Negative Interest Rates (or getting paid to borrow money)

This blog has a new address:

http://rashaadtayob.com/

Asking a fixed income manager about negative interest rates is like getting a taxi driver’s opinion on self-driving cars. You know that they are going to tell you that it’s a bad idea. But with over $5 Trillion worth of bonds having negative yields they are now a firmly established reality. Japan recently joined the negative interest rate club alongside Sweden, Switzerland, Denmark and the 19 countries that fall under the European Central Bank. These are a few thoughts on how we got to the scarcely believable point where 30% of the Global Bond Index now effectively entails the bond investor PAYING interest.

Click on the link for the blog post:

http://rashaadtayob.com/2016/02/23/negative-interest-rates-or-getting-paid-to-borrow-money/

Can Bono Save the World? (Again)

As growth slows and currencies depreciate, African countries which have borrowed in foreign currencies risk falling into the same debt traps they barely escaped. Bono, are you paying attention?

The turn of the millennium saw the Jubilee campaign, a massive effort to write off third-world debt. Bono was a leader of an admirable initiative to relieve highly indebted countries of financial burdens which were crippling their abilities to reduce poverty and grow. Much of the debt had been built up illegitimately in countries with weak institutions where the risk of borrowing was not understood; dictators such as Mabuto Sese Seko (Congo) and Idi Amin (Uganda) also amassed large debts which impoverished their respective countries.

The Jubilee campaign was largely successful, as it saw G7 countries pledge to cancel $50bn worth of debt. The true cost of the write-down is far less, given how little of the debt was actually being serviced. The Jubilee debt campaign has also worked against “vulture funds”, which buy the debt of defaulted countries and then attempt to bring judgements through legal systems in the developed world. Zambia faced an example of this when in 2007 one of its defaulted loans was bought for $3.3 million by a vulture fund, which then sued for $55 million — the full amount, plus interest and costs. Debt relief and campaigns like Jubilee are not a panacea, but they have reduced the debt burden of highly indebted countries and limited the ability of vulture funds to profit at the expense of poor countries.

As the quality of U2's songs declined into the new millennium, Africa's growth picked up on the back of the commodity boom. Unfortunately, debt relief and rising commodity prices were not sufficient to ensure sustainable growth, as institutions in Africa remain weak. With commodity prices declining since 2008, growth in Africa has slowed while government spending pressure has not abated. This has led to large deficits, which have to be financed with borrowing. With global yields at record lows, there has been a temptation to borrow in foreign currencies (specifically USD), as the issued interest rate is far lower than domestic borrowing. In recent years, we have seen USD bond issues by a broad range of countries including Ghana, Zambia, Ivory Coast, Kenya, Senegal, Ethiopia and Gabon. These enticing low-interest rates come at the expense of immense currency risk, which has now materialised with the depreciation of African currencies against the US dollar. The following chart shows the performance of the African universe against the USD since 2013.

How costly this depreciation is can be seen in the example of Zambia, where a $750m bond was issued in 2012 when the exchange rate was 5 kwacha to the dollar. Since the time of the bond issue, the exchange rate has weakened by 53% to 7,63 kwacha to the USD. The value of the debt has therefore ballooned from 3,75bn kwacha to 5,7bn kwacha. If the currency depreciates further, this debt burden will continue to rise.

The growth of foreign-currency debt in Africa since 2012 has increased the risk that certain countries find themselves once again in a debt trap. Weak institutions and a culture of patronage in Zambia have led to a mismanagement of the economy, as parties buy votes with populist policies in order to win elections. Michael Sata’s Patriotic Front (PF) made some impossible promises regarding employment, poverty and cost of living in order to get elected in 2011. A ruling party that campaigns with the slogan "More money in your pockets" will always be under pressure to deliver.

Once in power, the PF set about rewarding voters by ramping up spending. The total budget has grown by 45% between 2013 and 2015, which has caused a large increase in the fiscal deficit. Against a backdrop of falling commodity prices (copper is 85% of exports), the debt-to-GDP ratio increased from 26% to 40.5% between 2012 and 2015. The following chart from Barclays shows the past and present: a history of the fiscal deficit dating back to 2008 and the forecast looking to 2016. The fiscal deficit is projected to stay at high levels (8%+) in coming years, and Zambia has reached the point where it is difficult to finance its high level of spending.

