Emerging Market Debt Indicator November 2023
Our EM Debt team provides an update across the investment universe and shares the latest outlook and current top-down positioning.
1 How has the African private credit market evolved?
Private credit has increasingly moved to the fore in asset owners’ broader credit market allocations as investors discover the associated portfolio benefits. To date, discussions have centered on developed markets, but this is shifting as the structural dynamics underpinning emerging market credit become clearer.
For the experienced investor, the African credit investment universe offers attractive risk-adjusted return potential. It brings portfolio diversification benefits, while allowing investors to make a positive impact on the continent’s sustainable development – supporting a transition to net zero that is fair and inclusive.
Today, the African continent comprises 54 countries and a population of 1.4 billion (17% of the global total), which is expected to rise to 2.5 billion by 2050. With a GDP of US$3 billion, Africa is on par with India and economic growth rates are robust – growing by c.4% p.a. over the last two decades.1
Despite these compelling dynamics, Africa’s credit markets see relatively little foreign direct investment. However, it is not just in Africa where sizeable potential is being overlooked: of the c.US$1.3 trillion of assets under management in global private credit, only 5% has gone into emerging markets and less than 0.3% into Africa. Yet, in 2022, emerging markets accounted for 50% of global GDP and two-thirds of global GDP growth over the preceding decade.1 This scarcity of capital provides an attractive opportunity for discerning investors.
In contrast to its credit markets, Africa’s equity markets – public and private – have attracted significant inflows. The recent wave of institutional investment in the continent started at the turn of the millennium, catalyzed in part by the commodity super cycle that began in the 1990s, given Africa’s vast endowment of natural resources. Headlines like “Lions on the Move” from McKinsey in 2010 and “Africa Rising” on the cover of The Economist in 2011 captured the prevailing sentiment. However, the realized returns for the equity investments that ensued have been below expectations.
In Ninety One’s 30+ years of investing in Africa, managing assets in almost all asset classes, we have concluded that private credit – focused on corporate debt and infrastructure investments – is a more compelling asset class for global investors. A well-designed Africa private credit strategy can avoid the structural issues – a difficult exit environment given illiquid stock markets and a limited pool of buyers for successful investments, coupled with local currency depreciation relative to the US dollar – that affect equity-focused investments in Africa.
2 What are the opportunities across the continent and how have you sourced them?
Ninety One’s Emerging Market Alternative Credit team manages credit opportunities and infrastructure credit portfolios that invest primarily in Africa and secondarily in other emerging markets.
African/EM private credit markets are uncrowded and inefficient, providing significant opportunities. Africa is a structural growth story: GDP of US$3 trillion and a growth rate of 3% to 5% p.a. across 54 countries, as noted above. This region offers the potential for a diversified credit market with good supply vs. demand dynamics, low leverage, and a low correlation to US/Europe.
In Africa, most of our focus has been on countries with large and growing economies; strong, deep, and diverse private sectors; robust institutional and governance structures; friendly business and regulatory environments; and low or no capital controls. Historically, most of our investments in Africa have been into Angola, Botswana, Ghana, Ivory Coast, Kenya, Mozambique, Namibia, Nigeria, Senegal, Tanzania, and Uganda, but we are country agnostic and rather look for the opportunities that offer the most attractive risk-adjusted return potential wherever they may be in our investment universe.
From a sector perspective, we see attractive opportunities in three main categories:
- Infrastructure and telecoms, where capital facilitates improved access to clean, reliable, and affordable power, water, transport, digital infrastructure, and social infrastructure while aiding a fair energy transition. Roughly half of our investments go into the broad infrastructure sector, complemented by our dedicated impact-focused infrastructure credit strategy.
- Banks and financial institutions, where investments help to promote financial inclusion and deepen financial markets.
- Consumer and services to improve or offer new access to consumers while driving job creation and supporting the sustainable growth of businesses.
We promote positive impact outcomes by making investments that reduce GHG emissions, provide jobs, reduce gender inequality, and contribute to the tax base of the communities in which they operate.
Our on-the-ground Emerging Markets Alternative Credit team has more than 20 investment professionals with an average of 10+ years of relevant experience. Our track record and size allow us to have a deep understanding of our target geographies, establish and maintain relationships with sponsors and potential borrowers, and identify attractive investment opportunities.
We typically evaluate over US$1 billion in addressable investments annually. Of this, about one-third is originated directly by the team, another third in co-investment with local banks, and the remainder from a variety of sources (brokers, advisors, etc.). For further information on the investment team, and investment process, please see the important information section.
3 What are the perceived vs. actual risks of investing in Africa?
The perceived risks of investing in Africa are captured by the sovereign ratings of the countries in the region. Of the 32 sovereigns rated by global rating agencies, most are high-yield and only two are investmentgrade. This aligns with common perceptions of the region carrying higher credit risk.
However, beyond the macro/top-down view, there is a plethora of attractive risk-adjusted investment opportunities for a knowledgeable, experienced, and discerning investor who can combine the top-down with a bottom-up view. This is illustrated by Ninety One’s Africa Credit Opportunities strategy which – through investing primarily in the senior debt of market-leading blue-chip companies – has a realized 9-year loss-ratio that corresponds to an investment-grade rating, while delivering net returns that correspond to a high-yield rating.2
We typically track or engage with the companies we invest in over multiple years to gain a reasonable degree of comfort that they have the characteristics we seek, namely a leadership position in their market, a defendable business model, a track record of strong cash flow generation, low leverage, supportive and credible sponsors, high-quality asset backing, and an experienced management team. We then structure our investments to have robust protections: seniority in the distribution of cash flows, the pledge of valuable assets as collateral, strong covenants that act as an early warning in case of underperformance, and restrictions on the leakage of cash or earnings, to name a few.
