Investment Adviser:

Sanlam Investment Management

(February 2015)

2014 has just come to an end. How would you sum up the past year as a whole for the markets in which the Fund invests?


The performance of equity markets in Africa was mixed with the Nigerian Stock Exchange losing 25% in 2014, while both Egypt and Kenya were up 20%. The last quarter of 2014 was particularly disappointing in Nigeria as gains that were booked earlier in the year reversed as the oil price decline spooked equity investors.


Were there any particular success stories among the Fund’s holdings? Any companies or sectors which did really well?


Given that the Fund invests in several countries, each with its own peculiarities, there is no one sector that did well across all countries. However, financials in Egypt did very well with Commercial International Bank and Credit Agricaole up by more than 60% and 30% respectively. Again in Egypt, Oriental Weavers and Eastern Tobacco posted strong performance in the Consumer sector- both stocks were up by more than 60%. In Kenya, Safaricom in the telecoms sector performed well posting a 24% return.


Egyptian stocks performed well in 2014 – the main EGX 30 index was up by more than 30% for the year. Were you expecting that kind of yearly performance?


Given that we are bottom up investors, we had positioned our portfolio with stocks that we believed were undervalued. As a result of the bottom up approach our fund had a 25% exposure in Egypt and we benefited from the strong performance.


What was behind it? Was it a case of strongly improving sentiment towards Egypt as a whole or the exceptional outperformance of any one sector or group of companies?


Broadly all the sectors had a strong performance in 2014 except the tourism sector which is still recovering. Oil & Gas related stocks took a hit in Q4 on the back of the drop in oil prices. Political stability and an improving economy contributed to the good performance as investors interpreted announced cuts on subsidies and tax hikes as a sign that the new government was ready to push for macroeconomic improvements. To some extent, the return to civil order also helped.


Is that gain indicative of the potential rewards African stocks offer or is it more a case of a previously battered stock market finally picking up?


It was a combination of both. Some of the stocks had been sold off during the three years of political revolution and they were trading at valuations well below the long-term average. For example, when we invested in Oriental Weavers in Egypt, it was trading at a price-to-earnings ratio of 5x that eventually corrected. However, when you look at the banking sector, the performance was driven by an improvement in economic fundamentals and an uptick in corporate lending as corporates started spending again, on the back of improved macro stability and a return to civil order. On the back of that we saw banks like Commercial International Bank starting to grow their loan books and consequently earnings.


There is certainly a better perception of Egypt’s future at the moment than there was a year, or even two years, ago. Are you confident of the country’s economic and political future?


Some stability has returned to Egypt with the army having interceded in the political arena and ensuring a military candidate has succeeded to the presidency. The new president is enacting a pro-business agenda, but Egypt remains economically and politically fragile. The currency is likely to weaken further, the government is reliant on financial aid from Gulf countries to support the budget and balance of payments and a widespread energy deficit (gas & electricity shortages) is hurting Egypt’s industrial heartland. With continued external support, Egypt should successfully navigate through this period and we are seeing a rebound in demand that was pent up through the post revolution period, while businesses remain financially under geared and with spare production capacity. Economic growth should start to improve in the tourism sector that had dropped to 2% of GDP during revolution compared to about 4% pre-revolution. The IMF projects Egypt’s real GDP to grow at 3.5% in 2015 and given that consumer prices are forecast to average 13%, nominal GDP growth will be about 16.5% which is respectable.


As in Egypt, the Fund also has significant holdings in Nigeria. However, the Nigerian market fared relatively less well in 2014 and many stocks posted notable losses for the full year. What do you put this down to?


Brent crude prices slumped by more than 40% after September and as a result most oil dependent countries saw an indiscriminate sell off in equity markets. The Nigerian stock exchange came under huge pressure in Q4 losing about a quarter of its market value as investors were spooked by lower oil prices and currency depreciation (approx. 8% devaluation of the NGN). The Nigerian economy is reliant on oil for fiscal revenue and foreign currency generation. In the absence of structural buffers, lower oil prices are negative for economic growth in Nigeria and currency depreciation risks remain elevated. Given that the financial performance of banks is dependent on a stable macro environment, banking stocks in Nigeria came under huge pressure as negative macro news dominated. The Nigerian Banking Index plunged 30% in 2014. The market seems to be pricing in slower credit growth, potential top line headwinds and a major deterioration in asset quality. Most Nigerian banks extended loans to the Oil & Gas industry and given that the oil price is under pressure, asset quality concerns remain a significant overhang.