These difficulties were emphasised last week when Zambia launched a bond that has the unwelcome distinction of being the most expensive dollar debt ever for an African government. They issued at a yield of 9,38%, which is far more expensive than the 2012 bond which was issued at a yield of 5,625%. The desperation of Zambia to borrow is highlighted by the $38,4m “costs” incurred for the bond issue. This is a phenomenal level of expenses for a bond issue, and is an astounding 27 times the $1,4m cost of the 2012 bond issue. The additional “costs” bring the effective cost of debt closer to 9,85%.

Zambia is not alone amongst African countries which have ramped up spending in recent years through the build-up of foreign-currency debt. Ghana finds itself in a similar situation as it tries to launch another USD bond in order to meet it spending requirements, and it is likely to pay a significant price for this. There is a reason that foreign-currency debt is referred to as the “original sin”, since it has a history of triggering financial crisis.

Both Zambia and Ghana seemed to have reached the point where they are willing to borrow recklessly for political reasons. They need to satisfy the electorate in order to remain in power, and have used borrowed foreign money in a futile attempt to contain currency depreciation. While governments are thinking short term, the debts that they are building up in the present will not disappear after the next election, and citizens will suffer the consequences down the line. The extent of financial mismanagement means that both Zambia and Ghana are headed towards a financial collapse. They will soon find themselves in debt trap, beholden to their creditors and institutions like the IMF.

Bono’s services will be required shortly, and they should hope that U2 is done touring by then.

China Coverage

China's stock market crash continues to weigh on commodity prices. With the issue still topical Glacier (a Sanlam business) published my China article in their weekly newsletter.

http://www.glacier.co.za/mediacentre/GlacierMediaCentreArticles/funfonfrifay_glacier_20150717.pdf

Greece Coverage

With Greece being quite topical these days the Daily Vox and CNBC requested some commentary on the issue. Click on the links before for article and video.

http://www.thedailyvox.co.za/pay-back-the-money-greek-edition-can-the-referendum-end-the-crisis/

http://www.cnbcafrica.com/video/?bctid=4351572694001

The Significance of China's Stock Market Crash

1) These Chinese Stock market has crashed after a phenomenal bull run.
2) The Chinese equity bubble had the potential to boost growth, but now that the market has crashed this hope disappearing.
3) Growth has been driven by debt since 2007, which means an increased risk of financial crisis.
4) China has been the main driver of world  growth in recent years, but that growth will slow with knock on effects on global growth.

While the financial markets have been occupied with the turmoil in Greece, a potentially more serious development is the crash of the Chinese stock market after its  phenomenal run. Up to May 2015 the Chinese market had delivered 154% over a 12 month period and valuations of medium and small companies reached extremes. The market began selling off on the 15th of June and the crash continued despite measures by the central bank and government to prop up the market through the use of interest rate cuts and stock buying programs. The broad market has fallen 32% from its peak, a tremendous destruction of value given that the Chinese market is second only to the US in terms of size. Many companies have taken the strategic decision of suspending trading in their stock in order to prevent them falling further. Currently over 1000 stocks, out of a listed universe of around 3000, have suspended trading in recent days. This level of of suspension of trading is unprecedented as the action generally used for companies in Liquidation or Business rescue. As a comparison there have been 5 suspensions on the Johannesburg Stock Exchange for 2015 to date. While the market has fallen 32% in less than a month, the crash is actually understated due to the number of stock suspensions. 

China's economy slowed during the 2008 financial crisis, but then recovered strongly due to government stimulus and credit growth. Growth has slowed significantly in recent years, but at 7% it is still very high for an economy of its size. Expectations are that economic growth in China will remain strong (between 6% and 7% in coming years) and the equity bull market reinforced these beliefs.

The Chinese equity market crash is significant as the bull market had the potential to boost economic growth. New stock offerings (IPO’s) and stock issues by listed companies pull savings into businesses, which they can can then invest. High valuations lower the cost of equity and therefore the required return on prospective investments. This causes companies to ramp up investment and this in turn drives growth. There was some hope that the deluge of money being pumped into the equities would stem the decline in GDP growth, but with the market crash this hope has now disappeared. 

