On the horn of an African dilemma

Kenya was among the best performing stock exchanges in Africa last year, with the Nairobi Stock Exchange (NSE) 20 Share Index returning a stellar 32.86%. But so far in 2011, the market is down 21.75% as of late August, leaving it amongst the laggards.

Source: Bloomberg

With the third-largest stock market in sub-Saharan Africa (55 listed companies with a market cap of US$15 billion), Kenya is firmly on the radar of a growing number of African fund managers. But it’s certainly not a one-way bet.

“The Kenyan market is due for a haircut,” said Andrew Schultz, head of African research at Cape Town-based Avior Research, speaking to HedgeNews Africa last month. “It’s been coming off a high so it may drop off further. That said, we see the market as being not so much about sectors as about companies that have good exposure. There are some very good companies.”

This year has brought a number of macro-economic challenges for Kenya, ranging from high inflation and currency fluctuations to a severe drought. Additionally, a troubled global picture has had a knock-on effect on many African countries.

“The slowdown in Kenya’s stock and bond markets has been caused by rising inflation and interest rates as we have seen elsewhere in the world from Europe to China,” says Andre DeSimone of Nairobi-based Kestrel Capital. “The uprisings in North Africa and the Middle East, along with the Greek debt dilemma, seem to have affected foreign investor interest in Kenya.”

Kenya’s economy has grown consistently in real terms since 2002, managing annual growth rates in excess of 6%. Post-election rioting and the financial crash of 2008/09 impeded the expansion, shrinking growth to 2.6%, yet the economy recovered strongly in 2010 with a GDP growth rate of 5% year on year combined with a strong stock market.

Home groans

Despite the growth trend, Kenya has several home-grown problems that are coming to the fore. The Horn of Africa, including northern Kenya, Somalia and Ethiopia, is suffering its worst drought since the early 1950s, after two consecutive poor rainy seasons, promoting concerns about food security.

Kenya’s inflation came in at 15.53% for July 2011 according to the Central Bank of Kenya. Food and non-alcoholic beverages have been among the worst hit, with prices rising by as much as 22.5%.

Inflationary pressures have contributed to the Kenyan shilling losing approximately 15.05% against the US dollar year to date, detracting from the market’s appeal to offshore investors.

Analysts put this year’s market retraction down to a number of factors, the foremost being political turbulence in Egypt and Tunisia, along with Europe’s economic woes. This has caused emerging and frontier funds’ investments to slow as investors’ appetite for risk has declined.

“The situation in Egypt has been a major contributor,” says Simon Reid of Johannesburg-based Imara Securities. “Investment from emerging market funds has slowed. Many were scared off after having their money locked up in Egypt when the market was closed for an extended period.”

However, Reid believes that the market is not in negative mode. “Imported inflation due to higher commodity prices and a weakening currency is slowing momentum, but it’s a cyclical problem,” he said.

For all the bad news, Kenya remains an appealing option to investors.

The market has attracted significant foreign-investor interest, with roughly 50% of daily turnover coming from foreign funds, according to market sources. 

“For the last number of years foreign investors have dominated the market,” says Paul Sigsworth of ICEA Asset Management, who advises on the Imara East Africa funds and manages around US$500 million in institutional and retail money. “So when the foreigners move in and out it has at times added to the underlying volatility. Although the currency is weak, the valuations are very undemanding which is very attractive to foreigners. In the background, companies are doing reasonably well and banks in recent years have been better regulated and managed.”

Imara’s Reid adds that all the big South African funds are in Kenya, mostly investing on a pan-Africa basis. “There are also many players coming in from Asia and the US who access the market via Kenyan managers because they don’t yet have the expertise,” he says. “They need a weighting in frontier markets and that is the first round.”

Kestrel’s DeSimone notes that South African fund managers are currently the fastest-growing group of investors in Kenya by number, if not by value.  Furthermore, the Kenyan market has seen more broking activity coming from South Africa versus the traditional brokerage bases of New York and London.

Prior to the 2008 financial crash, retail and high-net-worth investors accounted for between 50% and 70% of NSE trading volume, according to DeSimone. As the NSE 20 Share Index fell 56.59% over the 10-month period starting in June 2008, retail investors fled the market, leaving the dominant share of volume to local and foreign institutional investors.

