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Hedge Fund Interview with Jonathan Chew and John Legat of Imara Asset Management

Imara began as Edwards & Co in Zimbabwe in 1954. Robert Fleming UK then bought a stake in 1994. Following the purchase of Robert Fleming UK by JP Morgan, an MBO in 2002 saw the creation of Imara. This new company operates in much the same mould as the old Flemings with three divisions: asset management, stock broking and corporate finance. Imara has been central to the financial development of sub-Saharan Africa, having established several of the regional stock exchanges over the years. As well as running two open-ended funds, Imara manages institutional money for regional clients and offers a wealth management service to private clients in South Africa. John Legat is the lead fund manager on the Africa fund whilst Jonathan Chew covers North and West Africa, as well as marketing, from the UK.

Jonathan Chew was the CIO for Emerging Markets at GT between 1989 and 1997 and was an active investor in all the emerging markets - through South East Asia, the Indian sub-continent, Latin America, Turkey, Eastern Europe, the Middle East, Southern Africa and Central Asia – as they opened to foreign investment. John Legat headed up GT's investment team covering Eastern Europe, Middle East and Africa throughout the 1990s. Between them, they set up and managed GT's Africa Fund in 1995, the first such mutual fund of its kind. They both left GT in 1997, with John moving to Zimbabwe. He then established Fleming Asset Management, which is now the second largest local fund manager after Old Mutual with over 90 institutional clients and 800 private clients. He also helped establish Fleming Asset Management in Botswana. He has travelled extensively in the region, and has a long track record of managing assets in Africa. At the same time, Jon established what is now the Imara Global Fund.

  1. Could you briefly summarise your case for investing in Africa? What do you identify as the key regions for growth and why?

    Change for the better: political and economic. Markets reflect change at the margin, so the fact that African governments are becoming more accountable and that economies are restructuring and growing faster, albeit from a low base, is having a positive effect.

    Partly because governments have become more accountable and partly because of IMF – or closet IMF – programmes, fiscal deficits have come down over the past decade, inflation and interest rates have fallen and currencies are more stable.

    There are over 50 countries in Africa, ranging from the rich to the poor, from the well managed to the unmanageable. There are four distinct regions of growth, though several countries have interesting investment stories and/or themes:

    North Africa: The biggest market is Egypt, and the pace of industrialisation is accelerating as a swathe of industrial and financial reforms continue to deregulate what is still a highly controlled economy. Valuations in North Africa look destined to reflect those in the Gulf as Gulf investors move offshore.

    East Africa: Kenya dominates the region and is now an important regional manufacturing base and hub for tourism and horticulture. The market has historically been sensitive to change in political risk - which we would characterise as two steps forward, one-step back.

    West Africa: Nigeria is the largest economy in the region, but thanks to a long military dictatorship, is a largely de-industrialised, cash economy dominated by the public sector. Reducing the size of the public sector, import substitution and industrialisation are a priority, implying high productivity growth for many years to come. The government recently introduced a Chilean-style pension system.

    Sub-Saharan Africa: This is a group of resource-rich countries each driven by different factors. Botswana is a diamond economy with large structural inflows; recent financial sector reforms should force the large domestic pension fund industry and parastatals out of the short end of the yield curve (dominated by high yield sterilisation certificates) either along the yield curve or into the equity market. In Zambia, thanks to a large investment programme, copper production will soon be back to record levels following a decade of mismanagement. The country is also close to a region blessed with untold natural resource wealth. Two outliers, Angola and Zimbabwe, both possess large commodity resources.

    In terms of markets performance, surprisingly, the markets seem to ignore the many crises brought to the world's attention by the media. Last year, for example, the four countries that outperformed the MSCI Emerging Markets index in US dollar terms were Kenya (+46%) – drought, corruption; Malawi (+42%) – drought; Egypt (+156%) – political unrest; and Zambia (+125%) – AIDS. Zimbabwe was perhaps the most surprising; +14% in US dollar terms with everything thrown at it. A common theme across the former markets would be solid earnings' growth; in the latter, the market remains the best hedge against inflation for the pension fund industry.

  2. How does your recently launched fund, Imara African Opportunities Fund, fit in with the rest of Imara Asset Management's portfolio?

    Although only recently launched, the fund is really our flagship fund. Imara was born in Africa following an MBO by employees in the various Flemings' offices in sub-Saharan Africa after the sale of Flemings to Chase and JP Morgan. Our investment management footprint is in Africa, so it makes sense to market ourselves as African specialists. We also manage a global fund, institutional mandates in sub-Saharan Africa, including Zimbabwe, and we provide a private client wealth service in South Africa.

