The talk of hedge funds in the African investment space can excite crafty investors and anger those with development agendas, but private equity probably did the same thing a decade ago.
Short-term volatility and uncertainty in the African growth story create opportunities for hedge funds. Hedge funds are generally authorized by their investors to operate under more flexible mandates than private equity, and they have the creativity to generate bond-like returns that outpace inflation. Critics will say hedge funds operate with limited liquidity in an opaque world.
Private equity is a similarly illiquid class to hedge funds — yes, it is clearly less opaque — but let’s not get hung up on the details.
Hedge funds and private equity funds do not operate in opposition to each other. The style (and structure) for investment differ significantly in many instances. The standard five-year investment holding period stands in contrast to hedge fund strategies that can range from equity hedge to event-driven. Yet it is these differences that can usually lead to alignment and joint participation in transactions, for example, where a hedge fund and private equity fund participate in a distressed company, albeit in different areas of the capital structure.
Private equity is not dead. A few major private equity firms saw management changes at the top of their organizations in 2016 and early 2017. Such changes have a few players in the industry and numerous outsiders questioning private equity in the African context.
The African private equity story is just beginning. Actis was created in 2004, two U.S. presidents ago during the George W. Bush administration. This period in private equity could be Chapter 1 in a great book.
The $400 million lost by Carlyle’s Vermillion hedge fund in a Moroccan oil refinery deal is recognition that not every deal becomes a great deal. That said, having more winners than losers (especially big winners), is key to surviving in the fund world. Carlyle surely has done that.
Where are the opportunities for hedge funds in Africa?
Financial services
The financial services industry in Africa took a beating the last couple years as currencies crumbled due to a commodity price downturn. Some private equity funds are quick to highlight the performances of retail banks in their portfolios as a justification for a noticeable underperformance of portfolio returns. For example, the banking sector in Nigeria and Mozambique dogged investors. The countries couldn’t escape the performance of oil and gas, and then bad debt both on and off the balance sheet further devastated currencies.
Many lessons were learned. Commodity prices are still big influences in some countries. Expect someone to bet on a couple of banks right at the moment when commodity prices appear to be rising. Oil and gas is undercapitalized for the long term in Africa, particularly with local banks withholding capital. A few big players will emerge in the next couple years to fund the necessary capital-intensive investment in the oil and gas sector.
Government debt management can drastically affect currencies and economic growth. Some investors are betting on economic upswings and opportunities in countries such as Ghana (with a new government) and Mozambique (with off balance-sheet debt in the open and the IMF in the picture). The Democratic Republic of the Congo is intriguing as financial services, including insurance, are a growing conversation.
Watch Nigeria. There may be a short-term one-or-two party outperformance in the banking sector until the greater Nigerian economy regains footing. Kenya, on the other hand, will present distressed opportunities as interest rate caps are fully digested for a full year — they were introduced mid-year 2016.
Metals and mining
Commodity discussions in Africa generally get bogged down by oil and gas price speculation, but such conversations ignore the vast mineral opportunity. Metals and mining awaken the hedge fund crowd because the sector itself operates in an opaque world. Opportunities can be event-driven or special-situation-type plays for hedge funds.
The DRC continues as favorite. It is complicated when it comes to mining, but some operators have found a way to operate under the radar and avoid scrutiny of questionable or illegal activities. In doing so, these operators generally source capital from private investors to stay “out of sight, out of mind” in some regions. Off the books of the banks, they may avoid becoming like the infamous iron ore deal/non-deal between the government of Guinea and other parties that continues to play out in court.
Niger is interesting for minerals. Uranium is an obvious target for nuclear power and batteries, but Niger is attracting interest for cement. Other countries to watch include Namibia for aggressive short-term plays around zinc, cpper and uranium, and Zambia for short-term plays in copper.
Namibia’s New Equitable Economic Empowerment Framework (NEEEF), which may have similarities to South Africa’s black empowerment laws, will create challenges and opportunity depending on who you ask. There are potential tax loopholes in such policies. Opportunistic plays exist with salt mining and possibly gold. Gold is highly dependent on general global economic movements, and rises in economic slowdowns.
Oil and gas
This is an obvious sector to target. The volatility and distressed assets across the continent are not new for investors. Oversupply continues as the story of 2017. Yet there is a reason that investors are lurking around Africa’s oil and gas assets.
Refineries, specifically those in North Africa, endured some pain during the last couple years and they’re embattled with impatient bank creditors and frustrated oil traders. The Mohammedia Refinery in Morocco is not the first (and will not be the last) target for hedge funds. Egypt is an interesting country to watch in North Africa. Ditto Nigeria in West Africa as its economic troubles play out. Sudan is a wildcard country to watch with ongoing fighting in South Sudan and sanctions.
As for the upstream assets, similar to mineral and mining rights, access to information and knowing the right assets is a game that some managers play well.
Avoid bribes. Follow the rules and know that U.S. legislation (signed in February 2017) does not require energy companies to disclose payments to foreign governments. Countries to watch include Libya, DRC and Equatorial Guinea. Onshore and offshore assets are on the table for discussion. Gabon was a subject of conversation until Carlyle bought Shell’s assets.
Agriculture and land
The riskiest play — but with big returns — is in agricultural and land. The risk has less to do with price prediction around crops and land, but rather evolves from how third parties view land purchases. Where land is for sale in Africa, investors ranging from wealthy individuals to governments to hedge funds are making a play for a limited resource, especially when it’s arable, ripe for agricultural production, or ideal for commercial and residential construction.
Critics argue that this is pushing up prices and thwarting a global development agenda. Others argue that these investors are the first to unlock the land from the grip of governments or individuals previously unwilling to sell, making the land marketable for the first time.
Bypassing that debate, there is one reality: land can provide quick profit plays for hedge fund investors. Countries to watch include all those that allow private land ownership.
Agriculture, especially crop-related investments, remain in the realm of private equity and impact investors. But some hedge fund players may want to keep their eye on salt and sugar plays. Those who found a way to buy exposure to avocados in 2016 made a decent return when prices spiked.
Although South Africa is home to a large portion of African hedge fund managers, it doesn’t own the market. Equity hedges sensibly begin with accessing the Johannesburg stock market. But managers are active in other markets, especially North Africa, Nigeria and Kenya. The current trend continues to point to special-situation type investments that are event-driven or distressed.
Private equity firms, limited by their structure and related investor requirements, have been slow to invest in the last 18 months in this type of investments.
Maybe hedge funds can be a little more active in the short term, right before private equity investors start spending the large cash piles that investors are encouraging them to use.
Author: Kurt Davis Jr. is an investment banker focusing on the natural resources and energy sectors, with private equity experience in emerging economies. He earned a law degree in tax and commercial law at the University of Virginia’s School of Law and a master’s of business administration in finance, entrepreneurship and operations from the University of Chicago. He can be reached at kurt.davis.jr@gmail.com.
