Ashburton investments: Global perspectives - Issue 2

APR 2014 ISSUE TWO

Ongoing Evolution Spotlight on emerging markets

Q&A Global Outlook EMERGING MARKETS Keeping a lid on contagion Indian Elections The most important for a generation CHINA IN FOCUS Xi tightens his grip RISK PROTECTION The African business environment

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Global Perspectives

A part of the FirstRand Group

Electricity pylons in South Africa, Getty images

Cover image: An exterior view of the Arena Pantanal stadium under construction on November 17, 2013 in Cuiaba, Brazil Getty images

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Global Perspectives

Contents 04 Welcome

Ongoing evolution: delivering on our promise CEO of Ashburton Investments Boshoff Grobler provides a business update.

06 Q&A

Global Outlook The economic outlook is dominated by what is happening in emerging markets.

11 Emerging Markets

Emerging markets: keeping a lid on contagion Macro view: what is happening to upset the emerging market apple cart?

15 Emerging Markets

“Only a short period into his tenure, China’s Party Chief has already taken bold and necessary steps to create a much stronger foothold than his predecessor Hu Jintao.”

Indian elections: the most important for a generation What might these elections mean for the future of India?

19 Emerging Markets

China in focus: Xi tightens his grip Why developments in Chinese leadership and reform are looking positive.

23 Risk Protection

The African business environment How much do politics and government decision making matter to businesses operating in Africa today?

p19 CRAIG FARLEY,

Fund Manager, Ashburton Investments.

www.ashburtoninvestments.com

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WELCOME

Ongoing evolution: delivering on our promise In the first issue of Global Perspectives magazine I introduced you to Ashburton Investments as a new generation investment manager.

A new generation investment manager motivated by the needs of our clients with products tailored very specifically to their needs. Our vision is to provide all our clients with access to more: more sources of investment return and more ways of managing their investment risks.

BOSHOFF GROBLER,

CEO Ashburton Investments.

Since then we have been organically growing and evolving the business by bringing together component parts within the FirstRand Group, leveraging existing capabilities and building new operating platforms to help deliver on our promise.

Our Jersey team for example used to operate very much as a separate business. Now they benefit from additional investment, risk management and system capabilities throughout the Group, growing

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Global Perspectives

not only the head count significantly, but enhancing our proposition. Where possible we have leveraged what we already had, strengthening and growing existing teams, and where necessary we’ve recruited to fill any gaps in what we can offer clients. We have made additional appointments right across the business but by far the greatest benefit to our clients has come from leveraging across the jurisdictions.

We have also audited our products. We’ve taken a long hard look at our existing product range and we’ve closed down any that either no longer fitted our strategy or confused clients. And then we’ve begun to develop a range of new products in response to what clients have told us they want.

“You simply cannot be part of the growth story in Africa by investing purely in listed equity.”

Cape Town, Western Cape Province, South Africa, Getty

If we take Africa as an example: other investment managers continue to talk about the potential growth in Africa but because they only have an equity capability that’s the only avenue into Africa they can offer. You simply cannot be part of the growth story in Africa by investing purely in listed equity.

So at Ashburton Investments we’ve developed an Africa Equity Opportunities Fund investing in listed equity. We are also launching our Africa debt fund and our Africa private equity fund as a lot of the capital currently flowing into Africa and benefitting from that growth story is in unlisted equity and debt. We’ve also been introducing, and are continuing to develop, innovative new products along similar lines in the Indian and Chinese markets.

Delivering on our promise means more than just new products: over the last few months we’ve been greatly improving our existing platforms. The UCITS regulatory structure is one of the most prominent regulatory structures for mutual and alternative funds, so with this as a basis we’ve built a SICAV platform in Luxembourg, providing more clients with

better access to our products across a broad range of mandates.

In South Africa we’ve developed a new investor platform as a conduit to a variety of investment instruments such as collective investments, share portfolios and structured products. All of our products are now available to all of our clients through a single point of entry.