To what extent was that poor performance among Nigerian stocks mirrored in the Fund’s Nigerian holdings?


The Fund had an average exposure of about 20% in Nigeria during 2014 and the negative performance of the Nigerian Stock market did affect our portfolio performance negatively. We saw an indiscriminate sell off across all sectors in Nigeria, even undervalued stocks came under significant pressure. On the other hand the 8% devaluation of the NGN by the central bank in Q4 detracted from performance as well. On a sector level, the biggest detractors to performance were banks, given that the Nigerian Banking Index plunged 30% in 2014. The Fund had about 20% exposure to financials stocks in Nigeria.


Nigeria is Africa’s biggest oil producer and depends on crude exports for 70% of government revenue and 90% of its foreign exchange earnings. How is the economy going to cope if oil prices do not rise significantly in the near future?


There are prospects in Nigeria for sustained growth driven by an improved performance of the key non-oil sectors – agriculture, information and communication technology, trade and services – but a decline in the contribution of the oil sector may dampen the positive outlook.


To what extent do falling oil prices affect the local stock market? How worried should investors with Nigerian stocks be about oil prices?


A sharply lower oil price has profound negative implications for Nigeria. Oil dominates export earnings as well as government revenues and feeds into every level of the economy. Government finances and the exchange rate are under pressure, banks are under scrutiny due to loans to the ailing oil sector allied with stringent central bank regulations and consumers are under severe pressure - Nigeria is facing multiple headwinds. But, the market has reacted, having fallen more than 30% in the last six months. We do not invest on the basis of macro factors and we have no ability to time markets. What we strive to do is buy stakes in businesses that trade at a reasonable discount to our intrinsic valuation. And, in Nigeria, we are seeing opportunities as some high quality companies come under severe pressure in the market.


A fall in oil prices has a mixed effect on stocks as there are many moving parts and it also depends on whether oil is a cost to a particular business or a revenue generator. A sharp fall in oil prices is bad for Oil & Gas companies as revenues could come under pressure. If the central bank were to devalue the currency due to pressure on FX reserves, then imported inflation could be a problem and profit margins could come under pressure and consequently earnings. However, a lower oil price is positive for consumer spending as that reduces how much consumers spend on transport costs. On the other hand, businesses that have high distribution costs (with fuel being a significant component) may benefit from lower distribution expenses.


Presidential elections are due to be held in Nigeria this month. To what extent do you expect local stocks to be affected in the run-up and immediate months after the elections?


Generally in a run up to election, foreign investor participation slows down as investors generally adopt a wait and see approach, therefore volumes traded could be low, but not in the long term. An election can either result in a win for the ruling PDP and the status quo or a win for the opposition ACP which could see a few changes. It is quite difficult to tell what the impact of either winning could mean and we do not have the ability to do so or to time this. What we strive to do is to look for opportunities in good quality businesses that are trading at discount to fair value.


Kenyan stocks had a reasonably good 2014, posting double digit gains for the year. What was behind these gains and are you expecting more of the same in 2015?


The Kenyan market was up 20% in 2014, and this was driven by positive investor sentiment given stable macro conditions and the benign regulatory environment for banks and telecoms. The KES was also stable in 2014. Corporate earnings were also strong, leading to strong share price gains of between 20-30% in 2014 for the likes of Safaricom, Equity Bank and Kenya Commercial bank. These three stocks make up about 40% of the Nairobi Stock Exchange All Share index. Investor flows were to some extent from investors that were avoiding Nigeria and found Kenya to be a safer place to park some of their investments.


Many analysts see Kenya as one of the best prospects among all frontier markets. Assuming you agree with that view, what would you say are the main characteristics that make it such an encouraging prospect?


