African fixed income investing not for the faint of heart – Allan Gray

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Eurobond

Recent years have been difficult for African bond investors. The shock of COVID-19 combined with questionable fiscal decisions crippled many African economies.

Debt levels approached or breached sustainable levels, leaving governments with fewer, harder choices. Previously sound countries defaulted, most notably Zambia and Ghana. Others progressed down a potentially similar path, including important economies such as Nigeria and Egypt. Debt concerns scared away foreign capital, putting pressure on local currencies. The Nigerian naira, Egyptian pound, Ghanaian cedi and Zambian kwacha have all lost about half their value relative to the US dollar over the last five years, with worrying consequences for everyday cost of living and their governments’ ability to service their debt.

Despite these challenges, the Allan Gray Africa Bond Fund has returned 5.1% per annum over the last five years, which is acceptable in absolute terms and good relative to alternatives. This is similarly true since inception. US$100 invested in the Fund in March 2013 would be worth about US$190 today. That same US$100 would be worth US$110 if one had invested it in the FTSE/JSE All Bond Index (the South African bond index), US$120 in the J.P. Morgan Global Government Bond Index (a global bond index) and US$140 in the supposedly higher return FTSE/JSE All Share Index (the South African equity index).

The saying goes that the windscreen is bigger than the rearview mirror. While it is pleasing to look back at the Fund’s performance, it is more important to look forward. We cannot predict the future, but we believe the Fund’s outlook is particularly attractive today. The exuberance of cheap and easy money in the early 2010s has been replaced by realism. Capital is scarce. Global investors remain scarred by recent events – with most remaining unwilling to engage with African borrowers. African bond prices reflect this indifference. This is an ideal setup for long-term active investors such as ourselves.

The Fund’s holdings highlight the opportunities. Ivory Coast, Senegal, Uganda and South Africa are among the Fund’s largest exposures. None appear in imminent distress yet offer high single-digit yields in US dollars and low double-digit yields in local currencies. These are combined with US dollar bonds issued by defaulting sovereigns such as Zambia and Ghana. These price in what we regard as punitive haircuts with attractive potential returns as restructuring outcomes are finalised. Egypt is similarly priced with added upside if it can avoid default – an outcome that is increasingly possible as its strategic role in the Middle East is reinforced by recent events.

Approximately a quarter of the Fund is invested in corporate bonds. These are arguably the most attractive opportunities in Africa today but are increasingly rare, as borrowers balk at the high cost of capital. Seplat Energy’s 2026 bonds, the Fund’s largest single issue exposure, offer low double-digit US dollar yield with low duration and credit risk. Seplat continues to execute well in the difficult Nigerian oil environment and should generate sufficient internal cash flow to repay the bonds before they mature.

We are seeing opportunity in Kosmos Energy, a deepwater independent oil and gas exploration and production company. The company’s key production assets sit offshore from Ghana, Equatorial Guinea and the US Gulf of Mexico. Their key growth asset pertains to liquefied natural gas projects off the coast of Mauritania and Senegal where they are partnered with BP. Recently, we switched our Tullow Oil bond holdings from unsecured debt into debt that is secured by assets. We also switched our Ghanaian and Egyptian sovereign bonds into bonds of the same issuer that should fare better in a restructure scenario. We trimmed our Ugandan and Sasol bond holdings, sold out of our Nigerian bond holdings, and added to Benin, Absa Bank and two-year US Treasury notes.

We are optimistic about future returns as African bond markets enter a period of rebuilding. We are competing in an uncrowded market with prices reflecting low expectations, which suits our investment philosophy and process.

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