Our vision at Ashburton Investments remains the same: to become the preeminent new generation investment manager enabling clients to invest in the exciting African, Indian, Chinese and the Asian markets. And when we say new generation we’re acknowledging what clients have told us: that they want more than just traditional products; they want to be able to take advantage of opportunities in less accessible markets and, particularly, the emerging economies.

There has definitely been a five year love affair with emerging markets but with quantitative easing tapering we have seen a reversal of liquidity. With quantitative easing, as a consequence

of a lack of global growth, emerging markets have benefitted considerably from global liquidity. Global liquidity is now tapering and is likely to taper still further, so emerging markets are going to have to find ways to benefit from real economy mechanisms as opposed to pure liquidity mechanisms.

People say emerging markets have fallen out of favour but the truth is that while asset allocation to emerging markets isn’t generally on the increase, it hasn’t decreased either, with many of our clients choosing to invest in markets we can make available to them in Africa and Asia.

So our vision remains exactly the same.

What we’ve done within the business, the products we’ve brought to the market, and the platforms we’ve developed, are all intended to strengthen our position as a new generation investment manager providing our clients with access to more.

In building our business organically, clients have continued to allocate funds into our investment propositions.

What better validation of our approach could there be? /

www.ashburtoninvestments.com

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Q&A

Global Outlook Tristan Hanson shares his views on the global economy and the outlook for markets going forward.

TRISTAN HANSON,

Head of Global Asset Allocation, Ashburton Investments.

Q: 2014 has started with heightened

worries about emerging markets. Will developments here derail global growth?

No, we believe the US and Europe will accelerate this year. This will outweigh weaker growth in some emerging markets.

China is the big call here. We expect Chinese growth to remain solid at 7% to 7.5%. This is down from the peak years, but still strong. If China grows at this rate, the world economy should do fine in 2014.

A dramatic escalation in the current Ukraine crisis poses a risk to business confidence internationally but, shocking though recent Russian actions have been, we think a NATO military response is unlikely at this stage. If oil prices remain steady and a significant military confrontation can be avoided, the direct global economic impact should not be large.

Q: So we shouldn’t worry about the ‘Fragile Five’?

India and Brazil are large economies, but Indonesia, Turkey and South Africa are not that significant in a global context. Growth is likely to slow in these economies, but their trade balances could turn around fairly quickly, which may be the time when

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Q&A

sentiment improves. These economies do have their challenges though. Economic conditions may get tougher, and with each of them facing elections this year, investors are likely to remain cautious. However, we think a sovereign default is very unlikely in any of these countries.

Q: How are you positioned

in regard to emerging markets versus developed markets?

We remain slightly underweight emerging markets in our funds. However, we acknowledge that sentiment is very negative and valuations have improved.

Should we get to a point where sentiment seems likely to turn for the better, we would increase exposure but we’re not looking to do that imminently.

Q: Recent US data has indicated

weakness, possibly weather related.

Are you worried about the US economy?

Crowds on Nanjng Road, Shanghai, China, Getty

We do think that poor weather has played a large role in recent weaker data, so this should be temporary. Spring follows winter most years! Housing is in the early stages of a multi-year recovery in our view.

Consumer spending is supported by rising asset prices and a stronger labour market.

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Q&A

“Emerging market policymakers should look to their own actions to improve the economic situation.” >

Business spending should pick up as companies see stronger final demand. The shale oil boom is also a boost for the US.

Q: Does this mean the US Federal

Reserve (the Fed) will continue ‘tapering’ quantitative easing (QE)? Will they raise interest rates?

Yes, we think the Fed will continue to reduce additional QE, terminating the programme in the fourth quarter of 2014. Our base case is the second quarter of 2015 for the start of US interest rate increases.

Q: Wouldn’t that mean more bad news for emerging markets?

In our view, recent anxieties in emerging markets have more to do with domestic policies than the Fed’s QE programme.

Emerging market policymakers should look to their own actions to improve the economic situation. Heightened tensions should focus their attention for the better. The Fed has been quite transparent since September, so less QE should be reflected in prices today.

An early and abrupt US tightening cycle would put further pressure on emerging markets generally, but this does not seem a likely course of action for the Fed.

Q: UK growth has improved.

