Experts discuss the investment implications of the coronavirus pandemic, a delayed rebound in global growth and dealing with South Africa’s energy issues head on. Chaired by Romil Patel in Cape Town.
Nazmeera Moola (deputy managing director and head of South Africa investments, Ninety One (formerly Investec Asset Management)
Paul Boynton (chief executive, Old Mutual Alternative Investments)
Pallavi Ambekar (portfolio manager, Coronation)
Funds Europe – What is your investment outlook for 2020 and where do you see the key opportunities in Africa, given investors’ need for yield?
Pallavi Ambekar, Coronation – It’s fair to say that the investment outlook for 2020 is changing quite rapidly with current events unfolding. We came into this year expecting a rebound in global growth given that trade tension is easing, interest rates are generally quite low across the globe and the monetary and fiscal stimulus all very much in play. But now, with the impact of the virus spreading in a much more global manner and having the impact of shutdowns in both the US and Europe, and potentially coming here in the southern hemisphere, we will definitely revise the outlook downwards. Global growth will slow down materially this year. Who knows for how long? It all depends on when the impact of this virus starts to fade.
If there is a temporary slowdown in global growth, then 2021 growth is going to be revised upwards. There’s a lot of pent-up demand, a lot of stimulus has gone into the economy and so I think we are looking forward now to 2021 being a very strong rebound year.
Funds Europe – Pent-up demand for which type of assets?
Ambekar – It would be pent-up consumption demand and commodities demand. There is some inventory build-up at the moment that will need to be worked through, but as we see things normalising and as inventory is drawn down, you could expect to see some demand acceleration. That’s very much related to the amount of stimulus that’s been put into economies. We have seen China do some level of stimulus, but if you see some of the signs in Europe and the US, it’s going to be very good for consumption going forward.
Paul Boynton, Old Mutual Alternative Investments – I’ll take a slightly less macro perspective. Where we’re seeing opportunity at the moment – and how this plays out in the investment space in Africa – is in the infrastructure space, that’s certainly a yield trading sector and there’s a huge infrastructure deficit within Africa. We think the consumer theme across Africa also remains intact. Some of the other variables that are investment-positive in the African space, broadly over the next year, are the development of the free trade implementation and rolling out of the free trade accord reached last year across the continent. Brexit can have some positive impact on the African investment opportunity, because investment into spaces such as agriculture, viticulture, fruit, sugar, can become less contested as it would into the UK, so there’s opportunity in Africa for that.
The consequences of the dramatic slowdown in China and the continued runout of the pandemic globally are going to be felt in Africa. At this point the incidence of the disease has been relatively modest in context but one imagines it’s merely a matter of time before it also becomes much more problematic across Africa. Africa does benefit from having a much younger population on average, and there is a huge incidence of fatalities in much older folk generally and people with pre-existing conditions, so although Africa’s infrastructure around healthcare may be deficient and not up to first-world standards, hopefully the impact on the population is less severe as a result. So, we do see opportunity over the next year to be involved in putting capital to work. Lastly the restructuring of Eskom [the South African electricity utility] and some of the impact opportunity spaces across Africa also present opportunities for investment over the next year.
Nazmeera Moola, Ninety One – We came into the year reasonably optimistic about growth. What’s happened with the virus is that it has started to expose some of the underlying weaknesses in the global economy, principally this massive build-up in corporate debt over the last decade. The global financial crisis (GFC) in 2008 had a consumer debt problem. What has happened now, particularly in the developed world, is a corporate debt problem. It wasn’t an issue because it was underwritten by monetary authorities around the world, by massive amounts of quantitative easing and low interest rates, but that firepower is significantly diminished. The eight major developed market central banks in the world had combined interest rates of 41.5% going into the GFC, two weeks ago they had 6% combined rates, and it’s down to around 3% – that’s the issue. Now we are at this point where markets are vomiting daily and they’re starting to disbelieve this underpin of monetary policy. So, it’s a question of what else can be done to support them. Do we see some sort of combined fiscal response? What does that look like?
The second, which is going to have a much longer-term effect, is what does fiscal response look like in a world where monetary policy has run out of room? That could be really interesting. You could see massive stimulus that is good for commodity prices.
As Paul said, Africa has a younger population, which should help. In South Africa, the government bond yields are looking really attractive on a longer-term basis. We just need the world to move from this credit freezing space that it’s in, to one where the value in those risk assets can be seen, because people aren’t just looking for places to hide. Unfortunately, even with 5% real interest rates, South African government bonds are viewed as a risk asset, not a safe haven asset.
Funds Europe – What do you identify as the top investment and/or business risks?
Boynton – Obviously Covid-19 is a very unpredictable outcome at this point. The way that China seems to have got across the issue in a profound way is very encouraging, but the way that other jurisdictions seem to be struggling is more worrying, so we can’t take a lead on where this will land.
