QUARTERLY CIO LETTER. How deep is the rabbit hole? Summary. 15 October 2018

Transcription

1 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 How deep is the rabbit hole? Summary With the exception of Europe, global economic growth increased over the quarter; however, macro risks remain high. Trade tensions have escalated and that has put the spotlight on pre-existing weaknesses in some emerging markets (EM). This year s EM sell-offs stem from a cocktail of negatives ranging from country specific factors to tighter financial conditions. The biggest casualties are currencies of economies with the largest current accounts deficits and high external debt burdens. Ghana has not been spared from the EM sell-off culminating in sharp currency depreciation against the dollar and continuous drop in business and consumer confidence. However, the drop in investor confidence is more linked to the upheavals in the banking space than increased global macro risks. The financial sector crisis deepened with five more bank failures while the Securities and Exchange Commission (SEC) moved to clamp down irregular activities of investment houses. All these actions kept investors apprehensive and heightened risk averse behaviour. The current financial landscape has proven challenging for money managers over the last quarter as investor perception of risk peaked at a level not seen in recent times. This informed our decision to reduce duration of government bonds, move up-in-quality across our equity and credit portfolios and improve the liquidity position of our portfolios. We believe this is a sensible approach to managing risk in the current environment where risk is heightened. The Investment team Isaac Adomako Boamah, CFA Chief Investment Officer Derrick Asare Mensah Portfolio Manager, Equities Obed Odenteh Portfolio Manager, Fixed Income While the two largest economies in the world battle it out on trade, Europe is still mulling the impact of BREXIT and emerging markets are suffering under the weight of capital outflows stemming from hawkish monetary policies. For frontier markets like Africa, this means weaker currencies owing largely to capital flight, rising yields on sovereign bonds and a fragile economic recovery that seems to be supported only by favourable commodity s. USD vs LCY of selected SSA markets against USD Eurobond yields of selected SSA markets 5.0% 0.0% 5.0% 0.0% 9.00% 8.00% 7.00% Ghana Kenya Nigeria -5.0% -5.0% 6.00% -10.0% -10.0% 5.00% -15.0% -20.0% -15.0% -20.0% 4.00% 3.00% South Africa Kenya Ghana Source: Bloomberg 1

2 GHSbn GHS Back home in Ghana, a rebasing of gross domestic product (GDP) saw the economy expand by 24.6% y/y to GHS 256bn while the country s credit rating also saw an upward review by Standard & Poor from B- to B with a stable outlook. Despite the improving macroeconomic data and positive outlook, investor confidence is low mainly on account of the challenges in the banking sector. The financial sector crisis deepened with five more bank failures while the SEC moved to clamp down on irregular activities of investment houses. All these actions kept investors apprehensive and heightened risk averse behaviour. Interestingly, banking sector deposits within the period increased contrary to the general consensus of panic withdrawals. For us, this suggests that perhaps deposits moved from the non-bank financial institution (NBFI) space and into the banking sector as the flight to quality intensified. Evolution of banking sector deposits Domestic debt purchased/sold by foreign investors Purchase Avg.USD/GHS Source: Central Securities Depository Sold Linear (Purchase) 4.9 Consequently, the yields on government bonds peaked at the 21% levels before easing back to the 20% level CASA FCY Demand Ghana s yield curve evolution 22.25% % 20.25% 19.25% % % 16.25% 15.25% 1-Yr 2-Yr 3-Yr 5-Yr 7-Yr 10-Yr 15-Yr Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Q4'17 Q1'18 Q2'18 Q3'18 Source: Bank of Ghana, IC Asset Managers Ghana The financial sector crisis forced the credit market to function abnormally as investors gravitated more towards risk free assets. However, local investor appetite for government bonds was not enough to withstand the supply of bonds from offshore investors who wanted to exit the Ghanaian market on the back of the ongoing emerging markets sell-off. Source: Central Securities Depository Despite talks of issuance of sovereign bonds to manage the crisis, investors remain apprehensive given the possibility of additional bank failures before year-end. This has been exacerbated by the Bank of Ghana indicating that asset quality weakness and insolvency are more prevalent in the NBFI space. 2

