Curious about the ESG risks and opportunities of investing in Sub-Saharan Africa? How are outperformers trying to avoid some of the problems seen in other fast-growing emerging economies? Bernstein portfolio manager Christine Phillpotts, who oversees a frontier market equity strategy, shares her take.
00:09 - 00:41
Hello and welcome to On Purpose. I'm your host, Travis Allen, Senior Investment Strategist and National Director of Purpose Driven Strategies at Bernstein. Today, I'm thrilled to be joined by Christine Phillpotts to talk about investing in sub-Saharan Africa. Christine is a portfolio manager in our Frontier Market Equity Strategy. She's also a senior research analyst with coverage of not only sub-Saharan Africa, but South Asia, Central and Eastern Europe as well. Christine, thank you again for joining us.
00:41 - 00:42
Thank you for having me.
00:43 - 01:17
I'm so happy that we finally get around to having this conversation, because we've been having a lot of conversations with clients who want to focus on responsible investing and are very interested in what's happening in sub-Saharan Africa. And it makes me think back to 10 years ago in the wake of the financial crisis, there was a lot of talk about the enormous potential for sub-Saharan Africa to play a more prominent role in global economic growth going forward. And we're now a decade, you know, after that period. And I'm just curious to hear your views on how those predictions have played out.
01:18 - 02:16
Sure. Well, thanks for asking that very important question. So I think it's really important to to say right off the bat or just to remind everyone that sub-Saharan Africa is a region and is part of a continent. It's not a country. So the performance has been quite mixed across different countries in Africa a decade later. So just to be more concrete about those, if you look at the equity market returns over the last decade in US dollar terms, the MSCI Emerging Markets Index generated 25 percent return over that period. The Kenyan equity market generated 58 percent returns. I think that's all in dollar terms, whereas the Nigerian market actually declined by 62 percent. So you can see that over that time period there there's a huge variance by countries and by even some regions within Africa in terms of outperformers versus underperformers.
02:16 - 02:24
So I would imagine that there were some differences that you could identify between those outperformers and underperformers. What were some of those factors?
02:24 - 02:54
So if I think about the key success factors for some of the outperforming markets, such as in Kenya, one where economies that had superior economic growth that translated to strong earnings growth. And I should mention that it's not just high economic growth numbers, but it's really kind of what are the growth drivers underlying that and how diversified and resilient are those growth drivers, regardless of boom-and-bust cycles in the global economy and commodity cycles, et cetera.
02:54 - 03:33
The other related point is, we've seen in many markets in Africa that are outperformed the emergence of new, higher value added industries and companies. So think about nascent manufacturing hubs, nascent services hubs, economies that again have diversified and are moving to more value added sources of growth, as in moving up the manufacturing value chain, as in providing value added services, not only for those countries, but for the broader region, in technology and renewable energy in other areas versus just being resource providers. And again, if you think about those resource providers, they're really subject to the boom-and-bust cycles of commodity prices.
03:34 - 04:06
You know, the other technical factors would be around improvement and liquidity and capital market enhancements. And I think not everywhere, but many officials and regulators of stock exchanges across Africa have really made a lot of strides in improving the functioning of the capital markets, making it more hospitable to foreign investors, and increasing liquidity and enforcing regulations that make it a fair playing field for both domestic and international investors.
04:06 - 04:10
So those are some of the things that have helped the outperformers.
04:10 - 04:13
What are some of the things that you've noticed among the underperformers?
04:14 - 04:43
I think some of the common themes are what I alluded to earlier, growth that is overly reliant on commodities and really subject to the Chinese growth outlook and the outlook of kind of demand and supply for these global commodities, like oil, like copper, like other key materials in which the countries really don't have control over their own destinies. They're really at the mercy of what the global commodity prices are. And again, this creates a lot of volatility.
04:43 - 05:36
So we saw that clearly in the case of Nigeria, but also in some other markets that are more commodity reliant. I think another bottleneck that is really across the board, and this, quite frankly, isn't just relevant to Africa, it's also relevant to other emerging markets, and even some developed markets, is a failure to implement structural reforms. Whether that's power sector reforms, whether that's privatization of state-owned enterprises to make them more efficient, whether that's a whole host of other reforms that help improve the ease of doing business and improve the functioning of the economy and of the private sector. So you come across this issue of the benefits of, for example, power sector reforms is going to be delivered over a five-year horizon. But the next election cycle is next year. So no politician will touch it because they don't want to increase tariffs.