It is critical for China that their growth does not slow as since 2007 they have amassed a large amount of debt. In the 5 years leading up to the financial crisis, China grew at over 10% p.a. The economy began to slow in 2007 and growth dipped to 6% in 2009. China reacted to this by significantly increasing borrowing and investment in an attempt to maintain its high growth rates.  They succeeded in boosting growth, but at the expense of massive increase in the debt levels. A McKinsey report earlier this year highlighted the extent of the borrowing binge (http://www.mckinsey.com/insights/economic_studies/debt_and_not_much_deleveraging). The debt to GDP ratio has increased from 158% in 2007 to 282% in 2014, which means that debt levels in China now exceed those is developed markets such as the United States, Germany and Canada. 

The speed and quantum of the debt increase has only a few precedents in history, with no nation in a comparable position able to escape an an economic slowdown and most experiencing a credit crisis. (http://on.ft.com/1aYv5KM). A country with a high level of debt is very dependent on growth as any slowdown can impact the ability to service the debt load, which would precipitate a financial crisis.

While China’s debt fueled boom has been under scrutiny for several years, investors have generally believe that the government will be able to deal with any fallout due to the low level of government debt (55% of GDP), the current account surplus (more exports than imports) and the size of their foreign exchange reserves ($3,7 Trillion) . Despite these fundamental positives and the fact that the economy and credit growth has continued to grow at a rapid pace this year, I believe that a slowdown is now inevitable and there is a meaningful risk of a hard landing brought about by a financial crisis. Over the last 5 years China has contributed 30-40% of the world’s economic growth and the consensus among economists and market participants is that this is likely to continue. A significant slowdown will be quite unexpected with massive knock effects for the global economy.

Yanis Varoufakis on Bloomberg: A Great Political Interview

Yanis Varoufakis is not a politician. He is an academic who has published several books on game theory and global economics. In January 2015 he moved from teaching at the University of Texas to being the Finance minister of Greece, a country that has been in a debt crisis since 2010. Prime Minister Alexis Tsipras appointed him despite Varoufakis not even being a member of Syriza, the party that won the election. Not being a politician means that he has not built up years of experience in obfuscation, but is able to speak clearly and incisively on the economic crisis and the upcoming referendum.

With Greece going to a referendum on Sunday the 4th of July 2015, the government is aiming to convince the people to vote "No" to the current debt-restructuring proposal. Varoufakis gave an interview to Bloomberg this week where he dismantled many of the arguments made by the Eurogroup, the financial industry and the media. He made the important point Greece will never be able to recover as long as they have an unsustainable debt load. The IMF belatedly confirmed this when they said they would not put another bailout proposal to the board unless it contained debt relief. http://www.theguardian.com/business/2015/jul/02/imf-greece-needs-extra-50bn-euros

Varoufakis had the financial world on hold for 20 minutes as he gave this interview. I am sure that that his straightforward approach would have changed the minds of many in the financial industry that view him as a left wing pariah. He is critical of the approach to the crisis since 2010, which has been one of denial and short term fixes ("Extend and Pretend"). IMF, Euro commission and the ECB have imposed a program that is one of the great failures of economic history. Greece has been insolvent since 2010, but the programs to bailout out private sector banks while barely altering Greece’s debt burden have caused a great depression in Greece. Five years later and Greece is still not growing, as no one is willing to invest in productive capacity in Greece while they are insolvent. The IMF, the United States and Global Investors all do not believe that the Greek debt is sustainable, but the Eurozone institutions, fearing a knock on effect in other indebted nations such as Italy and Spain, refuse to acknowledge this or propose a deal that will solve the problems.

Greece has to say "NO" to the status quo and seek deal that will set them on a sustainable path, either inside or out of the Euro.

A Greek Holiday or: How I learned to stop worrying and love the Grexit

A weeklong holiday in Greece last week cemented my view that the country would be far better off it were to default on its debt, leave the Eurozone and revert back to its own currency. A few days in Santorini highlighted the tourism assets (20% of GDP) that Greece has in its islands. I was also positively surprised with the quality of the infrastructure in Athens. The financial press continues to favour a compromise and debt restructuring due to the systemic financial risks of an exit. However, Greece has very little to lose as its economy has ceased to function effectively due to its debt burden and continuing uncertainty regarding its future. If an exit is managed well then they have much to gain in that exiting the Euro as devaluing will improve economic competitiveness and put back to work unutilized resources.

