The hunt for yield: tracking the big tuskers in Africa

These returns are not without risk. The main one is market related (the risk of losses on the trade due to interest rate and currency movements). Other key risks inherent in the trade for nascent African markets are liquidity risk and transfer and convertibility risk.

Liquidity risk for this strategy relates to both the costs of trading domestic instruments as well as the costs incurred due to limited forex availability in a country’s currency markets. Transfer and convertibility risk is the risk that the repatriation of foreign currency could be impeded by government-imposed capital and exchange controls. These can lead to a loss-making carry-trade investment if not properly considered.

Stanlib Credit Alternatives’ approach begins with an overarching view that requires having a favourable outlook on the country’s macro-fundamental trends. This would include an expectation of improvements in economic growth, budget and current account balances.

If a country satisfies this primary consideration, Stanlib Credit Alternatives applies a three-pronged approach based on the direction of interest rates, the direction of inflation and the valuation of its currency. Simply put, the optimal trade is where inflation and interest rates are expected to decrease and the currency is perceived to be undervalued with the potential to strengthen.

Stanlib also considers whether the jurisdiction charges withholding tax and, if so, its effect on the expected return of the trade. Another issue is whether to hedge the currency, as the costs involved are often too high and would erase the underlying local instrument’s return.

The African carry trade is a valuable tactical addition to a portfolio, particularly at times when hard currency yields are low. However, to execute this strategy correctly, Stanlib believes each investment must be grounded in a sober appraisal of a country’s outlook and an adequate consideration of its risks.

Lievin Mbuyamba is a fixed-income analyst at Stanlib and Jonathan de la Pasture is portfolio manager at Stanlib Credit Alternatives.

This article was paid for by Stanlib.