'Battle-Hardened' Investors May Need to Go Easy on African Bonds

  • Sovereign issuance hits record as hunt for yield persists
  • The market may turn as Fed tightens, Standard Bank warns

Such is the demand for African Eurobonds these days that not even army mutinies are scaring investors. That may not be the case for much longer.

Investors have become “battle-hardened” in their quest for yield, according to Union Bancaire Privee Ubp SA, with issuance from the continent reaching $12.7 billion in 2017, already a full-year record. Less than a month after soldiers rebelled in Ivory Coast, the West African nation attracted $10 billion of orders in a sale of $2 billion of securities on June 8, while Egypt and Senegal drew around $20 billion between them for deals in May.

For investors inured to the continent’s political risks, the boom may soon be over, according to Standard Bank Group Ltd., which recommends bondholders start reducing their overweight African exposure. The market may turn as the Federal Reserve raises rates, driving U.S. Treasury yields higher and reversing flows to risky assets.

“The bull market is living on borrowed time,” Dmitry Shishkin, an analyst at Standard Bank in London, said in a note to clients on June 12. “We probably still have a few weeks, if not a couple of months, during which U.S. Treasury weakness is likely to be limited. However, we think we should slowly start preparing for that eventuality.”

While African yields soared on U.S. President Donald Trump’s surprise election victory in November, they have since plummeted 140 basis to around the lowest since Aug. 2015, according to Standard Bank indexes. Still, the average rate of 6.25 percent for African government debt is almost 100 basis points more than what investors get for the riskiest emerging-market sovereign notes, according to data compiled by Bloomberg.

That spread has fueled demand from global bond investors and led governments and companies to pile in to the market this year. Egypt issued $7 billion of notes and Nigeria, struggling to get out of recession, sold $1.5 billion in its first offering of international securities since 2013. Nigerian lenders also made a comeback, with Zenith Bank Plc and United Bank for Africa Plc raising $1 billion between them. Kenya and Nigeria are among governments considering new deals, while the International Monetary Fund said last month that Tanzania would lower its borrowing costs if it issued.

Investors are becoming “increasingly familiar with the social and political risks,” said Koon Chow, a strategist at Union Bancaire in London. “They have a relatively low bar on what to expect. Plus, we’re in an environment where investors feel they need to own instruments with a high yield. Many African names satisfy that criterion.”

It’s a far cry from 2016, when many African governments were still reeling from the slump in commodity prices. Aside from South Africa, the continent’s most industrialized nation, Ghana and Egypt were the only governments to issue Eurobonds.

Better State

Union Bancaire’s Chow said African borrowers are in a better state today, with many having reduced their spending and tightened monetary policy in response to reduced export revenue and inflationary pressure.

“It probably still makes sense for investors to be overweight sub-Saharan Africa,” he said. “That’s because of the interplay of valuations and less stressed fundamentals.”

But investors should be careful not to focus too much on yields at the expense of the risks in Africa, according to Rand Merchant Bank.

“There’s more comfort around repayment risk,” said Nema Ramkhelawan-Bhana, an RMB analyst in Johannesburg. “But, often, it’s overlooking the fundamentals in favor of valuation when there’s a pickup relative to other emerging-market assets.”

— With assistance by Olivier Monnier

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