05:36 - 06:13
Thank you for that. And I think it is important to always emphasize that when you talk about sub-Saharan Africa, you're talking about a really diverse range of not just countries, but also different economies, countries that are in different places in terms of the equity markets. But I know that you've been investing in sub-Saharan Africa for now over a decade. What are the most exciting opportunities that you see today, given this, you know, sort of fits and starts and the progress that we've seen, like you just talked about over the last 10 years? What are some of the more exciting opportunities that you see today?
06:14 - 07:13
You know, I could talk about Africa as a region in terms of some of the characteristics I find attractive on a regional basis. And then I'll talk about more specifically some of the themes that I'm particularly excited about and that we're investing behind in our frontier and slow-moving market fund. First off, what we see at a regional level is that many African markets, first, strong economic growth and relatively high returns on capital; higher returns on capital than there are comparably sized peers in larger emerging markets. Yet these stocks typically trade at much lower valuations than their peers. And a large part of that can be explained due to more modest investment flows, limited liquidity. And in general, this region tends to be one of the least crowded investment destinations in the broader EM and even frontier universe. We see less sell-side and buy-side research coverage, which means that it creates a lot of great opportunities for active managers like ourselves.
07:13 - 07:37
If you kind of go down the less beaten path, you're more likely to use, be able to use your own fundamental research and due diligence to really uncover very interesting and exciting opportunities that should do quite well, not only based on how the company's performance unfolds. But as these markets become more developed, they're more mature and does attract more liquidity over time. We should see those valuation gaps narrow.
07:37 - 07:45
So that's on a regional level. Maybe you could talk about some of the themes that kind of cross several countries in Africa that you're particularly excited about.
07:45 - 08:28
One is infrastructure, I think, particularly in a market like Africa, where infrastructure investments as a percentage of GDP is still quite abysmal, we see a lot of opportunity for new investments in infrastructure and companies that are deploying infrastructure to support productivity growth and lower the cost of doing business. So these are infrastructure development projects that are critical and that will enable a lot of the commodity dependent economies I referred to earlier to diversify beyond commodities by developing a more robust manufacturing base, which we have found, f you look at the history of emerging markets, is really a critical transition that has been important for the economic development of other larger emerging markets.
08:29 - 08:35
So as you invest in that theme, what type of companies are you finding along the lines of infrastructure for the portfolio?
08:36 - 09:07
So, for example, we've invested in several listed cement and power companies, as well as a port operator that are all private companies that are involved in building out infrastructure, whether it's housing, whether it's the grid, whether it's power solutions, renewable solutions, and basic transport infrastructure, which, again, in Africa is still quite undeveloped, which is a bottleneck currently, but provides a lot of opportunity given that the penetration is so low but is ripe to improve.
09:07 - 09:59
The other theme that we like is really thinking about the evolution of the consumer and more specifically around the agribusiness value chain. And I think this has become an increasingly important topic as we think about food security more globally. So there are several listed companies we've invested in that are moving up the agribusiness value chain, and they are transitioning from being simple producers and exporters of raw agricultural commodities to becoming vertically integrated companies that service the growing food needs of their domestic markets. And what's important to think about is this move up the value chain only enhances the local economy and creates jobs because they tend to be labor intensive sectors, but they also reduce a country's reliance on imported food products, which improves their external balances and reduces their currency vulnerabilities.
09:59 - 10:12
I'm so glad you raised that point, because food security is one of the things that we've talked about with many of our listeners. And it's a growing concern among responsible investors as you talk to them about ESG. Please continue.
10:12 - 11:06
The last EM highlight is the use of technology to leapfrog bottlenecks. So one example of this is in the mobile banking space where we see a lot of really attractive developments in Africa, where Africa is actually a leader in innovation in this space. So mobile banking, if you look across the African markets, it's been offering millions of people a faster, safer, cheaper and more convenient way to send and receive cash. Send and receive money. And what's interesting is that many of these mobile banking platforms have evolved and flourished and developed way ahead of the US and other developed markets to the point where I know MasterCard, Google, American Express, Apple, and others are actually looking to the continent for lessons on what's worked there, that they can apply to developed markets. And for these mobile money players and fintech players, as they leverage the powerful networks,
11:07 - 11:31
mobile money platforms of scale should be a source of rapid revenue growth as standalone businesses for telecom and banks. We often have been, even before fintech became a common term, We've been playing that theme through Telcos, through banks and through other members of that ecosystem that are really kind of driving that growth. And like I said, bringing innovation that, quite frankly, developed markets could use in their own markets.