Will they raise rates soon?

We’re expecting a rate rise in the second quarter of 2015 at this point. We think the pickup in the UK is going to continue, but people’s expectations are quite high now. The perception of the UK economy until recently has been almost manic depressive – a year ago everyone thought

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Global Perspectives

we were about to go into a triple dip recession. Now everyone is thinking the economy is great and is growing rapidly.

We think the UK will continue to grow, but the market has begun to price that in now.

Q: Do you think sterling appreciation will continue?

It has probably done enough for now.

We favour the US dollar from here, but think the British pound will probably be stronger than the euro or yen.

Q: Can we say the euro crisis is over?

For the time being, yes. This is mainly because we’re in a cyclical recovery.

Unemployment looks to have peaked and the tensions in the financial markets are much lower than what they were.

Does this mean tensions will never return?

No – they could always come back if the region is subject to an extreme negative shock or if the political will to keep the euro intact is pushed too far. Greece’s debt situation still needs monitoring.

Q: How are you positioned in terms of asset allocation? What are your views on equities and bonds?

We’re currently overweight in equities, but have reduced that position into strength, on the basis that we were at maximum weightings and equities have had a very good run.

There is probably not massive upside in equities going forward, but we do think the world economy is recovering and therefore it is likely that bond yields will rise modestly over time, putting downward pressure

on capital returns. We think equities can continue to outperform over time, delivering modest positive returns.

We are slightly underweight in bonds.

Within the fixed income space, our largest overweight is still high yield corporate bonds. We think that developed market government bonds will battle to deliver a positive return in 2014, likely reversing the strong start to the year they have had.

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Shanghai, China, Getty

Q: Why hasn’t inflation been a threat

as we believe, we are probably close to the bottom in terms of inflation.

Simply because central banks control the money supply in the banking system, whereas commercial banks largely determine how much money gets into the wider economy. With people not wanting to borrow much (most people are trying to pay down their debt) and with banks not wanting to lend an awful lot, there hasn’t actually been much wider money creation, despite central banks ‘printing’ a lot of money.

Q: What is the biggest risk?

despite QE?

7%-7.5%

Chinese growth to remain solid

A pick up in inflation cannot be ruled out in the future, but this will likely be after a stronger period of global growth and tighter labour markets. While investors are currently concerned about deflation in Europe, if the global economy recovers

It all comes back to China. It has a bigger share of the world economy than it did ten years ago, so what happens in China is now far more important to the rest of the world. For the world to do well, we need China to be growing at a decent pace. As we have seen from previous market reactions to growth concerns in this region, any surprise on the downside poses a risk to the global economy.

Geopolitics will also be a risk always, but tensions in the Ukraine are particularly concerning. We expect a major military confrontation to be avoided but the situation is concerning and the risks high.

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Q&A

Spotlight on South Africa Emerging markets are very much in the spotlight. Paolo Senatore looks at this year’s developments so far from a South African perspective.

PAOLO SENATORE,

Chief Investment Officer, South African single manager funds, Ashburton Investments.

Q: What are your views on emerging markets?

We think many emerging markets are experiencing a similar problem in running twin deficits (current account and budget deficits). During the periods of quantitative easing, we saw portfolio inflows supporting emerging market deficits – and these inflows have now reversed somewhat as the prospect of reduced QE looms.

The combination of currency outflows and twin deficits leads to currency volatility and weakness, as we have seen. China, the most important emerging market, does not suffer from a twin deficit problem but concerns remain over risks in the financial sector.

Q: What’s the outlook for South Africa?

The South African economy is expected to grow at around 2.5% this year. There is something of a risk here because we’re going into a period of rising rates driven by inflationary pressure. However, the inflation issue isn’t necessarily demand driven in South Africa and 2.5% is below what is considered the long-term potential level of growth.

Consumer sentiment is also fairly fragile and would have benefitted from keeping interest rates low. If the trade balance improves, a resulting reduction in the current account deficit may well lead to support for the rand as the year unfolds.

Q: What’s happening with interest rates and inflation cycles in South Africa?

