Interview with Mthuli Ncube, Head Quantum Global Research Lab as Morocco leads 2018 Africa investment index

Quantum Global’s Africa Investment Index provides an annual guide to the most attractive markets. Professor Mthuli Ncube, the principle developer of the index explains this year’s highlights to African Business.

 Professor Mthuli Ncube heads the research lab for Quantum Global, the Zurich-based investment fund and asset manager with a large African focus. Previously chief economist at the African Development Bank, Ncube launched last year the Africa Investment Index ranking countries using a unique combination of data sets and criteria, both financial and social. African Business spoke to him ahead of the official launch of the 2018 index.

Before we talk about the index, I wanted to get your reactions to a recent article you penned on population growth in Africa. You cite some interesting, not to say frightening, statistics. The number of Africans joining the working age population will exceed that of the rest of the world by 2035. On one side, when I look at your latest report that you’re launching, you say that population matters because size matters. But on the flip side, you’re saying that we need be very careful in Africa because unless we control our population we are not going to reap the benefits of a large population.

That’s right. There’s no contradiction. The issue like this is that a large population gives you the fighting chance to have the right size of market place, a substantial market in the future. A new source of skills in the future. But you have to invest in those skills. You need to invest in education in health and also, kill the dependency ratio. So, that’s really the message that needs to be strong enough in terms of advocating that investment. That’s actually the key; that’s how you harness dividend.

Are you saying the top performers in terms of Morocco, Algeria or Botswana, they invest in education in a sufficient manner?

Well in the sense that they are investing in education more than the other countries, that’s for sure. You look at Morocco, you look at Egypt, you look at Botswana, they have put some serious investment in education. But, of course, the reason being is that, one of the other reasons is that the index itself relies on a variety of factors. These demographic factors are not the only factors. You have factors appertaining to the risk side or the credit side or indeed the doing business environment in this social capital variable. So, there are other things that are in play and not just the demographics.

I was interested to find out whether a country that ranks high in terms of ‘investability’ will also result in higher returns. In certain cases, those investable countries attract the most competitors and therefore, lower returns. What are your thoughts on that?

In our methodology, what I do is I correct for that because one of the things that is included here is GDP growth. If you think about GDP growth, it is a proxy for real returns on investment on average; real returns in a country. Naturally, if a country is in negative growth, negative growth economic-wise, it is not likely that when you go there you’ll make a serious amount of money, you might, depending on the sector, but not overall; profit is very low. So, the GDP growth factor tries to capture that return element and then balances that, that is counter-balanced by the risk factors as well. So, we are able to capture that in the index for the GDP growth factor.

I see that you are not only focused on FDI but also domestic investments. How have these faired over the past couple of years?

Domestic investment is now on the rise because it is also linked to some commodity price and trends in those countries are positive. Just as FDI is beginning to pick up. So, both of those types of investments are on the up and that’s a good thing. And the reason for bringing in domestic investment is because you also want to invest in a country where there is ease of doing business, even for domestic investors. So, that’s also a good signal and therefore, domestic investment is now a counterpart to FDI in a way and that’s been on the up.

Many African companies have complained that it’s often easier for a foreigner to come and do business in their country than it is for their own companies. Are we seeing the business environment being eased for domestic companies as well?

Yes, certainly, it’s improving for them; and that’s an important point you raise, which is, that is the case that domestic investors have felt that they’re the last in the queue. And that’s what we wanted to capture in this index as well, to say that look, if the domestic investors are not comfortable, you as a foreign investor should also not be comfortable because you need partners, you need counter-parts. So, over time, most of the domestic investors are also beginning to feel the impact of the ease of doing business in their own countries.

I was surprised to see Algeria score so highly. People say it’s still a difficult place to do business unless you’re a large or multi-national company and recently, they’ve made it even harder with the importation ban, etc.