Kenya’s macro and political environment has been stable and that has seen the shilling being stable over the past two years. However, the Kenyan FX situation was to some extent supported by the USD2bn Eurobond issue in 2014 and we would caution that the tourism industry needs to recover to provide a suitable source of foreign currency. The Kenyan economy will benefit from lower oil prices as these will help narrow current account deficits and this implies firmer currencies, low inflation and most likely low interest rates for longer. However, sentiment is fickle, and can change before you know it, hence, we prefer to focus on market valuations rather than sentiment.


Kenyan stocks have risen more than 150% in the last three years and much of that rise has been driven by company earnings, suggesting firms there are in good shape. However, some argue that there are only a handful of large companies worth investing in. What would you say to that argument?


To us Kenyan valuations are looking rather lofty from a price-to-earnings ratio and price-to-book point of view. Some banking stocks are now trading at huge premiums over their long-term average and above what we consider to be fair value. For example Equity Bank now trades on 3.5x book value, which is quite steep.


The Fund also has a fairly large exposure in South Africa where the economy is much more developed than those of the Fund’s other focus markets and equity markets have a much wider offer. There is also greater correlation with global markets. Do you have a different strategy for the Fund’s South African exposure compared to its holdings in other African markets?


Our exposure to the South African market will always be capped at 25% of the portfolio as we plan to capture more of the Africa-ex South Africa opportunities. Our approach to investing is bottom up regardless of region, and we apply the same principles of buying businesses with a sufficient margin of safety.


South African stocks, although making some modest single digit gains for the year, were held back by domestic economic problems and the continuing sluggishness of the global economy. Are you expecting 2015 to be any better for local equities?


Peering into the future, it is almost certain that volatility will continue to afflict us. However, volatility is not really the enemy if you have a long-term horizon. Forecasting is always perilous - more so in an uncertain environment, but eventually valuations matter and financial markets revert to fundamentals. The JSE has re-rated now from being at a discount to emerging market peers to trading at close to a 40% premium to other emerging market indexes. At a forward PE of over 15x, we are back to the lofty valuations of the pre Global Financial Crisis. It does feel at times that Mr. Market has forgotten basic valuation fundamentals and has opted instead to chase the momentum.


While the broader market managed to squeeze out a positive return, the resources sector lost over 19% in the final quarter of 2014. These stocks continue to feel the effects of falling commodity prices as the demand outlook remains uncertain given the performance of the Chinese economy. This fact, coupled with the sluggish performance of the local economy, has resulted in an equity market where the careful selection of stocks is required to avoid capital loss. We continue to focus on valuations derived from our fundamental bottom-up research process and are particularly aware of the need to avoid capital loss wherever possible. It is our belief that our disciplined process will remain the source for the continued sound long-term performance of the Fund.


IMPORTANT NOTE: This report has been prepared for information only, and it does not represent an offer to purchase or subscribe to shares. World Investment Opportunities Funds (“WIOF”) is registered on the official list of collective investment undertakings pursuant to part I of the Luxembourg law of 17th December 2010 on collective investment undertakings as an open-ended investment company. WIOF believes that the information is correct at the date of production while obtained from carefully selected sources considered to be reliable. No warranty or representation is given to this effect and no liability can be assumed for the correctness or accuracy of the given information which may be subject to change at any time, without notice. Past performance provides neither a guarantee, nor an indication of future performance. Value of the shares and return they generate can fall as well as rise. Currency fluctuations, either up or down, may also affect value of the investment. Due to continuing market volatility and exchange rate fluctuations, the performance may be subject to significant changes over a short-term period. Investors should be aware that shares in the financial instruments entail investment risks, including the possible loss of the invested capital. Performance is usually calculated on the basis of the relevant NAV unless stated otherwise. Performance shown does not take account of any fees and costs associated with subscribing or redeeming shares. It is assumed that all dividends were reinvested. WIOF prospectus is available and may be obtained through www.1cornhill.com. Before investing in any WIOF Sub-fund(s) investors should contact their financial adviser / legal adviser / tax adviser and refer to all relevant documents relating to the WIOF and its particular Sub-fund(s), such as the latest annual report and prospectus that specify the particular risks associated with the Sub-fund, together with any specific restrictions applying, and the basis of dealing. In the event investors choose not to seek advice from a financial adviser / legal adviser / tax adviser, they should consider whether the WIOF is a suitable investment for them.