Historically, currency has been identified in the alternative investment area as the biggest risk in Africa, and certainly in terms of our investment process of putting money to work in Africa, it’s a huge focus area for us, both on the exchange rate side – how do we protect ourselves against exchange rates and on the remittability side in terms of can currency be expatriated cost-effectively and time-effectively when needed?
The other thing about Africa is that with 54 different countries, jurisdictional risk is also a big factor, and certainly understanding the complexity of each country or area of jurisdiction that you are exposed to in any particular investment is a very important part of managing risk in terms of investing across Africa.
On Covid-19, there are first-order effects, but there are also second-order effects with the value chain dislocation being a big risk this year in terms of businesses being able to step up.
Ambekar – The biggest risk right now is the systemic risk that Eskom presents to the country as well as to businesses, both manufacturing and consumer-facing businesses. We are currently in a phase where Eskom’s operational issues are well known, as well as its financial issues. We think the operational issues are being addressed, we have indications that the right management has at least been put into the entity, however the fix for Eskom will take a number of years, in our opinion. It is the right thing to do to have consistent load-shedding so that maintenance can be caught up in underlying plants, but the implication for South African corporates of a consistent load-shedding regime and environment is actually quite a headwind. So, businesses in South Africa have to understand how they are going to deal and face this problem over the next two to five years, if that’s how long it takes.
The second risk that we see for South African businesses is this environment of political uncertainty and negative outlook from a political point of view, which we think is stabilising now but has built up over a number of years. This has led to quite high levels of immigration – especially as we see the very highly skilled wealthy population leaving first. This leaves you with a skills vacuum in South Africa. Our education system is not at the levels it needs to be at, and so on a more medium to longer-term view, this is going to be another challenge that confronts South African businesses.
More widely, not just in South Africa but in Africa as well, policy certainty is another key risk. We have been late here in finalising some key policies and businesses don’t like an uncertain environment, and the direct consequence of that is that they hold back on investment levels. Unfortunately, in this negative spiral if you’re not having certain policy then you’re not going to have the necessary investment to generate the growth that we need.
Funds Europe – In terms of Eskom and the two issues, operational and financial, how much of that is a microcosm of the ESG issues facing South Africa today, in terms of governance and social particularly?
Ambekar – The governance issue is probably more prevalent. We’ve had a decade of corruption under the previous presidency. That has hollowed out Eskom as an institution, so we are now left with a mismanaged entity which has overspent its budget and, as I said before, is not just had operational issues, but financial issues. Taking steps to address these two large burdens for this economy right now requires many of the parties to come to the table. In order to address Eskom issues, every single party that directly interacts with that business has to take a haircut in some way – whether it’s the consumer in terms of increased tariffs, whether it’s the debt holders in terms of maybe a potential haircut on the debt or in the longer term, and then of course the people who work for Eskom and the staff complement, and that is a much more difficult hurdle to overcome and there’s a lot of uncertainty about whether or not that will actually come to fruition, but the labour complement has to be reduced.
Some of the positive steps we’re seeing from government, and especially addressed in the last budget, was that they are looking internally first and they are trying to address their own wage issues, and that maybe sets up a precedent for starting to address Eskom’s wage issues. So, the governance aspect is starting to move in the right direction, but we are a long way from having a complete solution and being on a more stable footing.
Moola – Having looked at a few of these state-owned enterprises over the last five to ten years, one of the things I’m trying to understand is what sort of a governance regime makes sense? We seem to be in a position where you set up these boards/committees/structures and then people spend a lot of time figuring out how to circumvent them. So, the board box-ticks the requirements without actually fulfilling the purpose that they’re meant for, and I don’t know what the appropriate structure is that actually does provide good governance.
What is clear is the over-involvement from the shareholder, namely the government, in these entities’ boards is dysfunctional. Either the government became too involved on an executive level or they pushed objectives that were completely opposed to the long-term sustainability of the entities for which the boards were legally responsible. I’ve become a bit disillusioned with the idea of a traditional corporate board structure in a state-owned company. I’m not sure I know what replaces it, but I am not convinced that a board structure makes sense.
Funds Europe – So there could be a potentially more hybrid solution, rather than ridding the board altogether, or is that a question mark?
Moola – I think some sort of hybrid solution makes sense. The ultimate solution is much more clear private sector involvement in infrastructure provision wherever possible. It is a movement away from these mega-entities like an Eskom or a Transnet [the rail, port and pipeline company], which creates massive dependency of the country on any one entity and its governance structure – or flawed governance structure.
Ambekar – We are at such an extremely low base that private sector involvement would only improve the situation. This is unfortunately the situation we find ourselves in, nine hours of load-shedding in Johannesburg is just simply not acceptable, and if that reduces to two hours of load-shedding that’s already a huge improvement. I agree with Nazmeera – private-sector involvement and increased private-sector involvement in power provision is potentially a solution. Some of the government’s willingness to allow, for example, mining companies to self-provide and take some of the burden off the state. They will do it naturally anyway to the extent that they can, and you’ve already seen self-providing electricity and moving off the grid in households as well. Market forces will move you there, and the only caveat to that is that it doesn’t fundamentally solve Eskom’s problems and it’s the burden that it still presents to government from a debt point of view.