The first rate hike this year came as a surprise to most market players and was much earlier than we had anticipated. The reason for the early rate hike was as a result of worsening inflation expectations, largely due to the weakness in the South African rand. Obviously there is a need to control inflation in the South African context, which means keeping it below 6%. The Governor (of the South African Reserve Bank) is forecasting inflation at around 6.3% this year; this necessitated the first interest rate rise of 50 basis points. For the remainder of this year, we forecast a further 1% rise in the repo rate (so two rises of 50 basis points), and potentially another 1% during the course of 2015.

Q: What’s your positioning in terms of asset allocation?

Part of the problem with the South African economy is the current account deficit and the weakness in the rand.

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Global Perspectives

Equities are our preferred asset class as we go forward, but we are not expecting

the returns we had last year. The FTSE/ JSE Africa All Share Index returned around 21% over the last calendar year. It is unlikely that the equity market will be able to deliver these types of returns over the current calendar year. The bond market is expected to remain difficult with the potential for yields to drift upwards. So it’s shaping up to be a year of lower returns.

Q: What are your views on commodities?

We are seeing fairly robust global growth led by the acceleration of US growth and countries like China where the absolute levels of growth remain quite high. Europe is showing signs of a recovery though it may be somewhat fragile. We are expecting global GDP growth of around 3.5% in 2014. Theoretically this should be helpful for a country like South Africa that is dependent on a commodity cycle.

The difficulty is that the growth we are experiencing is consumer driven and is not necessarily resource-heavy or big on infrastructure spend, so this time we shouldn’t expect a strong commodity cycle. Our view on commodities is that they will trade sideways, so it could become more difficult for a country like South Africa to leverage strongly off that type of commodity cycle. /

Keeping a lid on contagion

Emerging markets

Recent bouts of volatility have put the spotlight firmly back on emerging markets.

DERRY PICKFORD,

Global Macro Analyst, Ashburton Investments.

Dramatic currency and stock market falls have been making headlines since the US Federal Reserve first hinted at tapering its quantitative easing programme back in May 2013. The first few months of 2014 have seen similar bouts of volatility, notably affecting emerging markets such as Turkey, South Africa and Ukraine.

Office block in Uganda, Corbis

Other emerging market ‘darlings’ such as Brazil, India and Indonesia also saw their fair share of market volatility in the second half of 2013, with the Indian rupee plunging by almost 28% between May and the peak in late August to reach a record low of 68.8 against the US dollar.

So what is happening to upset the emerging market apple cart? And are these isolated events that are simply part and parcel of emerging market investment, or is there a longer-term trend at play?

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Emerging markets

> Self-contained The popular image of emerging markets is that contagion is an endemic problem.

You only have to have one emerging market fall over and they all go down. In fact, statistically emerging markets have more of their own idiosyncratic drivers than developed markets do. Crises in developed markets may be fewer but they’re more likely to spread to other developed markets. The classic example of contagion is the 1997 Asian Crisis but even here the underlying drivers of the problems in different economies were very different and the trajectory of the economies afterwards also very diverse.

One of the main reasons for this idiosyncrasy is the enormous diversity in both policies and position in the economic cycle among emerging markets. Take Mexico and Brazil, for instance. Mexico has made great progress on its supplyside reform process. Brazil on the other hand has a long reform journey ahead of it.

These two economies also differ massively where they are in their monetary cycles.

Brazil has hiked interest rates by 3.5% to 10.75% and its last communiqué signalled that they were coming towards the end of their rate hiking cycle. Mexico by contrast has had only rate cutting phases since the financial crisis. Despite these significant differences, investors often view the two countries in tandem.

Policy approaches Amidst this diversity, many emerging market countries do face similar developmental challenges, however.

This is especially true where fiscal and monetary policy is concerned. In South Africa, growth potential is significant, but the policy mix is yet to strike the right balance. In Brazil, fiscal policy is very loose, yet the central bank has been disciplined in keeping inflation within its designated band (far more so than the Bank of England). Turkey, on the other hand, adopted very unorthodox monetary policy when it was suffering from a surge of capital inflows. Rates were cut too far, and even when the economy began to stabilise, no action was taken to rein policy back in.

