased from 3.20% to 9.60%, while the exposure to local African currencies was decreased to 14.35% from 29.40%. At the end of the third quarter, the strategy’s largest regional / sovereign exposures were Diversified SSA (32.10%), Egypt (15.30%) and Nigeria (12.70%). The strategy’s main sector exposures were Sovereigns at 47.30% and Financials at 27.30%.

Proceeds received from maturities during the quarter enabled the strategy to reposition sovereign allocations. Exposures to Kenya and Ivory Coast were increased from 4.7% and 0.0% to 10.4% and 2.6% respectively. with the Ivory Coast ranked favourably in the Adventis African macro scorecard which demonstrates stronger fundamentals and fiscal sustainability against a backdrop of acceptable short-term political risk. The Kenyan exposure was increased on the back of strong export growth – tea and horticultural exports were up 9% and 23% year-on-year respectively giving the economy a reasonable possibility of achieving positive growth for the year.

The strategy opted to repatriate the capital from maturing local currency Nigerian debt, versus rolling forward the exposure. Lack of Nigerian central bank transparency and a reluctance to allow repatriation for offshore investors raised concerns for reinvestment in the local currency market. Notwithstanding the bearish view of local currency Nigerian debt at the time, supportive oil prices above USD40/bbl called for the strategy to maintain a dollar exposure to Africa’s largest economy, maintaining the exposure whilst minimising repatriation risk.

Zambia’s request for a six-month suspension of interest payments was dismissed by a representative group of bondholders. A lack of progress on fiscal consolidation measures remain at the forefront of concerns. The Eurobond payments amounted to an estimated USD162mn over the requested suspension period with consensus that the amount of payment did not warrant a deferral and would not materially resolve the prevailing fiscal position. The hitherto slow pace of progress on achieving agreement on an IMF seems to have finally turned a corner with the government “to do whatever will be necessary” to secure an IMF program “whatever its form”. The strategy has continued to hold its Zambian exposure with the view that an IMF support package is inevitable, and the deep value sovereign debt will reprice.

Q2 GDP growth prints shed light on the magnitude of the impact that COVID-19 on African economies. The absence of tourist arrivals in Q2 saw Mauritian real GDP decline -32.5% year-on-year whilst Botswana published a record-high contraction of -24.0% yoy due to large contractions in key sectors. Regional neighbour, Namibia, saw an 11.1% year-on year decline, as strong agricultural growth failed to offset lower general economic activity. The three-week lockdown in Ghana in June contributed to an economic contraction of 3.2% yoy. Rwanda, despite boasting a diversified economic base, recorded a GDP contraction of -12.4% yoy. The lifting of lockdown restrictions in Q3 20 will be a key driver for African sovereign’s growth performance for the remainder of 2020.

The African local currencies recovery was paused in September as the USD Dollar Index rose 1.89% to 93.89. Euro-pegged African currencies lost much of the previous months’ gains. Country specific risks of Zambia and Angola led local currency weakness relative to African peers with the Angolan kwanza (-3.83%), the Zambian kwacha, (-2.15%) and the West African franc (-2.01%) losing ground against the US dollar over the period. Top performing African currencies for the month (vs the US dollar) were the Nigerian naira (+1.21%) and the Egyptian pound (+0.86%).

August inflation prints were mixed across the continent following the easing of July inflation rates with supply side issues buoying food price inflation. Notwithstanding this, softening of generalised inflation suggests central banks do not need to prioritise inflation over the short to medium term. Several MPC meetings took place over the backend of September with decelerating inflation prints supporting already attractive local currency real rates. Foreign inflows into domestic markets have assisted balances of payments and currency stability over this volatile period. Mauritius, Angola, Ghana, and Kenya left their policy rates unchanged as Egypt and Nigeria cut rates. The GDP Q2 20 prints and low inflation prints may suggest a re-start of the cutting cycle as central banks prioritise economic growth.

Despite current global market uncertainty, we maintain a constructive view as the African fixed income market offers attractive risk adjusted yields. African sovereign Eurobonds offer significant risk premia with attractive yields of 8.53% on average. Considering the strategy’s low duration and maturity profile, the recent market volatility is likely to continue to present attractive opportunities in both African sovereign, and corporate fixed income assets. The run-up to the US elections in November could result in cautious market conditions as investors await the much-anticipated presidential outcome.

This month we profile the upturn in the commodity cycle and the translational impact on the GDP and fiscal balances for resource-based African economies.