3 Thoughts from my trip:

1) Greece has the potential for a quick economic recovery

Greece's economy is currently clogged by uncertainty regarding its future. No country can function properly while living in a suspended state where its currency, banking system and political institutions may cease to exist at any point. Under these circumstances it is no surprise that there has been no progress on the economy since 2008.  Even if there is another bailout agreement, the uncertainty will continue because a debt burden of 180% of GDP is unpayable. This is understood by Greek citizens and private institutions, even as officials within the Eurozone try to deny it. While a default will be a shock to the system, it will remove the uncertainty overhang that has made the economy dysfunctional. The country will get a massive boost by the elimination of its debt, while the devaluation of the currency will boost its competitiveness and cheapen assets thereby enticing investors.

Threats of being "locked out of financial markets" will prove to be empty. In an environment of surplus global savings and ample liquidity, Greece will not struggle to find alternative creditors. Their funding requirement is not onerous as they are running a primary budget surplus, while their current account deficit is currently 1,5%, having narrowed from 10% since 2012.

The risk to a rapid recovery is a possible descent into populist policies by the left wing government, which will waste the opportunity for a fresh start.


2) 21st Century Politics and Norms makes sovereign debt virtually unenforceable

While Merkel, Draghi and the European political elite have been painting a nightmare outlook for Greece if it defaults and leaves the Eurozone, it is the lenders who are really scared. Greece has around EUR 320bn worth of debt, the majority of it owed to external parties such as the ECB, IMF and the EFSF (European Financial Stability Fund). (http://www.theguardian.com/world/datablog/2015/jun/19/the-greek-debt-what-creditors-may-stand-to-lose)  There is a further EUR 80bn borrowed by the Greek banking system via the Target 2 payment systems. This is the means by which Greeks have been able to withdraw Euros even as their banks have run out of money. The European banking system would need to make up this amount and it would have to be done with state assistance. (http://www.yardeni.com/Pub/target2.pdf)

Costs to the Eurozone

For the Eurozone, the cost to Greece defaulting is high, both in monetary terms and in the additional fragility it will add to the Eurozone. It would highlight the fact that countries can exit the Euro, making the currency more fragile. If Greece successfully manages to walk away from its debt burden it will add to the risk that other highly indebted such as Spain and Italy may choose to do the same.

Costs to Greece

Since 2008 Greek debt has migrated from private sector balanced sheets (banks, investors, pension funds) to taxpayer backed institutions like the Eurozone/IMF/ECB investors. (http://money.cnn.com/2015/01/28/investing/greek-debt-who-has-most-to-lose/). With the debt now held largely by foreigners, the cost to Greeks in the case of a government default is relatively low. This is in contrast to South Africa where 65% of the government bonds are held locally by Pensions Funds, Banks and other investors.

While the Eurozone has an incentive to make life as difficult as possible for Greece once they default, there is very little that can be done to enforce sovereign debt payment in the modern world. The Greek state does not hold significant offshore assets, and it would not be easy to attach the assets of Greek citizens. Throughout history war has been used as a means to enforce sovereign debt payments but that would be difficult in today's political environment. While the European creditors would like the Greek government to sell assets (like its islands) in order pay them back, there is little they can do to force them.


3) Sovereign Debt needs to be Legitimate

Credit quality is defined as the capacity and willingness of an entity to meet its financial obligations. Greece has neither the capacity to pay (given size of the debt burden) nor the willingness (given the electoral victory of Syriza on a debt repudiation platform). The Greek electorate understands that a debt load of 180% of GDP is impossible to recover from without severe sacrifices, no matter how the debt is restructured and how low the interest rate. In the mid 90's South Africa's debt burden crept towards the 60% of GDP level, a breach of which risked sending the country into a debt trap. While the 60% level is no longer considered the “Red Line” and interest rates are very low at this point in time, it is difficult to believe that an external debt load 3 times the "debt trap" level is in any way sustainable.