Another country where fiscal policy has been very loose is India. Monetary policy also failed to deal with a pick up in inflation in the country. With Indonesia also demonstrating poor supply side policy and struggling with a divided labour market, it is clear that policy hurdles are widespread among emerging markets – and that lessons are still being learned by many developing countries’ leaders.

Indeed, many of us are guilty of considering emerging market economies ‘en masse’. Perhaps this mind-set is a result of well-publicised acronyms such as the BRICS or CIVETS, newer terms such as the ‘Fragile Five’ and the ‘Vulnerable Eight’, or quite simply an old fashioned divide between ‘developed’ and ‘developing’. Whatever the reason, taking a broad brush view of emerging markets is no longer effective – it is important to differentiate between emerging market economies, making country by country judgements, to see the real picture. After all, these are diverse economies at very different stages in their monetary cycles.

Petrobras world headquarters in Rio de Janeiro, Getty

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EMERGING MARKETS

“In Brazil, fiscal policy is very loose, yet the central bank has been disciplined in keeping inflation within its designated band.” www.ashburtoninvestments.com

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Emerging markets

Fragile 5 FDI Inflows % GDP (Values from 2014 Oxford Economics Forecasts) 6

4

2

0

-2

-4 80

85

90

95

00

5

10

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Mistakes of the past have been taken on board, however. The 1997 Asian financial crisis highlighted the dangers of allowing banks and governments to borrow in (cheaper) external currency: namely that jumps in the foreign currency can significantly increase the value of the underlying debt. The good news is that today, the majority of emerging market government borrowing takes place in domestic currency instead. There are also strict controls placed on banks, stipulating that foreign currency borrowings must be hedged. Unlike in 1997 exchange rates are now largely floating. This has encouraged foreign exchange hedging of foreign currency denominated borrowing. Foreign exchange reserves are typically much larger and because exchange rates are no longer pegged, they are less likely to be frittered away defending an unsustainable rate.

However, we should be far from complacent. Borrowing in external markets by non-financial emerging market corporates has increased significantly.

This is particularly true in India. According to research by the Bank for International

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Global Perspectives

25

30

35 Source: Fragile 5

Turkey India Indonesia Brazil South Africa

>

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Settlements, a large proportion of this borrowing is being carried out by offshore entities. If this external borrowing is then repatriated, this will show up in the balance of payment statistics as foreign direct investment (FDI). Investors should therefore be aware that if large proportions of quoted FDI figures are in fact corporate borrowings being repatriated by offshore entities, these flows could potentially reverse. In short, FDI should not necessarily be relied upon as a steady source of capital for emerging market economies.

as these countries do not try to defend their exchange rates too aggressively and allow moderate depreciations, they should avoid any crisis situations.

Food for thought

Individual countries also have extremely exciting stories to tell. India, for instance, has made huge improvements in controlling inflation. There is also a new inflation committee which is looking to implement an impressively low inflation target of 2% to 6%. If this can be maintained, then the exchange rate should reach fair value and rebalancing of the economy should be achievable.

While it may seem that investors have many points to consider when it comes to emerging markets, there are strong positives supporting the rationale for investment. Default risk in emerging markets has come down substantially in recent years, for example. In fact, a number of emerging markets now have foreign exchange reserves greater than their external debt and have current account positions that are benign.

Even if we get capital flight, as long

One of the best times to invest in emerging markets is actually when scepticism about emerging market economies is at its highest; since this is reflected in valuations. Naturally, not all emerging market assets represent good value for money today, but there are certain types of assets which are not pricing in the macroenvironment correctly. These ‘dislocations’ are a great opportunity for investors and your investment manager will be able to assist in identifying these sweet spots. /

EMERGING MARKETS

Indian elections: the most important for a generation We are again about to witness one of the modern world’s greatest achievements – Indian elections and her lively democracy.

Jonathan Schiessl,

Head of Global Equities, Ashburton Investments.

