HOW FAR CAN THE BULL RUN? 2018 INVESTMENT OUTLOOK

HOW FAR CAN THE BULL RUN? 2018 INVESTMENT OUTLOOK

CIO LETTER Safeguarding compelling returns By Isaac Boamah, CFA Isaac is the Chief Investment Officer. He is a CFA Charter holder with over 10 years working experience in the Ghanaian investment management industry. Isaac joined IC Asset Managers in 2017. The psychology of a market cycle depicts the various emotions investors exhibit as the market fluctuates. As an investment professional, I have come to understand that the key to delivering value regardless of the stage of the market cycle is knowing when and how to shield returns. We believe 2017 and more importantly, 4Q17 exemplified this philosophy. Given the flattening of the yield curve, going long was no longer an alpha generator By the end of 3Q17, our portfolio had recorded an aggregate return of 24% which translates into GHS 184.8m. Most of these returns had been achieved through our earlier decision to go long. However, in 4Q17, given the flattening of the yield curve, this approach was no longer an alpha generator. Consequently, we deployed an active management strategy by rolling down the yield curve. We sold government securities close to maturity at a premium to crystallise the gains, while distributing proceeds across assets which were trading at a discount. In all this, we still kept our focus on the long-term. As part of efforts to safeguard the returns, we sold into strength across our equity pot. In simple terms, we took profit on counters which had realised gains in excess of 40%. This was because, several of our equities were fully valued and were approaching our target price. Furthermore, our research indicated that in spite of the transactional costs, active management returns higher yields on the GSE. In backing our claim that equities is the next alpha generator (read our 3Q17 CIO Letter - Next stop: Equities), we increased our exposure significantly to our top pick, Ecobank Ghana (EGH). We currently hold 0.4% of the bank and as we get ready to go to print, EGH has gained 20.9% since we increased our exposure in September. On the macro front, economic performance was largely in line with our expectations as the Cedi was relatively stable, inflation declined and the yield curve elongated. For us, most of the uncertainty was surrounding the risk to the outlook. This came to a head in late September when the International Tribunal of the Law of the Sea (ITLOS) finally ruled in favour of Ghana on the matter regarding the maritime boundary between Ghana and the Ivory Coast. A loss would have resulted in a material shift in our economic outlook considering that a greater part of Ghana s oil wells were in this disputed region. While we remain optimistic about 2018, it is difficult to see where the opportunities lie. A new year offers new beginnings but while we remain optimistic about 2018, it is difficult to see where the opportunities lie. With yields coming off, equity markets fully valued and everyone playing the long game, fund managers are likely to struggle in generating alpha. Fortunately, we have a plan.

We expect government revenue to remain constrained following the 2017 tax cuts. Policy initiatives in the agriculture and education sectors coupled with debt servicing should weigh heavily on the deficit, which is likely to widen more than government s 4.5% target. This should have negative implications on the currency and inflation. In effect, we anticipate a softening of the Cedi between 5.5% and 9% against the U.S. Dollar compared with the 4.9% recorded in 2017. We will remain neutral on treasury, overweight credit assets and be neutral to overweight on currencyhedged assets and equities On the equity front, we believe the market is poised for yet another rally but unfortunately, stocks are fully valued. We intend to consolidate our positions in the few undervalued names and continue to take-profit should corporate earnings not support valuations. We also intend to launch our equity fund which will potentially serve as our pan-african equity offering. To summarise, we will continue to safeguard returns by rolling down the yield curve to take profit as well as being extremely selective in our stock pickings. We will remain neutral on treasury, overweight credit assets and remain neutral to overweight on currency-hedged assets and equities.

EQUITY PORTFOLIO Goldmine or minefield By Derrick Mensah Derrick Mensah is the portfolio manager responsible for the equities and credit pot. He was previously an equity analyst with nearly a decade of work experience in both Ghana & Nigeria s financial markets. Derrick joined IC Asset Managers in 2017. It s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price - Warren Buffett. While we anticipated a bull market in 2017, the performance of equities on the Ghana Stock Exchange (GSE) far exceeded our expectations. Even more surprising were the equities which drove the rally. It appears investors had little regard for fundamentals, turning speculative bets into self-fulfilling prophecies. At the start, the markets were largely sane as corporate actions and earnings guided investment decisions. However, by half year (2H17) value investing gave way to speculation as fixed income yields tanked with more intensity than envisaged and more cash found its way onto the GSE. In effect, the GSE Composite Index (GSE-CI) closed the year at an aggregate return of 52.7%. Quarterly performance of interest rates and equities 52.73% 37.71% 23.5% 21.3% 22.5% 21.0% 20.0% 17.4% 18.5% 17.0% 17.0% 19.2% 15.55% 15.0% 15.0% 15.0% 11.26% 11.9% 13.2% 13.4% 17.2% 12.9% 14.1% 13.9% 1Q17 2H17 9M17 FY17 Portfolio Analyst Susana Abraham GSE returns MPR 91-day T.Bill 182-day T.Bill 1-year Note 2-year Note Source: Bank of Ghana & GSE While our equity portfolio at an aggregate return of 45.9% underperformed the key benchmark, a closer analysis indicates that, we remain quite concentrated in undervalued equities. These equities are currently leading the rally on the GSE since 2018 commenced. In effect, we anticipate that by FY18 we will outperform the GSE-CI.