I believe that the Eurozone powers erred in not legitimising the debt restructuring through a democratic process like a referendum. (http://rashaadtayob.blogspot.com/2011/11/referendums-are-solution-to-european.html) In November 2011 then Greek president George Papandreou suggested a referendum on the bailout package. Four days later he was forced to backtrack under pressure from Merkel and Sarkozy and 10 days later he had to resign. Had they gone ahead with the referendum, it would have granted legitimacy to the bailout package and the debt that the people of Greece assumed. Without legitimacy the people of Greece feel no need to continue for further sacrifice in order to pay back the debt, which is why they elected Syriza on the promise of a new deal. Without legitimacy private entities were not willing to hold the debt and it continued to migrate on to Euro/IMF/ECB balance sheets, which means that taxpayers in the Eurozone and globally are now on the hook for the debt.

3 Lessons from the South Africa's Election Results

The final results for South Africa's election were released yesterday (http://www.elections.org.za/resultsNPE2014/). What was expected to be a hotly contested battle and a rejection of President Jacob Zuma's leadership instead turned out to be another sweeping victory for the ANC, the fifth since the first democratic election in 1994. We can take the following lessons from the results:

1) The ANC is Unbeatable 

In 2009, President Zuma declared that the ANC would rule “until Jesus comes back”; with the 2014 election results, there is no reason to doubt the veracity of his statement. The last 5 years have been a period of economic stagnation in South Africa, with the country’s economic performance lagging far behind its emerging-market peers. Corruption and governance issues within the ANC have consistently gnawed at the ANC's reputation among middle- to upper-class voters. In Gauteng specifically, the e-tolling saga and dysfunctional City of Joburg municipality have led to suggestions that ANC supremacy would be challenged in this election. Despite the poor performance of the ANC over the past five years, predictions that the party would be fall below 60% nationally, or below 50% in Gauteng, have proven to be pipe dreams. While the DA has cemented its position as the national official opposition (increasing from 17% to 22% of the national vote) and the ruling party of the Western Cape (increasing from 49% to 59% of the provincial vote), the party still struggles to attract the black vote. A recent survey of black youth suggest that around 50% of them believe that the DA would bring back apartheid if elected.

The ANC has suffered only a mild decline in its popularity as its share of the national vote fell from 66% to 62%. The key to the ANC's popularity is that it has implemented programs which have boosted the incomes of large swathes of the population. The ANC has driven the implementation of a broad grant (welfare) system in SA, with 21m registered recipients. With 44% of SA household’s dependent on the grant system to keep them out of abject poverty, they are unlikely to risk their livelihood by voting for any other party. Since 2009, the majority of jobs created have been in the public sector. The large increase public-sector jobs (which pay around 34% more than equivalent private sector jobs) driven by the ANC has also created a large middle class beholden to the state for their income. With these large numbers of voters dependent on the state for their livelihood it is very difficult for any party to make significant inroads into the ANC support base.

2) Change will come from working with the ANC

Because the ANC unbeatable, it does not make sense for the private sector to adopt an adversarial approach when dealing with them. The private sector needs to work more closely with the ANC in order to drive policies which grow the economy. With the level of state dependency, it is essential that economic growth (currently 2% yoy) recovers in order to generate the tax revenue required to fund the current welfare programs and to create the employment necessary to reduce the number of dependents. A continuation of the dysfunctional economic environment of the past 5 years is unsustainable as the country risks a debt crisis given the extent to which government spending has increased. South Africa needs an environment more conducive to high levels of economic growth, and the ANC needs to be more effective in providing it. 

3) The Economic Freedom Fighters (EFF) are a real threat to future of the country

Despite the progress made since 1994, and the grant system which helps reduce the worst levels of poverty, SA remains one of the most unequal societies in the world. Median white income is around 6 times median black income. The EFF has sought to capitalise on the high levels of dissatisfaction by advocating for more aggressive redistributive policies, loudly touting Venezuela and Zimbabwe as models for an economic rebalancing with South Africa. Despite the fact that the policies of Chavez and Mugabe have destroyed the economies of their respective countries, South Africa's extreme imbalances means that this is still a message which resonates among the disaffected millions. The EFF was only formed 9 months ago by Julius Malema, but it received 6% of the national vote and 25 seats in parliament to make it the 3rd most popular political party in SA. The platform provided by its parliamentary position is dangerous in that it now has a base on which to build its following. I think that poor economic outlook and growing resentment among the poor will result in at least a doubling of the EFF's vote in the next election. South Africa needs economic policy certainty and continued investment in order to deliver growth and employment, but the EFF loudly advocating the  nationalization of the banking and mining sector along with aggressive land distribution will put this at risk.