  3. What is your estimate of the size of the hedge fund industry in Africa? Which countries are the main sources of capital for these funds? Could you answer with reference to your fund?

    The hedge fund industry is really confined to South Africa where markets are more liquid – and more efficient.

    With the exceptions of northern Africa and South Africa, African markets are not liquid so hedging is not generally practical. Outside of Egypt and South Africa, hedge funds have largely focused on debt markets which will likely remain the case for some time to come.

    Our investors in the fund are local authority pension funds, private client managers and hedge fund managers for their personal account. The latter seem most attracted by the non-correlated nature of Africa and the scope for un-reformed outliers to improve in the way that Latin America did in the 1990s. It is because we cannot know when these latter markets will reform that we suggest investors take a 3-5 year view.

  4. What would you say are the key performing sectors in the region? What is the current sector-wise breakdown of the fund's assets? Does the fund actively pursue sector-wise diversification as well?

    We think buying anything above intrinsic value is risky, so buying two negatively correlated assets, if both trade above intrinsic value, is risky. We would much rather buy two assets at a discount to intrinsic value even if they were in the same industry.

    In practice, we look for sustainable business models first - companies that can provide their own free cash flow after capex. Because the cost of capital in Africa is high and capital is limited, Africa is about buying companies that can generate free cash flow - not investing in companies that are massive users of capital – such as mining.

  5. It is stated in your investment presentation that corporates with a sustainable business model are often monopolies or duopolies in Africa. How is this so?

    When the rules-of-the-game can change quickly, ie, where there is policy uncertainty, corporates require a fast payback on investment. Payback in 2-3 years implies a return on capital invested of at least 33%. The cost of capital is also high in this environment since banks also have to factor in the risk of policy uncertainty. Banks therefore rarely lend, except for working capital. In turn, corporates have to provide their own capital to fund investment through surplus free cash flow. Only corporates with a sustainable business model that can generate free cash flow can invest to expand. The big therefore gets bigger. Over the years, the "reward" for a sustainable business model is therefore often a monopoly or duopoly. Many such companies in Africa are locally listed subsidiaries of multinational companies. The beer market in Africa, for example, is a virtual duopoly.

  6. One of the fund's stated objectives is a 3-5 year investment horizon. Given the high policy uncertainty in the region, how frequently do you expect the portfolio to be reviewed and re-allocated?

    Each of the 15 or so investible countries in Africa is different with different drivers. In countries where the pace of industrialisation and growth is high, earnings, dividends and share prices seem to move hand-in-hand. Identifying good business models, buying below fair value then holding is the most sensible strategy. In countries where financial sector reform or political changes are driving events, it is more important just to be in the market early.

    In general, our objective is to hold about 30 stocks with sustainable business models. Too many, and good ideas start to get diluted.

  7. The fund employs a long-only absolute return strategy. Could you elaborate on the risk management practices in place?

    There are many risks in Africa, and our response to many of these is common sense. For example, corruption risk is minimised by looking for good multinational-run business models and political risk is minimised by holding a reasonably diversified portfolio.

    Currency risk is also hard to hedge directly, but in general, if a country is doing well, currencies will tend to firm. Asian demand for commodities is also tending to apply an upwards momentum to many African currencies. One interesting aspect of Africa is that some countries benefit from a rising US dollar, whereas others, like the vast majority of emerging markets, prefer a weak US dollar. However, the risk of a sudden reversal of capital flows by the investment community is reasonably low; much of Africa is still off the beaten track and does not appear in the indices.

  8. Who do you perceive are your key competitors? What edge does the fund have over them?

    Our office footprint is sub-Saharan Africa, and in sub-Saharan Africa ex-South Africa we are a big fish in a small pond. A big fund would naturally end up investing mainly in North Africa and the Gulf or in South Africa, thereby diluting some of the interesting regional changes that are, or could, happen. As far as we are aware, there are very few funds of this kind.

  9. What is your outlook for growth in the region in the near term?

    Growth rates vary throughout Africa, but some countries are pitching in with Asian levels of growth. Middle classes are starting to emerge in some countries; consumer demand is rising sharply in others. Many African countries have been experiencing growth of 5% or more for a number of years, with low inflation and stable exchange rates. Unfortunately, the international media only focuses on a few bad spots in Africa whilst overlooking the good ones!

Contact Details
Jonathan Chew
Imara Asset Management (UK) Ltd
+44 14 915 7723