11:32 - 12:23
I know that you manage money across emerging markets and frontier markets and the investments in the region that we're talking about today, sub-Saharan Africa tend to fall in for the most part frontier markets, or many of the countries still appear in frontier indices and not the emerging markets index. I'm just curious how the landscape for public equity investing in sub-Saharan Africa compares to some other countries that are also frontier markets that seem like they're becoming more and more mainstream. You know, Vietnam and Bangladesh and so on. Where are, you know, especially the frontier countries in sub-Saharan Africa in that same process of becoming a mainstream thing that normal investors are very comfortable holding in their globally diversified portfolios?
12:23 - 12:54
Yeah, so I've used sub-Saharan Africa, excluding South Africa, which is considered a larger emerging market. So sub-Saharan Africa, ex South Africa, I think, is really at the frontier of the frontier markets. It's kind of the bleeding edge in terms of liquidity, in terms of disconnect between valuations and returns. I think they were at an earlier stage of development relative to other what are deemed frontier markets, as you mentioned, you know, Vietnam, Bangladesh, Colombia, Chile, et cetera.
12:54 - 13:25
So, you know, if you think about just the listed equity markets for a second. Their stock exchanges established in over half of the African countries. However, if you look at market cap to GDP, gross domestic product, and that's often a marker used for the stage of development of listed equity markets. So within sub-Saharan Africa, if you include South Africa, that ratio is 42 percent. If you look at sub-Saharan Africa, excluding South Africa, it's only 11 percent, which is incredibly low. It's really lower than other emerging market peers.
13:26 - 13:46
So I would think that the fact that these equity markets are in an earlier stage of development will present some challenges, of course, but also some opportunities that you may not see in advanced emerging markets. So when you look at these areas, how do you assess the viability of these equity markets?
13:46 - 14:20
So what that indicates is that there are a couple of different opportunities for that to grow. And that one is addressing the lower liquidity profile. And it becomes a little bit of a chicken and egg issue because of the lower liquidity that keeps many investors away. And it constrains investment flows, but that constrained demand then disincentivizes companies to go public on their local markets. They'd rather go public in London or Canada or the US, as opposed to Kenya, for example, or Botswana, or Mauritius. And so kind of breaking that logjam is really critical.
14:20 - 14:55
I know that's what a lot of the regulators I've spoken with and a lot of the heads of stock exchanges have been making progress on. So, for example, increasing the supply of IPOs by reducing the barriers to going public, working with private equity funds to have them consider IPOs versus strategic sales, for example, as another alternative to exit. And just one side note, a lot of PE funds dedicated towards Africa were raised over the last 10 years. Many of those funds are coming to the end of their life cycle, so they're going to have to exit their investment. So I expect there to be a pretty robust pipeline of IPOs that we've already started seeing coming through.
14:55 - 15:15
Thank you for that, Christine. You know, we titled this podcast On Purpose largely so we can talk about ESG investing, impact investing, and really just create a set of conversations that advance the ball for people who want to invest in ways that will earn attractive returns, but also be good for society.
15:15 - 15:35
I'm curious about the ESG risks and opportunities investing in sub-Saharan Africa. How are business leaders and government regulators ensuring that we avoid some of the problems that we've seen in other fast growing emerging economies in the past?
15:36 - 16:15
You know, there's been a really interesting evolution. And I wouldn’t even say in the last decade, I would say during the last three to five years. We've seen and I've seen a lot of regulators, business leaders, different key actors within the various economies I cover, responding pretty quickly to the increasing demand they're getting from investors, particularly foreign investors like us, but also domestic institutions, that are kind of increasingly demanding that the companies and entities they invest in pursue opportunities and mitigate risk across the ESG spectrum. So, you know, just in a way of backdrop, ESG integration is a core part of what we do.
16:15 - 16:39
So I'll give you an example. I a period of a time I was looking at the palm oil sector in Nigeria, and there were two main companies operating in that sector. I'll call them company A and company B. And they were trading at about similar valuations, had similar growth prospects, and a kind of surface level analysis would kind of argue that if you're bullish on your own palm oil, you could own either one and you should be fine.
