Coffee is what probably comes to mind when you think of Ethiopia. But in November 2014, the coffee producer made headlines with its first-ever issuance of sovereign bonds.
And Ethiopia’s not alone. Sovereign bond issuance is rising across sub-Saharan Africa. More than a dozen nations— including Uganda, Nigeria and Kenya—have issued international sovereign bonds for the first time in recent years. This emerging trend, among others, presents opportunities for Canadian pension funds in today’s low-yield environment. But risks lurk, too.
1. More bonds
Ethiopia’s 10-year bond issue, totalling $1 billion, will have interest rates of about 6%. Proceeds are expected to go toward electricity and infrastructure projects.
“There’s a massive shortage of infrastructure in Africa,” notes Duncan Artus, a South Africa-based portfolio manager with Allan Gray Ltd. African nations’ infrastructure shortage and their generally low debt-to-GDP ratios will lead to more sovereign debt issuance on the continent, he says.
African government debt typically comes with higher interest rates than developed market bonds—up to 11%, in some cases— which is attractive in today’s low-rate environment, Artus adds. The bonds are denominated primarily in reserve currencies and usually have 10-year maturities, says the International Monetary Fund. Issuances typically exceed the $500-million minimum threshold normally required for inclusion in global bond indexes, the IMF adds.
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Corporate bond issues are also growing. “The shift in consumer growth patterns has resulted in a significant broadening of corporate issuance, as companies in consumer-driven industries such as telecoms, energy, real estate and banking turn to capital markets to finance their growth,” says a 2014 Manulife Asset Management paper on emerging markets debt.
The paper predicts this trend will continue and notes credit ratings are rising in developing markets while declining in developed economies.
But emerging markets debt comes with risks stemming from currency fluctuations, corruption, political instability and prior defaults, experts warn.
2. Fat and sick
As developing countries expand economically, the waistlines of their citizens follow suit. A 2014 report by the Overseas Development Institute, a British thinktank, says, “In the developing world, the number of overweight or obese adults more than tripled from 250 million in 1980 to 904 million in 2008.” It blames greater consumption of sugar and fat found in processed and fast foods.
“When I travel in many parts of Africa and Asia and ask middle-class families ‘What do you like to do on weekends?’, they say, ‘I love to go eat Kentucky Fried Chicken,’ ” explains Sammy Suzuki, a New York City-based portfolio manager of emerging markets core equities with AllianceBernstein.
Dietary shifts and weight gain will cause “a huge increase in the number of people suffering certain types of cancer, diabetes, strokes and heart attacks,” the ODI report warns.
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The growing incidence of diabetes is already hitting statisticians’ clipboards. In 2010, four out of five diabetics were living in developing countries, reports the Brussels-based International Diabetes Federation. “China has the world’s largest diabetes epidemic, and it continues to grow at a fearsome pace,” says the IDF. About 11% of Chinese adults have diabetes.
The developing world’s appetite for convenience foods will likely grow despite the health risks, leading to opportunities in food manufacturers and fast-food franchises, Suzuki says. “Per capita concentration of fast-food chains in emerging markets is still less than one-tenth of U.S. levels,” he wrote in a 2013 AllianceBernstein blog post.
Higher calorie consumption and the attendant sedentary lifestyles will also prove a boon for screen-based technology firms and providers. “There’s still a huge opportunity in online gaming,” Suzuki notes.
And efforts to combat obesity-related diseases present investment opportunities in pharmaceuticals, he adds.
3. It’s elementary
While developing economies will have to grow, they can’t do that with the same carbon-heavy technologies that drove the West, says Eugene Ellmen, national director of Oikocredit Canada, which provides funding for green initiatives in developing nations. “[The developing world is] going to have to figure out how to grow without adding substantial new carbon emissions,” he says. And that’s where opportunities lie.
Countries worldwide need to invest US$36 trillion in clean energy and low-carbon transportation between now and 2050 to avoid the worst impacts of climate change, says a 2014 report by Ceres, a Boston-based non-profit. “A lot of that money will be spent in developing countries,” explains Deb Abbey, CEO of the Responsible Investment Association.
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Developing countries already support numerous green initiatives, including renewable energy projects and endeavours aiming to mitigate both desertification and rising seas. Unfortunately, many of these localized initiatives are too small for pension funds to consider, says Abbey.
Small deals aren’t cost-effective for pension funds because researching big and small deals costs the same.
Also, green projects often aren’t competitive enough because governments tend to subsidize fossil fuels rather than clean energy, Abbey adds. “The lack of leadership in terms of public policy is a huge issue,” she explains.
However, Abbey says, in the medium and long terms, more big initiatives will appear in the green space, so pension funds will likely increase allocations. Indeed, Canada’s pension plans appear ready to grab these opportunities. For example, in 2013, the Caisse de dépôt et placement du Québec bought a 25% share in London Array 1, the world’s largest offshore wind energy farm, located in the U.K.
An expected increase in green bond issuance will help solidify the green trend, Abbey adds.
4. Forever young
The demographic story is changing, too. Countries with the youngest median ages remain in the developing world— particularly in Africa, the Central Intelligence Agency’s World Factbook reveals. In 2014, it notes, Niger had the lowest median age (15.1), followed by Uganda (15.5) and Mali (16).
This youthquake means potentially higher sales growth for most businesses and numerous opportunities in retail, including mobile phones and alcohol, says Artus. It also translates into opportunities in financial services. “As you get a job, you get a bank account,” he explains.
To capitalize on demographics, investors should look for companies that understand the unique characteristics of youth in developing nations, Artus adds. “Most young people are in Islamic countries or in places like India and China, where people don’t necessarily have a western view of things.”
But emerging markets won’t stay young forever. The BRIC economies and others are already showing a touch of grey. The median age in Brazil is now 30.7. Russia stands at 38.9, India at 27 and China at 36.7. Some of these numbers are close to the median ages of developed societies such as Canada (41.7), Belgium (43.1) and Japan (46.1).
And a youth bulge doesn’t guarantee investment opportunities. “Never confuse need with ability to pay,” says Artus, referring to the high youth unemployment rates in many developing countries.
Widespread youth joblessness can also bring political instability. “You can see it with what happened in the Middle East and North Africa,” notes Artus. Worse still, disaffected unemployed youth can easily fall under the influence of extremist movements. Young people usually fill the ranks of Al Qaeda, Boko Haram and the Islamic State of Iraq and Syria.
Taking advantage of developing markets requires watching these trends closely. “Investing is partly about knowing how people’s lives are changing,” says Suzuki. But, he cautions, while trends matter, the actual opportunities come from specific companies and circumstances. “I would never encourage somebody to invest purely based on themes.”
Yaldaz Sadakova is associate editor of Benefits Canada.
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