Deep on-the-ground expertise is vital for success. This, combined with a US dollar-denominated portfolio that mitigates currency risk, offers investors compelling returns potential.
4 How does Africa private credit compare to developed market private credit from a risk-return profile?
There are several considerations when comparing the Africa private credit opportunity set with developed market private credit, including:
Higher returns potential
Based on our experience managing the Africa Credit Opportunities strategy and its performance over the last nine years, we believe that an African private credit strategy can deliver higher returns than a US/European equivalent portfolio.
Lower leverage
Leverage levels among companies in the African private credit investment universe are much lower than in the US and European private credit universe. We see leverage of 3x or lower in most transactions, compared with 5x or more in the US and Europe.
Robust structures
Relative to developed markets, the balance of power in the borrower-lender relationship in Africa favors lenders, allowing for the structuring of investments with strong covenants, good security, and robust protections. There are generally no covenant-lite structures, which are common in the US and Europe, in Africa.
Lower competition
Owing to the scarcity of capital in the region, few institutional investors are actively pursuing opportunities. In addition, local banks are typically not willing or able to fully fund corporate and infrastructure financing opportunities, preferring instead to invest in government debt. Furthermore, there are few senior private credit managers, due in part to the platform and resources required to properly manage such strategies. Lastly, regulatory limits and a local currency deposit base limits the ability of local banks to fund hard currency (US dollar and euro) investments resulting in them typically collaborating with us rather than competing to fully fund opportunities. As a result, Ninety One has access to a large and robust pipeline where we leverage local expertise, patience and prudent discretion in the investment decision-making process to find the ‘hidden gems’ in our investment universe.
Legal/governance
US dollar-denominated credit investments in Africa are typically documented using the Loan Market Association (LMA) framework, governed under the laws of England and Wales. That makes them lender and contract friendly given the transparent nature of English law. Security/collateral is typically structured such that it is enforceable outside of the local courts.
5 How should allocators who are interested in social and environmental impact think about Africa private credit?
Regardless of the importance asset allocators place on impact outcomes, the reality is that environmental, social, and governance (ESG) considerations are vital to investment success in Africa and emerging markets, in general. In our experience, borrowers who score well across these factors represent better investment opportunities as they have lower exposure to risks and, therefore, are more likely to generate compelling investment outcomes.
At Ninety One, analysis of ESG factors is inherent (integrated or standard) in the investment process of our Africa-focused private credit strategy. Launched in 2014, the strategy was originally funded by European Development Finance Institutions who made the implementation of an ESG management system in the investment process a requirement of their investment. We have since refined our ESG management processes to incorporate learnings and to align with the evolution of industry best practices. Examples of our refinements include integrating a proprietary ESG and development impact scorecard into our investment process, tracking the greenhouse gas emissions of our portfolio and engaging with our portfolio companies to reduce this, and monitoring a list of key performance indicators (KPIs) to track the developmental impact of our investments.
In addition to the risk-mitigation benefits of considering ESG in investments, private credit also drives development in a region with significant infrastructure deficits. The continent’s annual infrastructure investment need is c.US$170 billion and of that c.US$100 billion is unmet – we see this as an opportunity to fund the development of vital infrastructure in a sustainable manner, using the latest materials, technologies, and processes while leap-frogging existing norms. This was well documented in the telecommunication space, where wireless has quickly surpassed wired technology in a surprisingly short space of time to make a significant tangible improvement to communities and businesses.
Closing thoughts
It is clear that private credit investors are looking for diversification that can complement existing developed market exposure, albeit with a discerning eye. In Africa, where access to finance can be challenging, opportunities are plentiful and offer competitive risk-adjusted returns while also contributing to economic development and sustainable growth. Africa is a large and growing market, with a deficit in global private capital, creating opportunities for institutional investors willing to make the journey.
1 Ninety One, Worldometer, International Monetary Fund, World Economic Forum.
2 Past performance does not predict future returns; losses may be made.
Source: Moody’s Annual Credit Loss Rates by Rating, 1983-2022.
General risks. The value of investments, and any income generated from them, can fall as well as rise. Where charges are taken from capital, this may constrain future growth. Past performance is not a reliable indicator of future results. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Investment objectives and performance targets are subject to change and may not necessarily be achieved, losses may be made. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Default: There is a risk that the issuers of fixed income investments (e.g. bonds) may not be able to meet interest payments nor repay the money they have borrowed. The worse the credit quality of the issuer, the greater the risk of default and therefore investment loss. Derivatives: The use of derivatives may increase overall risk by magnifying the effect of both gains and losses leading to large changes in value and potentially large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems. Interest rate: The value of fixed income investments (e.g. bonds) tends to decrease when interest rates rise. Liquidity: There may be insufficient buyers or sellers of particular investments giving rise to delays in trading and being able to make settlements, and/or large fluctuations in value. This may lead to larger financial losses than might be anticipated. Sustainable Strategies: Sustainable, impact or other sustainability-focused portfolios consider specific factors related to their strategies in assessing and selecting investments. As a result, they will exclude certain industries and companies that do not meet their criteria. This may result in their portfolios being substantially different from broader benchmarks or investment universes, which could in turn result in relative investment performance deviating significantly from the performance of the broader market.