South African Hustle - The Externally Managed Property Company

Last month saw the buyout of two small listed property companies in South Africa. Vividend was acquired by Arrowhead and Annuity was acquired by Redefine. One would expect that shareholders in the target companies would have seen a nice profit on their holdings as acquiring company's generally have to pay a premium in a takeover scenario. This was not the case. Healthy profits were indeed realised, but in both cases these profits were effectively channelled to external companies set up to "manage" the property assets of the listed company, leaving shareholders with negligible returns on their investment.

The exceptional performance of listed property in South Africa over the last 10 years, combined with SA institutions generally low weighting to property, has created a huge pent up demand for listed property assets in recent years.  The property and financial sectors have stepped up to satiate this demand, with numerous new listings of property companies providing investors with the exposure that they have been seeking. The returns of many of these new property companies have generally lagged the sector. I believe that this lacklustre performance is due to conflicts of interest inherent in the structure of new property funds. The market convention is to establish two companies when listing. One company is established to hold the physical properties ("Propco") while a separate company ("Manco") is established to provide "asset management" services to Propco. Propco is the listed publically traded entity, while "Manco" is generally owned by the founders, management and related parties and is privately held. This structure enables management and founders of the company to profit handsomely, regardless of the performance of the underlying property company. 

Using the example of Vividend we can see how this practice leads to a conflict of interest between the shareholders of "Propco" and "Manco". The structure has been a fixture of new property listings in SA over the last decade. At the inception of the company, Vividend founders and management begin by setting up two separate companies:

1. Vividend Management Group - A company which is paid an asset management fee in order to manage the assets of the fund. I refer to this as "Manco".
2. Vividend Income Fund - A new listed company which raises capital through a public offering in order to buy property assets, the income on which flows through to shareholders. I refer to this listed company as "Propco". At inception Propco signs an evergreen contract with Manco (Vividend Management Group), wherein Propco agrees to pay Manco a fee of 0,5% of the its total asset value per annum for the provision of asset management services on the property portfolio. 

Given that the Manco's earnings are determined by the total size of Propco's assets, Manco is now directly incentivised to grow the asset value of the fund.  This is done through the purchase of property assets funded by either new equity or debt. The quality and valuation of the properties purchased is critical to the return expectation to shareholders of Propco, but is of secondary consideration to Manco. Given the conflict of interest inherent in this structure it is not surprising that the returns to Propco shareholders have generally been poor, and in some cases disastrous. 

The last 10 years have seen numerous examples of externally managed companies where the Manco's incentive to grow the portfolio, and hence its income stream, has led to the acquisition overpriced or low quality assets. The perpetual "evergreen" contract entitles Manco to a portion of Propco's income forever, so the value of the Manco is directly related to the total size of assets in Propco, regardless of property yield to investors. Once Propco has purchased sufficient properties to provide Manco with an attractive income stream, the owners of Manco then look to capitalise on this through its sale. Manco can be sold to another party as in the case of Vividend and Annuity, but in many cases Manco is sold to Propco itself. 

This market structure has always resulted in an excellent deal for shareholders in the privately held Manco, but results for shareholders in publically held Propco have been mixed. Recent transactions have seen Vividend Management Group (Manco) purchased for R87 million while Accuity property management functions were bought for a total of R103m. A lot of value has been accrued to the shareholders of Manco and in these two cases it has been at the expense of shareholders in Propco. The charts below from Bloomberg show the performance of Annuity and Vividend (white lines) relative to the SA Property Index (JSAPY) from the time of listing to the time of acquisition.

Since listing in April 2012, Annuity (ANP) had no share price appreciation so Propco shareholders only profited from income for an annualised return of 6,39%. Investors in ANP lagged the SA Property Index (SAPY) by 16,49% for the period. The performance of Vividend (VIF) was even worse as the share price actually fell 6% since listing in October 2010. The total return of 4,47% was below cash and a massive 34,62% below the Property Index in just over 3 years.

For delivering these poor performances the Manco’s of Annuity and Vividend benefited to the tune of almost R200m when the Manco's were acquired. Both companies launched with a R500 million market cap, and the original shareholders of Propco’s in these two companies effectively lost R256 million relative to the property index.

