Monthly Highlights: December 2009

•  Base case scenario does not call for aggressive tightening of global monetary policy
•  Sub-Saharan Africa underperformed global, emerging and frontier market indices in 2009
•  African equity market valuations remain attractive on both an absolute and relative basis
 

Base case scenario does not call for aggressive tightening of global monetary policy

Mixed economic data contributed to greater uncertainty regarding forward-looking economic prospects. Although housing and employment-related data remain weak, manufacturing indicators suggest expansion in industrial output and global restocking of depleted inventories. While this dynamic is presently fuelling the broad-based rise in global commodity prices, we believe that it is cyclical and not secular in nature. As such, we do not envisage aggressive tightening of monetary policy as policymakers are unlikely to risk derailing an economic recovery via the removal of central bank stimulus. Should dovish sentiment persist, global risk appetite is likely to increase through the first half of 2010 amid greater demand for high beta assets (i.e. commodities, credit and emerging market equities). Over the medium-term however, we must prepare for increasingly hawkish rate expectations as improving economic fundamentals lead to higher yields. Should yield curves remain at historically steep levels, investors will continue to benefit from positive carry although banks are unlikely to redeploy capital in the form of new loan commitments. Yet if yield curves flatten in the months ahead, bank lending to corporations and individuals may well be re-energized as tighter spreads result in declining carry via the compression of net interest margins. While this is not our base case scenario, we do believe that a combination of market and policy-induced factors will encourage greater lending to businesses with strong balance sheets and promising growth potential in the months ahead. In effect, this forms the basis for our bullish case on Africa. We enter 2010 with a slightly more defensive posture, and continue to place greater emphasis on balance sheet strength at the expensive of forward-looking growth.

Sub-Saharan Africa underperformed global, emerging and frontier market indices in 2009

On the whole, African equities underperformed the global, emerging and frontier market universes in 2009. To put things in their proper perspective, the MSCI World Index (USD), MSCI Emerging Market Index (USD) and MSCI Frontier Market Index (USD) rose +29.99%, +78.51% and +11.61% respectively. In comparison, the MSCI EFM Africa ex-SA Index (USD) climbed by a relatively modest +3.09% on the year. Thus, after having sharply outperformed the MSCI World, MSCI Emerging Market, MSCI Frontier Market and MSCI EFM Africa ex-SA Indices by 817bp, 2079bp, 2161bp and 1601bp in 2008, fund performance was more muted in 2009. When compared to the rest of the world, the relative underperformance of Sub-Saharan Africa may be attributed to sharp expansion of liquidity premiums and massive compression of portfolio time horizons. Given that Sub- Saharan Africa is marked by tighter than normal liquidity conditions and longer than average return on investment (ROI) windows, this outcome should come as no surprise. Throughout the year, Sub-Saharan Africa was forced to contend with a litany of asymmetric country-specific factors, including: the banking crisis in Nigeria, weather-related drought in Kenya, currency shortage in Malawi and hyperinflation in Zimbabwe, to name but a few. Fortunately, our strict operational and risk management framework enabled us to successfully contend with and subsequently profit from these events. As a result, the Fund managed to successfully outperform its peer group and post positive returns for the year.

African equity market valuations remain attractive on both an absolute and relative basis

Looking ahead, we believe the African capital markets are poised to benefit considerably despite the challenging macroeconomic environment. Investor interest continues to grow in both size and diversity as practitioners seek to diversify their holdings away from USD-denominated assets. Liquidity conditions continue to improve and currency volatility has only just begun to normalise. Although December was characterised by local selling amid generally thin trading volumes, African equity market valuations remain fundamentally cheap on both an absolute and relative basis when compared to the rest of the world.