Reid notes that past concerns about being able to exit have now been overshadowed by restricted entry resulting from illiquidity, with daily turnover on the NSE of just $4 million to $5 million. This has led to the expansion of private equity in the region as investors are keen to gain a share of the high growth rates. 

On the bond wagon

One way that investors have accessed the Kenyan growth opportunity is through the debt markets.
“The excitement is probably in the bond market,” says Sigsworth. “Interest rates have spiked.”

Demand for government bond issues rose substantially in 2010 with average daily bond trading in Kenya amounting to $60 million. Demand for the new 25-year government bond was oversubscribed by 260% in June 2010, showing investor appetite for fixed income instruments.

In March, the government launched a new 30-year Savings Development Bond that is available to retail investors with a coupon rate of 12% per annum, according to the Central Bank of Kenya.
The NSE plans to introduce a treasury bond index this year that should provide a benchmark for fixed-income securities and portfolios.

Developing capital markets

With the aim of increasing investor confidence in the Kenyan markets, the NSE is implementing a host of changes to aid market growth.

The exchange has reduced the settlement date from T+4 to T+3, in line with international best practices as recommended by the International Organization of Securities Commission (IOSC).

The NSE is also currently inviting tenders for the operation of a futures exchange, which initially will focus on energy and minerals. Kestrel’s DeSimone, who is also a director of the NSE, expects the new market to be up and running within the next two years.

“Realistically it will probably be another year or two before it becomes operational,” he says. “With currency futures expected to be traded we would expect foreign investors and hedge funds to utilise this market to hedge positions, primarily in bonds but also possibly equities.”

Reid believes that the futures market, along with the introduction of innovative products, should enhance liquidity and further help to reduce brokerage fees, which currently sit at 1.5% for transactions greater than Sh1,000,000 (US$10,678).

At present, exchange rules do not permit margin lending for purchasing securities, or securities lending to allow for shorting. However, DeSimone says the rules are currently being revised by the Capital Markets Authority, and changes are expected this year that would open the market to more hedge-fund activity.

DeSimone also confirmed that the exchange is in talks with London’s FTSE, with the aim of introducing a series of indices in the third quarter of 2011. The adoption of new instruments such as exchange-traded funds (ETFs) as well as FTSE best practices should enhance investor activity and market liquidity.

In addition, the Capital Markets Authority of Kenya has said that the NSE is expected to launch a new small- and medium-sized index in the fourth quarter of 2011 to aid the capitalisation of small and medium-sized firms.

By sector, Kestrel’s DeSimone expects continued growth in telecommunications, information technology, financial services, infrastructure (from power stations to rail roads), mining and other extractive industries as well as an increase in general trade with neighbours in the region.

For investors seeking exposure to the risky but potentially lucrative frontier markets of Africa, Kenya needs to be considered. An undervalued currency, high yields on bonds and discounted equity offer much upside potential as the economy continues to grow. Copyright. HedgeNews Africa – September 2011

Stock Picks:


Dominant mobile phone company focusing on data growth but facing strong competition from Airtel and Orange.  Has very successful mPesa mobile banking service.

East Africa Breweries

Near monopoly brewer in Kenya, expanding in East Africa region, including recent acquisition in Tanzania. 

Equity Bank

Recording strong earnings growth and expanding in East Africa region. Largest bank by number of customers. 

Barclays Bank

Viewed as the local “blue chip” bank but facing growing competition. 

KCB Bank

Successful turnaround story, recently raised new equity capital for expansion, including in South Sudan. 

Kenya Power & Lighting

Near monopoly distributor of power, recently raised new equity for expansion.

Cooperative Bank

Successful restructuring story and recent listing on the NSE. Large and growing customer base

KenolKobil Petroleum

Largest, most efficient oil marketing company in East Africa, bought 50% of Shell Ethiopia. 

Kenya Airways

Dominant carrier in greater East Africa including to/from West Africa, raising new equity later this year to finance fleet expansion. 

Source: Kestrel Capital