16:39 - 17:24
But we obviously dug deeper. So beyond the traditional questions we look at in terms of demand/supply balance and operational issues. We dug into ESG on both companies, particularly on the environmental front, since, as you may know, palm oil, particularly out of Asia, has had a very, I would say, bad reputation when it comes to environmental and land management. Luckily, a lot of those issues aren't necessarily the case in West Africa, but it's obviously important that was important to dig into. When we broached this topic with company A, we said, look, we really want to understand your environmental, social and governance policies and procedures. Who's held accountable for this performance? How do you take advantage of opportunities, etc. We were just very impressed with how they addressed the topic.
17:24 - 17:58
So one is they were actually the head of Nigeria's Roundtable for Sustainable Palm Oil Initiative. And as a result of that, kind of working towards RSPO certification, that meant that not only they felt that they were being good corporate global citizens, but it also enabled them to actually sell to customers like Unilever, who are increasingly demanding that not only their palm oil suppliers, their all their suppliers adhere to increasingly rigorous standards for environmental and social performance. So they were able to kind of penetrate those accounts, whereas competitors who did not have the certification would be shut out.
17:58 - 18:56
The other thing that was quite interesting, and at the point at which we invested, they had just undertaken a fairly large investment in converting their entire basically processing facilities to be able to run on biomass. So all the waste that gets created from crushing palm oil seed, getting the palm oil, all that waste, figured out a way to convert that to biomass that was then used to power their plants. So effectively, what they were able to do is shift from a diesel fuel to biomass, which not only is much more environmentally beneficial, but also cost a lot less. So they experienced a significant operating margin expansion as a result of that switch while also helping the environment. But the other thing that it wasn't only these specific initiatives that set a process, we realized that they were really tracking internally their ESG performance. So to my surprise, they actually sent me a dashboard that they track on a monthly basis. And they have specific managers who are held accountable to that performance.
18:57 - 19:08
That's interesting because we're seeing that more and more across industries and across the globe that there is no accountability for these ESG standards as a key performance evaluator for these companies.
19:08 - 19:33
It's not just a question of this is what we'd like to do, it’s this is what we'd like to do and by the way, you're being held accountable for meeting these targets, you know, and it’s […]. So that was company A. In addition to that, I should mention for everybody, they had very strong relationships with the local communities. They often had plantations in communities where a lot of smallholder farmers and they found ways to engage the smallholder farmers so that they weren't competing against them and actually trying to engage them and incorporate them in their valuation.
19:34 - 19:58
Company B, on the other hand, when we kind of brought up the topic, first off, they questioned even the questions that we're asking, like why does this matter, so that it was a red flag, and it became clear to speaking not only with them, but some nonprofits who worked in the area, some other key stakeholders, that this company was not only not taking this seriously, but actually was exposing themselves to significant number of risks by not doing this.
19:58 - 20:46
In particular, this company had a really horrible relationship with the local communities who view them as just really extracting value from the community without giving anything back. And this company was perceived as really shutting out the smaller farmers that lived around their plantations. And the tensions got so bad, and the company did such a poor job of addressing some of those tensions that actually led to essentially a riot in the community where this community took over their plantation, which obviously had a significantly negative effect on their performance and caused their stock price to take a hit. Looking back, this is the point we invested. So we decided to invest in company A. We decided not to invest in Company B. Company A significantly outperformed company B. That delta in performance could be directly attributable to what some would deem as ESG why I would call good business practice and good stakeholder management.
20:46 - 20:48
Thank you for sharing that example.
20:48 - 21:28
I think it highlights something that we've talked about on other episodes, which is, you know, how interconnected many of these issues often are in terms of sustainability, but also the impact it's having on the community. And so your discussion about how proactive company A was not only from a sustainability standpoint, but also from a community engagement standpoint, highlights that that's reinforcing. You know, once you start to focus on these issues, you know, oftentimes you find those connections. And it's great to hear that example of a company that's, you know, much farther ahead than one of its competitors. And it's good business. And also, you know, better for the community and for society more broadly.