BOPP GOIL SCB HFC TOTAL ETI FML EGL ADB UNIL CAL GCB TBL SOGEGH GGBL SWL EGH ALW ACI AGA CLYD CPC GWEB PKL PBC SPL TRANSOL MAC ACCESS GSR CMLT PZC AYRTN SIC TLW MLC FY17 equities performance 190.0% 140.0% 90.0% 40.0% -10.0% -60.0% Source: GSE Note: Stocks held in ICAM portfolio indicated in dark blue We remain optimistic of the current bull market but valuations remain a concern. We remain optimistic of the current bull market although valuation remains one of our principal concerns. Average sectoral valuation multiples Sector Period PB ratio PE ratio Banking FY16 1.5x 5.9x FY17 1.9x 9.6x Insurance Consumer Energy Source: ICAMGH Research FY16 0.7x 3.9x FY17 0.8x 5.8x FY16 7.7x 23.4x FY17 5.7x 45.8x FY16 1.4x 6.5x FY17 2.7x 16.0x Generally, valuation multiples have increased sharply within the review period, supporting our thesis that Ghanaian equities are fully priced. However, with yields on alternative investments still pointing south, price behaviour is still risk seeking. We are also of the view that, economic growth in 2018 will push investors from defensive and interest rate sensitive sectors. We could potentially be seeing an uplift in cyclical sectors such as commodities and the consumer sectors. While we intend to closely monitor developments within these sectors, we will largely maintain our 2017 investment approach for our equity pot in 2018. Selectivity and safeguarding returns will remain at the core of our investment decisions. In conclusion, we believe the script for Ghana s equity market in 2018 will be largely unchanged from that of 2017. We will be careful not to be caught up in the euphoria that is likely to characterise activities on the bourse and maintain our intelligent investing philosophy.

TREASURY PORTFOLIO Playing the yields game By Obed Odenteh Obed Odenteh is the portfolio manager responsible for treasury securities. He was previously a fixed income dealer at IC Securities. Obed joined IC Asset Managers in 2017 Although our inflation expectation for FY17 implied a flattening of the yield curve, rates tightened with more intensity than envisaged. We are of the view that, improvements in the country s macroeconomic indicators and subsequently its credit ratings attracted several foreign investors following the global search for yields which characterised the year. This most likely heightened demand for long term bonds and consequently led to the decline in rates at the long end of the yield curve. The yield curve 30.0% 2014 2015 2016 2017 25.0% 20.0% 15.0% 10.0% 91 Day 182 Day 1 Year 2 Year 3 Year 5 Year 7 Year 10 Year Source: Bank of Ghana & ICAMGH Research At the short end, Government s re-profiling of its debts contributed to the decline in Treasury bill rates, as government reduced supply of short term debt instruments. Evolution of yields Portfolio Analyst Susana Abraham 28.0% 26.0% 24.0% 22.0% 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% FY14 FY16 FY14 FY16 FY14 FY16 FY14 FY16 FY14 FY16 FY14 FY16 FY14 FY16 FY14 FY16 91 Day 182 Day 1-year 2-year 3-year 5-year 7-year 10-year Source: Bank of Ghana & ICAMGH Research

GHS Million Given our first mover advantage in going long, our portfolio was well protected against the intensity with which yields tightened. On an aggregate basis, we returned an average yield of 26% for our treasury portfolio compared with 16.5% yields offered over the same period. A greater part of these gains were attained by virtue of going long earlier than most of our competitors. However, at the latter part of the year, we rolled down the yield curve to take profit. Consequently, our treasury portfolio outperformed its benchmarks. Treasury portfolio returns Vs. Key benchmarks 30.00% 25.00% 20.00% 15.00% 10.00% 91-Day 1-Year 2-Year Average Portfolio YTM Source: Bank of Ghana, Company filings We anticipate a rebasing of GDP to provide fiscal space for government borrowing. In 2018, we believe government s re-profiling programme will continue, with keen focus on reducing interest cost. However, we anticipate further debt accumulation due to the very little fiscal space. In our view, for government to achieve these targets amid the conditionalities of the IMF, we anticipate a re-basing of GDP. This will create room for further borrowing albeit long term. Evolution of public debt in Ghana Domestic Debt External Debt Debt Accumulation 140000 120000 100000 47.45% 49.90% 60.00% 50.00% 40.00% 80000 60000 40000 20000 25.97% 21.98% 13.58% 30.00% 20.00% 10.00% 7.90% 0 2013 2014 2015 2016 2017 2018 0.00% Source: ICAMGH Research, Ministry of Finance