Propco shareholders desire growing income and capital growth, which requires the purchase of attractively priced properties or the improvement of existing properties in order to enhance their income generating ability. Manco's are responsible for investing Propco's assets, but they are only incentivised to grow the portfolio so as to grow Manco's income stream. The interests of the two entities are at times directly in conflict, and the decisions taken are often to the detriment of Propco shareholders. 

This is not the only structure of property companies in SA, as mature companies generally having internalised management structures. In these "Internally Managed" property companies, both management and ownership of the property assets reside in Propco. In most cases this is as a result of an "internalisation" of the manco at some point in its history.  Aside from the two companies discussed, there are numerous other examples of the mismanagement of listed property companies due to the existence of external Manco's. For that reason we invest solely in internally managed property companies, where the interests of company shareholders do not directly conflict with management.



Note: Further to the above examples are there also Manco's which are paid a commission on property (generally 1%) transactions on behalf of Propco. In this egregious structure Manco's are incentivised not only to grow the portfolio without regard to quality, but to churn the portfolio as well.

Are Emerging Markets Proving Their Detractors Right?

After more than a decade as the darlings of the investment world, Emerging Markets (EM’s) have fallen out of favour rapidly as it becomes apparent that they are not following the linear path to prosperity that many had envisioned. Whereas previously the investment world focussed on the seemingly unlimited potential of billions of new consumers, recent events in such disparate countries as Turkey, Thailand, Nigeria and Ukraine highlighted the fragility of governance and institutions that is typical of emerging markets. Other EM’s such as South Africa, Brazil and India have not seen political crisis, but have still come under scrutiny due to their falling growth rates and rising inflation.

Over the last decades, EM’s have been the beneficiary of massive capital flows, partly due to their potential for economic growth, but in recent years also due to the flood of money brought on by ultra-easy monetary policy (low interest rates and quantitative easing) in developed markets. With the prospect of ultra-easy monetary policy coming to an end, EM’s will have to provide an attractive environment for capital in order to fund their investment plans. Sceptics contend that most EM’s are stuck in the "middle-income trap”. The theory is that an EM can grow from being a poor country to a middle-income country by capitalising on natural resources or cheap labour, but it then gets stuck in a “trap” when it does not have the strength of educational, legal and social institutions necessary to continue its development into a higher-income country. Capital flows are not effectively absorbed into the economy but instead they fuel a temporary consumption boom. A consumption boom without improvements in productivity eventually leads to a crisis followed by a reversal of capital flows. While each EM has its own unique circumstances, this sequence of events does seem to accurately describe many countries in the EM universe, including Turkey, Brazil, India and South Africa.


Recent events have highlighted the weakness in EM institutions, and their ability to negatively impact the growth potential of a country. In Turkey, Prime Minister Erdogan seems to be turning into the autocratic ruler that many had been warning of. The recent corruption scandal has seen him launch an offensive against the judiciary and police the media, and now even the Internet. Turkey’s mishandling of their monetary policy over the last year, also due to political pressure, has resulted in a dramatic fall in the currency. Nigeria has experienced rapid economic growth in recent years despite its high level of corruption. The firing of Reserve Bank governor Sansui after he exposed a $20bn hole in the state oil company’s finances highlights how weak Nigerian institutions are. Investors see immense potential due to the population of 170 million people, but this potential won’t be realized if the state continues to mismanage the economy.

On the ground in South Africa, we are painfully aware of the difficulty of generating a level of economic growth necessary to reduce unemployment, poverty and inequality. SA has struggled to generate more than 2% growth over the last 2 years and it clear that development has stalled. While SA’s institutions are amongst the strongest in the EM universe, the country is constrained by poor educational outcomes that limit productivity growth.  Recent years have also been characterized by deterioration in the efficiency and effectiveness of government institutions. This has created a high level of uncertainty that has limited investment in the economy.

As a citizen of an emerging market, I am not just an impartial observer in the recent reversal of fortunes. Whilst I think that the euphoria around EM over the last decade was in part due to ignorance about the developmental challenges these countries face, the current pessimism (and market valuations) seems to imply that progress has permanently stalled. EM may currently be regarded as a poor investment destination, but if governments can create the right environment then convergence can resume and EM’s can outperform developed economies for a considerable period of time.