21:28 - 22:16
And Christine, I think that people forget that the term emerging markets was coined way back in the 80s, and it took probably 15 or 20 years for emerging markets as an asset class to become sort of an accepted part of an investor's global equity portfolio. And I know this is an impossible question for you to answer precisely. So I'm asking you to take out a crystal ball a little bit. But, you know, where do you think we're going to be 10 years from now? Right. We talk about how this whole thing started 10 years ago with the predictions about the coming decades of growth in sub-Saharan Africa. And you’ve given us a great update on where we are today. Where do you see us going, you know, 10 years from now? Will this be mainstream? What are your thoughts on that?
22:17 - 23:08
Yes, a couple of things. One is, as you know, as I mentioned before, returns become increasingly correlated across different asset classes, across different geographies. I think there's going to be an increasing need for finding uncorrelated sources of returns that ultimately can help increase your overall risk adjusted return. And I think as the sources of uncorrelated returns diminish, as markets become more developed, more liquid, as global capital flows flow more easily across more parts of the world, I almost feel like Africa becomes that natural last destination, like I said, the frontier of the frontier, that people will almost have no choice but to go to or to explore.
23:08 - 23:46
And you asked about, well, what's different for the next 10 years versus the last 10 years? I just think that that trend will continue even more. Ten years ago, Vietnam wasn't on the map or even Indonesia and the Philipines weren’t on the map. Right. Some of these small to midsize emerging markets weren’t on the map, it was all about Brazil, Russia, India and China, and that was it. Now, some of these kind of mid-market or mid-sized emerging markets are growing in prominence. And we definitely think there is a long way to go in those markets as well. Right. They're just kind of at the beginning stages of becoming more part of the mainstream. So we're not even done at all with that process for the smaller emerging markets.
23:47 - 24:18
I think the other driver that will help boost global equity allocations to sub-Saharan Africa in particular is the maturation of the local individual financial markets. So PE in Africa was barely done 20 years ago. I think the World Bank, IFC was really the only players investing in Africa back then. Since then, we've seen a number of large private equity funds, very mature, large, well-established private equity funds establishing themselves and doing business in Africa.
24:18 - 24:41
If you think about the stages of development, the next natural stage of the furthering and deepening of the financial ecosystem is having a robust public equity market and robust public markets in general that allow for larger projects to be financed. Larger companies being able to source larger pools of capital and really be integrated into global capital flows.
24:41 - 25:32
So I think the combination of those two factors, combined with strong underlying growth characteristics, very compelling themes, such as the ones that I've described earlier, and particularly the fact that Africa has an opportunity to leapfrog and innovate in multiple different areas, by the way, not only in mobile banking and fintech, but in renewable energy, in other key areas that are kind of viewed as extremely strategic on a global basis. Africa has a real opportunity to be a leader because they don't have outdated infrastructure that's blocking progress. They're kind of starting from scratch. You know, I think all of that will combine to provide additional supply of compelling opportunities that are high growth, high return, discounted valuations with investors who will be increasingly looking for those type of return flows and return streams in their allocations.
25:32 - 25:44
So what do you think it will take for investors to actually make that connection? Right, to see that there is the return potential that you described, but also feel comfortable from a risk perspective?
25:44 - 26:14
I think at the end of the day, it takes education. I speak to a lot of investors who say, look, you know, I'll be honest with you, I know nothing about sub-Saharan Africa. I can't place most of the countries on a map. The only time I hear about Africa on the news is when there's a disease or natural disaster or a coup. And that's all I know. I really don't know. I need to be educated. So I actually think the starting point beyond everything I mentioned is people like me going out and actually having conversations and saying, OK, let's do Africa 101.
26:14 - 26:45
You know, and I've actually done that with a number of investors because I think there also just needs to be that comfort level developed and the understanding of what's the reality of investing in Africa and what are the myths, what are the real risks and where are the inflated risks that caused valuation discrepancy so you can capitalize on and things like that. So I think that's actually the starting point that you need before you get to kind of all the other factors I mentioned before. You get to Africa being a larger part of global equity allocations. Thank you, Christine. Yeah, no, thanks for having me. Appreciate it.
26:46 - 27:03
This has been On Purpose. Thanks for joining us. And remember, we all have values we hold dear. Now you can ensure your investments reflect them. You can reach me on LinkedIn. If you enjoyed the podcast, please rate us on Apple Podcasts, Spotify, or your podcast service of choice. And be sure to subscribe. Thank you again.
27:05 - 27:13
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- Travis Allen
- Managing Director