3 Feb-00 Apr-01 Jun-02 Aug-03 Oct-04 Dec-05 Feb-07 Apr-08 Jun-09 Aug-10 Oct-11 Dec-12 Feb-14 Apr-15 Jun-16 Aug-17 USD Billion Furthermore, the SEC s actions to regularise the activities of investment managers has also fueled tensions. Based on data from the SEC, we estimate an amount of GHS 23.7bn as at 1Q2018 to be within the irregular business activities space. Industry 1Q2018 AuM Fiscal data Source: Securities and Exchange Commission With the market pondering how deep the rabbit hole goes, or the regulatory interventions necessary to fix the core problems, sentiments remain extremely risk-averse. Market sentiment Other Funds 69% GHS 34.4bn Pensions 23% CIS 8% Q2017 4Q2017 1Q2018 2Q2018 Total Revenue International Reserves Source: Ministry of Finance, Bank of Ghana Total Expenditure Trade Balance Potential shortfall in revenue as we suggested in our 2018 Investment Outlook: How Far can the bull run? Could lead to a higher deficit and weaken the currency even further. While we anticipate some appreciation in the value of the Cedi on the back of inflows from the syndicated cocoa loan, we expect the impact of a higher than expected deficit to keep the Cedi soft. Cedi s performance against major currencies Consumer Confidence Index Business Confidence Index Linear (Consumer Confidence Index) Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug Source: Bank of Ghana Although we observe improvement in the macroeconomic data, the risk to the outlook is elevated in light of the weakness in business and consumer confidence. We struggle to see how credit can grow in the current environment despite the dovish monetary policies and interventions such as the Ghana Reference Rate. In essence, government s focus to stimulate growth by lowering taxes could be short-lived as the volume of business required to sustain revenue at lower tax rates may not likely be achieved. USD/GHS EUR/GHS GBP/GHS Amid the uncertainty and the elevated risk to the immediate term, our response over the quarter was unchanged as we largely envisaged the lower revenue, weaker currency, rising yields and risk-averse sentiments. In effect, we continued to reduce duration of government bonds, slow down on credit exposure and increased liquidity across our portfolios. 3

4 Effective and efficient management of risk has become more prominent, following the level of uncertainty in the financial market. The emerging markets sell-offs which largely characterised the third quarter exposed the bond portfolio to interest rate risk as bond s declined. To curtail and effectively manage the risk, we reduced the duration of the bond portfolio from 3.42 years to 3.05 years. We managed our liquidity through the 30-day reverse repos and fixed term placements with 30 days or lower tenors. This strategy gave us the room to take advantage of under-d assets and mitigate the negative impact of declining s on our bond portfolio. Specifically, on our credit portfolio, we maintained our exposure to highly liquid and well capitalised issuers. We limited our placements to only banks which have met the minimum capital requirement and have passed our stress tests. We refrained from investing in corporate bonds due to the issuer profile. Issuers of corporate bonds within the period were mainly NBFIs, which given our risk outlook within the sector we preferred to remain unexposed. The fourth quarter has started on a good foot, with yields declining. However, we will still stick to reducing our portfolio duration. We will switch back to our profit taking strategy by selling most of our long dated bonds as government could be forced to issue more bonds to save depositor s funds and thus weaken Ghana s fiscal position. Top five gainers for the quarter Equity Closing Opening Return YTD return TOTAL % 55.8% MTNGH % 17.3% RBGH % 4.3% PZC % 140.0% GCB % 5.9% Top five laggards for the quarter Equity Closing Opening Return YTD return SIC % 50.0% PBC % -50.0% CMLT % -9.1% GOIL % 4.5% AYRTN % -20.0% Although we maintain a significant position in banks, our equities portfolio benefitted from the sharp rally in the share of MTN Ghana (MTNGH), helping recover some of the losses incurred from the market selloff in 2Q2018. We also managed to dispose of some positions we inherited that contributed significantly to the drag we experienced in the previous quarter. We will be guided by our risk assessment framework on issuer selection, keep fixed deposit tenors short and continuously engage issuers to offer us callable option on our credit portfolio. Treasury Maturity Profile Portfolio allocation by equity Banks 44% Insurance 4% Energy 2Q2018 Other 1% Consumer Telcos 51% Source: IC Asset Managers Research Source: IC Asset Managers Research Despite our active management we trailed the key benchmark (GSE-CI) by 7.6 percentage points. Given our current portfolio and our active management strategy, we are confident that this occurrence is only temporary. 4

5 We believe that the relative pricing of real and perceived risk in relation to the local economy remains dislocated and have positioned our portfolio to take advantage of this inefficiency. In our opinion, the aversion to banks will subside once the deadline for recapitalisation elapses and the central bank provides clarity on the way forward for the sector. We expect this to happen within 1Q2019. Following this, we envisage increased demand for banks on the GSE especially for those that are 1) undervalued, 2) suffered no distortions to key performance ratios owing to additional shares from a capital raise and 3) maintain a strong earnings outlook. Considering that our portfolio consists of only such banks, we are confident our current negative alpha is only ephemeral. In the nutshell, the current financial landscape has proven challenging for money managers over the last quarter as investor perception of risk peaked at a level not seen in recent times. This informed our decision to reduce duration of government bonds, move up-in-quality across our equity and credit portfolios and finally improve the liquidity position of our portfolios. We believe this is a sensible approach to managing risk in the current environment where risk is heightened and the risk of the unknown is high. Isaac Adomako, CFA Chief Investment Officer 5