This is a situation which will play out over a number of years, and the fact that it will take a number of years to play out is the reason why our businesses have to adapt and change the way they look at things in South Africa. One of the reactions to that has been that many corporates have started to look offshore and allocate their budgets offshore to find different growth avenues and diversification away from South Africa. Some of the risks that we think about when we look at investments in South Africa: moving offshore and looking elsewhere for growth seems like the right solution, but that in itself present some risks because it’s different jurisdictions, different political regimes, different regulations, and often our management teams who are very familiar with the environment here are moving into unfamiliar territory. If they are stretching their balance sheets to do so, that is another risk they have to contend with if things don’t go well in offshore jurisdictions.
Boynton – With Eskom, the difficulty is that you’ve got a set of circumstances at the moment that create a wickedly complex problem, and private-sector capital can step up rapidly with solutions – partial solutions or solutions that in some way can mitigate aspects of this complex problem. For instance, this issue of the mining sector being allowed to self-provide, or residential consumers who install rooftop solar being allowed to feed back into the grid in times of surplus. Modest regulatory reforms to the electricity space in terms of these feed-in tariffs would free a lot of private capital to invest in self-provision. These feed in tariffs should be time-based, so in other words if you’re feeding electricity back into the grid between six and eight o’clock at night, you’ll get a higher price than if you feed it in at three in the morning, when demand on the grid is low. These kinds of reforms can potentially mobile private capital in a profound way.
Technology is also moving in this direction; we’re going to see the same kind of thing happen in the power space globally as has happened in telcos. There’s going to be a lot more modest, small grid and self-provision as the whole space becomes deconstructed. These huge utilities that were the structure historically around providing power are not the solution for the future, and certainly the estimates for Africa as a continent going forward are that rooftop solar is 25% of the ultimate power capacity in Africa. It doesn’t make sense to build these huge utilities any more and link everybody up with lines, it’s not the most efficient way to go.
Government needs to step into this new space with conviction and drive, and that really is the opportunity for us at the moment. Importantly, this all needs to be done conscious of the folk who are going to be negatively affected in that kind of outcome, and we need a just transition that looks to support people employed in legacy power businesses like coal mining into a new set of employment outcomes with retraining or reskilling against this new framework, but for us to remain entrenched in this historic construct is just crazy as a country.
Funds Europe – Overall, are you optimistic or pessimistic on South Africa and the African continent as a whole over the next 12 months?
Boynton – One of the issues for South Africa, and this is a little bit like Australia, is that we are more exposed to climate change than the average global exposure, so we’re going to heat up at a faster rate, the change in our agricultural outcome is more extreme, and it’s the same case in Australia. In a sense, although we are a culprit in terms of our current climate emissions, as is Australia, we’re a beneficiary of getting the climate transition moderated. So, we just need to be thoughtful about how we optimise our position.
Ambekar – I wouldn’t say I am optimistic or pessimistic, just realistic is probably the fair answer. Given where South Africa has come from, from a political point of view we are in a much better space than we were three to five years ago. We are still an integrated population, we are a young democracy, we enjoy basic human rights such as freedom of speech, which I think in some of the more developed markets is slowly dissipating, so there’s much to be positive about in South Africa.
Now, the evolving global crisis of Covid-19 means that the next 12 months will be tough for South Africa. The African continent will also face challenges over the next 12 months – there are resource-heavy economies, pressure on oil prices will be quite a challenge for certain large economies in Africa which have already not shown significant growth over the last three to five years, so I think a very challenging 12 months both for South Africa and Africa. Longer-term, if some of the underlying local issues that we’ve spoken about are addressed, there is reason to be optimistic.
Moola – South Africa’s outlook is going to be determined by our actions over the next 12 months in that the global environment has become distinctly unfriendly. As we started the discussion, I was saying it may reverse quite quickly if there’s stimulus and the virus subsides, but we don’t know, and we can’t count on that. So, it’s about self-help.
To me, the two things that we need to be doing are: one, if the South African government was a company, it would be controlling costs, which means controlling the public sector wage bill. Two, South Africa should be doing everything we can to improve the top line, which would be the growth outlook. In this case, it means energy reform – the sale of spectrum, making it easier for small businesses to operate amongst other things. The regulatory reform we were talking about, essentially anything we can do to implement regulatory reform.
That’s it. If we can actually do those things, and there’s some signs it is potentially possible, the next year could leave us in a position where locally we are in a really good space in two or three years. If the global conditions improve, that would set us up really well, but it is about self-help. Without self-help, an improving global environment is not going to help us nearly as much.
This article was first published in Funds Europe April 2020 edition
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