The implementation of TSA and its extension this year to cover donor funds of MDAs as well as subvented agencies will help meet government short term need for funds. With this, we expect yields and supply of short term treasury securities to decline. Furthermore, the banking sector s new capital requirements should see fresh equity capital raised by banks placed in short term treasury securities as they gradually build their loan book. This is also likely to push rates on short term securities down. We believe treasury bonds are fully priced. We still see strong appetite for Treasury bonds from both local and foreign demand, which should drive yields further down. However, considering the position of inflation currently, we believe treasury bonds are fully priced (at the 15%-16% yields) and any further decline below 14% without significant improvement in inflation and current account balance is a fair trigger point to take profit on overpriced bonds. On investments, we will tilt towards the midsection of the yield curve. This strategy will protect our treasury portfolio against a potential pick-up in yields post the IMF programme. We will hold 7-year and 10-year bonds purposely to take profit. Our profit taking strategy will focus on selling these bonds when overvalued. Our outlook on the yield curve indicates that we stand to gain on the profit taking strategy since yields are likely to fall.

CREDIT PORTFOLIO Look before you leap By Derrick Mensah Derrick Mensah is the portfolio manager responsible for the equities and credit pot. He was previously an equity analyst with over a decade of work experience in both Ghana & Nigeria s financial markets. Derrick joined IC Asset Managers in 2017. Portfolio Analyst Susana Abraham Similar to the treasury market, yields on corporate debts tightened to multiyear lows and the yield curve elongated largely on the back of improvement in economic indicators. Given our outlook for 2017, we restructured a significant portion of our portfolio to take advantage of this. In effect, the tenor on our bank deposits extended from an average of 182 days to 365 days. Furthermore, we derisked our portfolio by seeking 100% treasury cover for some of our bank deposits and limiting our exposure to fundamentally weak debt issuers. Consequently, we were insulated from reinvestment risk when yields tanked as well as the chaos that engulfed the market in August when UT Bank and Capital Bank collapsed. In total, about GHS 1.3bn of assets were repriced from north of 20% to south of 10% following GCB s takeover of the two banks. Fortunately, our exposure to Bank Certificates of Deposit returned 21.5% at the close of the year. Although yields tightened across the curve, a flight to quality following the bank failures steepened the distortion between the spreads on investment grade and non-investment grade debt instruments. The above notwithstanding, we maintained our portfolio strategy to continue to derisk while safeguarding returns. In this regard, we did not participate in any corporate debt issue in 2017 with the exception of the Energy Sector Levy Act (ESLA) Bond. Our decision to invest in the ESLA bond was primarily based on the robustness of the structure and our view that the pricing was more than enough to compensate for any inherent risks. In effect, based on our strategies outlined above, our credit portfolio returned 23% at the close of 2017. Looking ahead, we believe yields will tighten further while the risk premium between investment grade and non-investment grade debt securities normalise. Our view is based on our perceived impact of the recapitalisation of the banking sector and the issuance of the second tranche of the ESLA bond on credit yields. In our opinion, tier II and III banks currently with the higher risk premiums will reprice downwards as capital adequacy and liquidity ratios improve. In effect, we struggle to identify where the alpha generator for the credit market will be. That notwithstanding, we have identified some potential opportunities in the cocoa sector. While PBC s weak financials informed our decision not to reinvest, we believe the cocoa sector remains fertile for debt securities. We intend to engage COCOBOD, the regulator of Ghana s cocoa sector on the financing of its cocoa rehabilitation programme. The entire programme is

estimated to cost GHS 3.4bn and will be undertaken over a three to eight year period. We expect yields on ESLA to tighten. We will take profit if the spread below our lower band width. Furthermore, we believe deploying a switch programme to cover our credit portfolio will ultimately enhance returns. We hold the view that, government is seeking to transfer the energy sector debts from banks to pension funds. We expect yields on the ESLA bonds to tighten as supply on the secondary market dries up. We peg the spread on the ESLA bond to hover around 150-250bps (similar to what we have on fixed deposits) above government securities. We will be inclined to take profit if the spread move below our lower band width. All-in-all, the crunch in yields and the lack of investment grade assets will make 2018 a challenging year for the credit market.