The country has a number of things going for it: an increasingly positive demographic outlook, an economy rapidly moving up the global rankings and a host of corporates gaining scale internationally all make India a compelling investment proposition.

And yet the last couple of years have seen much of the gloss of the India story fade.

The children in tricolor formation at the Historic Red Fort, on the occasion of 66th Independence Day, in Delhi on August 15, 2012, PIB India

Economic growth has been anaemic by recent standards, corruption scandals have hindered government and India is seemingly regularly out-manoeuvred by her biggest rival China in global geo-politics.

But all this should be about to change.

India is on the cusp of an election, the result of which could over time radically alter India and her place in the world.

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EMERGING MARKETS

> The current economic picture Before we delve into the politics, it’s worthwhile to recap where we are today.

India has just posted third quarter GDP growth of 4.7% for 2014, whereas most of the last decade growth averaged somewhere between 8% to 10%. It is a measure of how far expectations have deteriorated that the latest GDP print didn’t disappoint the market. As well as slowing growth we have seen an acceleration in inflation and a worsening fiscal and trade position. There are many reasons we could highlight to explain India’s current woes, but we attribute the most important factor to a breakdown of government.

India’s current Congress-led administration was elected to much fanfare in 2009.

However, the government was soon embroiled in extensive corruption scandals that reached the very highest levels of the administration. The good news was that finally corruption and crony capitalism was being exposed, the bad news was that the effect of this was to bring most government departments to a standstill

as every decision was examined and reexamined to look for signs of graft. One area particularly hard hit was investment.

In an infrastructure deficient country such as India this is particularly damaging, as obtaining the necessary government permits and approvals ground to a halt.

The overall result was a fall-off in investment that subsequently hit growth and therefore government revenues, and crucially clouded growth expectations which are so necessary when planning corporate spending. India was embroiled in a downward spiral.

500

The number of different languages spoken

Over the last year however, we have begun to slowly move forward. A new Finance Minister and a new Reserve Bank of India governor have between them begun to instigate some policy actions that have at least put a floor under the current growth rates. Expectations are now fairly consensus that India has bottomed and we will see a gradual acceleration in growth going forward, albeit nothing in comparison to a few years ago. With this brief economic picture in mind, let’s turn to the politics and highlight why the upcoming election is perhaps the most important one in a generation.

India’s Congress Party president Sonia Gandhi poses with her ink-marked finger after casting her vote in the Delhi state assembly election in New Delhi on 4th December, 2013, Getty

Indian labourers clean the glass facade of building in Mumbai, India, Corbis

“Modi is the great hope of many as the leader that can put India back onto its rightful course through a combination of good governance, reforms and charisma: the Thatcher of India.”

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Global Perspectives

Elections in India are a marvel A total of 543 seats are up for election in a country of nearly 1.3bn people spread over 28 States, with diverse topography and nearly 500 different spoken languages; a logistical headache for anyone. The election will start on 7th April, take place over several tranches with the last one on 12th May. Exit polls should be out on the same day (these are usually fairly reliable) and final results on 16th May. The last two elections have been won by the Congress party and its allies, with the Prime Minister being Manmohan Singh but the real power held by Sonia Gandhi.

Congress has long been considered more centre-left in Indian politics, with a focus on

the rural, lower income demographic. The main opposition party is the Bharatiya Janata Party (BJP), which in the past appealed to predominantly Hindu urban centric voters of a more centre-right disposition. Narendra Modi is the Prime Minister candidate for the BJP. There are also more than 40 regional parties, which have been gaining more importance over the past few decades at the expense of the two main pan-Indian parties. This disparate block is known as the Third Front.

In addition the Aam Aadmi Party (AAP) was launched in 2012 with a focus on an anticorruption agenda. The party is otherwise known as the “Common Man Party�.