What’s doing it for Algeria is that it has got low risk factors in terms of exchange rate risk, in terms of the debt levels, but also, it’s a large economy, so it’s a large market and there’s strong domestic investment flows as well. It is easy in liquidity, but it doesn’t do well naturally on this issue of exchange controls but it does well on the other factors. So, this tool tries to balance across factors.

I don’t know if you had the chance to look at the effects of an election for example. I have in mind Kenya here. Do you know if an election impacts a country’s investability, or a country’s appeal in that particular year?

Yes, it does. Our tool doesn’t capture that, and I decided that I don’t want to focus too much on the politics because there’s always an issue about politics in every African country. I don’t know an African country where there is no political issue. So, I thought, look, I want to steer away from that and focus on other factors that the country could really manage, regardless of the politics of the country, that’s what we tried to do here. But quite clearly elections are key. Every election cycle produces some strange environment for investors. Investors then tend to wait for the election to invest. Take Kenya for example, I think for a long-term investor in Kenya, there’s no need to wait. That’s my view. Because over time, things will be sorted out, in three to five-year to ten-year horizon. Kenya is always a good investment, regardless of the cycles. I think where the issue is, is for the short-term investor it’s an issue in that year and maybe the following year. But in our methodology, we don’t take that into consideration.

And I saw that Zimbabwe featured quite low in your ranking this year but if we see elections this year that the western and the international organisations deem fair and credible, then we will see new lines of credit, debt forgiveness, opening up of the market and a more conducive business environment. Would it be on your must watch list for 2018?

Definitely; and we said the same thing about Angola [last year] and we see that Angola has improved. We expect Zimbabwe to improve significantly within the next three years, exactly because of that improved growth, improved business environment. If there’s debt forgiveness and the deal with the arrears, the debt position is also going to improve. Everything will improve, absolutely it is on the watch list and we expect a significant movement there.

You have an interesting chart entitled risk premium and discount rate for countries and also, within that chart, there’s something called an implied PE multiple. Can you talk us through this?

We are using this investment index tool to come up with our own risk premium for each country. Now, then once we’ve done that is then to be able to say something about the right discount rate that you should be using as an investor in a business. Say, in Morocco for example, what we’ll do is come up with that risk premium calculation and then adjust that risk premium with the GDP growth of the country, because the higher the GDP growth, the lower you should discount future earnings and therefore, the higher the value of whatever you are investing in. Adjusting the risk premium with the GDP growth rate gives us the discount rate and then finally, the PE multiple is nothing other than 1 divided by the discount rate. That gives you the PE multiple, which is the price you should pay for any transaction. Let’s look at Zambia for instance. Zambia right at the end, has got a PE multiple just close to 6. So, you shouldn’t pay more than 6 times the earnings for any investment in Zambia according to this tool. Of course, this is an average figure but tells that 6 times multiple is the ball park for Zambian investments. But for example, for Malawi, you should only pay out 2 times multiple, so Malawi deals should be very, very cheap. In fact, they’re the cheapest. But in Mauritius, you will be paying PE multiples of 18 and above.

What would you say the common denominator is amongst the best performers and what sort of recommendations do you have for others to improve?

If I look at the best performers, they all do well in managing the risk factors and in doing business factors. Those are key. If you manage those risk factors and doing business factors, that will stimulate a further investment domestically but also external through FDI, drive growth and then the country moves up the rankings. So, clearly, those are the two critical factors.

And risk for you mean macro, so currency risk…?

It’s macro risk. Certainly, the macro risk is macro-economic management. One element which we added to our criteria is the Facebook penetration rate. What I was trying to do was come up with a measure of social cohesion, of the ability to network within a country. Hopefully, that networking ability results in business being done. Not only to get results in business. So, the Facebook penetration rate is a proxy for that. If you look at Morocco at number 8, Egypt at number 7, Algeria number 6, it’s not always indicative of the ease of doing business in a country, but I think t is a good signal. We’re looking at developing a similar index to cover the Middle East and the entire corridor of emerging economies globally. It will provide interesting benchmarks and will enable our clients to compare these metrics across different regions.