SEPTEMBER 2020

MARKET COMMENTARY

IN FOCUS: A REVIEW OF THE IMPACT OF THE RECOVERY IN THE COMMODITY CYCLE

The resource-based nature of many African economies makes continued analysis of commodity supply/demand and price cycles particularly relevant and often underscores economic growth and fiscal revenue collections of many sovereign issuers. Since the sell-off in early March when COVID-19 was officially classified as a pandemic, the global commodity complex has staged a strong recovery.

The CRB Commodities index provides an aggregate measure of commodity performance. In Q3 20, commodities were up 12.73% and 9.66% over the 6-M period since March. The current risk-off backdrop towards month-end (1M) demonstrates that commodity prices are highly susceptible to short-term volatility.

Crude oil, a major African export has remained stable above USD40/bbl after an initial 82.8% recovery from the low USD22.74/bbl at the end of March. Copper has witnessed a strong rebound as demand picked up in China following a bid to kickstart their economic growth. Gold reached all-time highs of USD2,063.54/ounce, with a 19.57% rise over 6-M. To a lesser extent, soft commodities – cocoa, cotton, and sugar – have all benefited from USD weakness and the turn in commodity prices.

Utilising OECD data, recent changes in commodity prices can be used to infer the impact on the GDP of resource-based economies and to estimate the impact on sovereign issuer fiscal revenues.

Angola’s economy is heavily reliant on oil production at 88.0% of their exports. The oil price change from March to September translates to 14.14% increase of GDP (production level fixed). The significant price recovery in the oil price will assist in aiding the economic rebound and fiscal recovery. West African counties of Nigeria (8.50% of GDP), and to a lesser extent Ghana (5.62% of GDP) also have high GDP exposures to oil production.

Ghana overtook South Africa as the continent’s largest gold producer in 2020. A gold price rising to all-time highs (largely on the back of risk hedging), will significantly assist in achieving their positive GDP growth target this year. Other strong gold producers, Cameroon, and Rwanda will both benefit in receiving improved gold dollar revenue as will Senegal and Ivory Coast to a lesser extent.

The rally in copper prices has been welcomed by the Zambian government, announcing that 1H 20 production numbers were measured at +5.8% year-on-year. The 10.63% additional impact on GDP from the change in copper price will materially assist the government amidst recent forex liquidity concerns.

Despite Ivory Coast and Ghana producing 60% of the world’s cocoa output, their GDP exposures to cocoa are relatively low. On the back of improved prices, Ghana is projected to increase production capacity by 5.8% with the aim of assisting local producers.

RMB (Rand Merchant Bank) sourced tax revenue data assists in translating impact of the commodity cycle performance on the government fiscus and their ability to service dollar debt.

Angola

The monoline revenue stream of Angola is highly elastic towards changes in the oil price. Revenue generated from oil taxes in 2019 contributed 60.7% of total government revenue. Imputing the change from the increase in crude prices since March results in an estimated USD7.2bn improvement in revenue (8.48% of GDP) on the assumption of stable prices and constant offtake. Considering interest expense over the next 6-M on outstanding Eurobonds total 0.4% of GDP, the moratoriums and DSSI agreements will aid the government with fiscal room to stimulate economic growth and service partial debt obligations.

Nigeria

Nigeria, Africa’s largest economy, generated 40.0% of government revenues from oil production in 2019. The improvement from the commodity rebound will translate into additional revenue of 1.6% of GDP. The debt service expense on dollar debt over the next 6-M is estimated at 0.2% of GDP. Nigeria have the advantage of being able to raise domestically sourced funds, although oil generates petrodollar revenue to fund dollar denominated debt repayments.

Zambia

Zambia’s revenue collection profile mirrors that of their peers as 76.2% of government revenue was received from copper tax during 2019. Their overburdened debt profile however exacerbates their current fiscal situation. Despite the copper rebound in both price and production volumes resulting in a USD1.74bn marginal revenue increase (7.5% of GDP), Zambia is likely to remain under pressure as arrears on its external debt repayments reached USD485mn at the end of June. A foreign reserve’s shortfall puts further pressure of two large Eurobond redemptions due in the next 2-4 years exacerbated by the need to service outstanding Chinese loans.

Overall, Ghana and Ivory Coast commodity exposures should contribute to their respective economies avoiding a recession for the year. A weaker dollar and stable to positive commodity price growth outlook is likely to support the external positions of many African economies. The strategy’s allocation will benefit from improving African sovereign fiscal balances and strengthening forex buffers on the back of rising base metal, stable precious metal and energy prices from its sovereign allocations.

In a forthcoming report we will look an analysis of hard and soft commodity consumption across African countries and the likely impact on the future path of inflation.

Please contact Joseph Rohm (josephrohm@adventis.ltd) should you require any further information.