We now must consider why this particular election is so important. It is for two reasons: firstly, the current administration

has been particularly inept, for reasons already highlighted. The formation of any stable government from this election is likely to at least prod from slumber some of the capex sidelined due to sheer bureaucratic inaction or companies’ feeling of uncertainty. The second reason is simply Narendra Modi, the leader of the BJP. Modi is the great hope of many as the leader that can put India back onto its rightful course through a combination of good governance, reforms and charisma: the Thatcher of India. He has been the Chief Minister of the state of Gujarat since 2001, during which the state has rapidly outperformed other states in India. He is not however without controversy. Modi was the Chief Minister in 2002 when

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EMERGING MARKETS

Assembly Elections in Bangalore, India, 5th May 2013, Corbis

> religious riots broke out in Gujarat killing

over 1,000 people, mostly Muslims. While he was never charged in connection to the riots, some of his close associates were convicted of inciting violence. Turning the large Muslim vote (c.15% of the electorate) his way will be a significant hurdle.

The BJP campaign is very much centred around Modi, and his strong economic credentials. He has vowed to bring to the rest of the country his economic expertise and strong growth bias. We are even hearing his economic philosophy being called “Modinomics”. If he indeed does become the next PM, he will face daunting expectations that will be set against India’s system of government that will present significant hurdles to rapid change.

That said, India does have a history of strong leaders accomplishing much.

Before we get ahead of ourselves, what are the actual polls saying and how are we positioned running into this election?

The latest polls are indicating the BJP is the leading contender to form India’s next government. With 270 seats needed to form a stable government a number of permutations present themselves, which will likely impact financial markets:

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Global Perspectives

• Any BJP win of over 200 seats should be considered a good result. The party should then quickly form a stable government with three to four other regional parties. If this happens, Congress and its allies will probably gain less than 100 seats – a disaster for Congress.

This would be market positive.

• Any BJP win of more than 220 seats would be a significant mandate from the electorate for growth and change. The market reaction would likely be very positive.

• A BJP win of less than 200 seats, with a corresponding better vote for Congress and the regional parties would be market negative. Forming a stable government in this scenario would be problematic.

Of course, with two months of campaigning remaining we cannot rule out changing poll dynamics. And Indian polling has been reliably unreliable in the past!

How therefore should we position our investments in India with an imminent election?

Trying to second-guess the Indian electorate is a fraught strategy at the best of times, even if we are confident that Modi

MAY

35

The number of days the Indian election will last

543 The number of seats that are up for election

will be India’s next PM. Experience has taught us that from an equity perspective we would rather stick to our philosophy and process when selecting companies to invest in, rather than speculating which company will benefit more from whatever election outcome. If Modi posts a convincing victory and subsequently delivers on his economic agenda then we will certainly have to factor that into our considerations. But if that pans out, there is every likelihood that the rest of the world will have to as well... /

CHINA IN FOCUS

Xi tightens his grip January’s global equity market wobble provided a timely reminder of the old adage, ‘if the US sneezes, the world catches a cold’.

CRAIG FARLEY,

Fund Manager, Ashburton Investments.

In this case, however, symptoms ranged from a mild case of the sniffles in developed markets to a severe case of man-flu in emerging markets, notably the Fragile Five (Brazil, India, Indonesia, South Africa and Turkey) on account of their sizeable current account deficits and vulnerability to capital flight. Investors voted with their wallets, pulling $12 billion from emerging market funds in January, versus $15 billion of outflows for the whole of 2013.

The Great Hall of the People, where the Chinese Communist Party plenum is held, seen behind red flags in Tiananmen square in Beijing, Corbis

A common response to bouts of larger than usual volatility and/or dislocation in the financial markets is to label the event as a blanket ‘risk off’ trade. Yet this assumes the emerging markets are a homogenous group of countries with similar prospects, policies and valuation propositions. We have sympathy with the view that alongside

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EMERGING MARKETS China’s President Xi Jinping during a welcoming ceremony at the Great Hall of the People, Beijing, 13th November 2013, Corbis

“China has its issues, but when viewed in a broader context, some very positive developments are taking shape.” > structural economic frailties, the Fragile Five all

face the prospect of national elections in 2014 – with a diverse picture of possible outcomes and risks – which brings into question the notion of fundamental reform, at least in the short term. Comforting as it is to view all emerging markets under the same lens, we believe a high degree of differentiation exists within the emerging market universe.

It is here that China stands out.

As the biggest developing economy and the largest component of the MSCI Emerging Markets Index, China remains burdened by its own worries. Weakening data and associated decelerating growth in the economy have been a consistent message in the investment community for some time, alongside the perceived ‘moral hazard’ in its banking system, with the opaque area of trust products viewed as the tinderbox that will trigger its inevitable collapse. Yes, China has its issues, but when viewed in a broader context, some very positive developments are taking shape, particularly in the areas of leadership and reform. In sharp contrast to the Fragile Five, China’s political direction for the next decade was established back in 2012.

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Global Perspectives

Last November, the Third Plenum came and passed, typically nonchalantly. Despite the intense media coverage and elevated expectation running up to the China Communist Party (CCP) meeting, the initial outcome as far as equity markets were concerned was a damp squib. Outdated Maoist language and political slogans littered the communiqué, before the leaking of the Decisions Document almost as soon as the Plenum had concluded gave renewed cause for optimism. The nature and path of reforms to 2020 demonstrated enormous ambition in the intent of the CCP, yet it was clear from the outset that the onus would be on execution and implementation.

We would argue far more progress has been achieved than the consensus believes, evidenced by the dearth of media coverage on the subject. We wrote shortly after the Plenum, ‘through a combination of astute political manoeuvring and the setting up of two new groups to oversee; 1) the reform agenda, and 2) domestic and national security, Xi appears to have effectively and efficiently consolidated his powerbase’. Only a short period into his tenure, China’s Party Chief has already

Martial arts group practicing tai chi along Huangpu River promenade beneath Pudong skyline at dawn, Corbis

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taken bold and necessary steps to create a much stronger foothold than his predecessor Hu Jintao.

Late January of this year saw the crystallisation and inaugural meeting of these two key new decision-making bodies, although both went largely unnoticed. First, the Leading Group for Overall Reform has quickly seen its powers extended from the purely economic boundaries announced back in November to a wide-ranging sphere of responsibility including the economy and ecology, democracy and the rule of law, culture, the social system, ‘Party

Building’ and discipline inspection. Second, the National Security Commission has also seen its mandate broadened out to the allencompassing task of ‘making overall plans and co-ordinating major issues and major work concerning national security’. Both steps would ordinarily be seen as merely an additional layer of government, were it not for the introduction of a common denominator. Xi is chair of both Party bodies (in addition to leading the Central Military Commission and assuming roles of General Secretary and State President).

His appointments have been swiftly followed by moves to place trusted

and loyal high ranking officials at his side.

Areas such as foreign policy, domestic security and even police enforcement have all been brought in-house.

What we are witnessing is part of a larger trend at work; a conscious and directed attempt to bolster the Communist Party’s supremacy over the government, augment the power of Party Chief Xi (remember his term does not expire until 2022) and provide more coordinated decision-making, while removing deep-rooted systemic problems and vested interests. Evident from the initial disclosure of the Detailed

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EMERGING MARKETS

2022 The year when the current Party Chief Xi’s term expires

The Sixth National People’s Congress in Peking, China, Corbis

“Managing China’s slowdown is likely to be the biggest test of the current leadership.”

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Global Perspectives

> Document was Xi’s efforts to place himself

squarely behind the programme and its reform agenda. It would appear that Xi now believes he is capable of achieving a consolidation of economic, political and strategic policies that China desperately requires if it wants to succeed in increasing efficiency through market mechanisms without relinquishing Party control.

The ultimate objective of reform is to make the path of economic growth more predictable and sustainable, yet in a system as complex and interconnected as China’s, unleashing this programme is likely to be disorderly and disruptive.

Certain areas such as hukou, urbanisation, the environment, agriculture, healthcare and state-owned enterprise reform could be considered lower hanging fruit (and indeed are already being addressed), but there are plenty of issues likely to give Xi restless nights in the months and years ahead. A large and aspirational

middle class is becoming increasingly frustrated with issues such as corruption, media control, pollution, food safety, as well as energy and water resources.

Managing China’s slowdown is likely to be the biggest test of the current leadership.

The key question is whether the risk of implementing and executing the reform plan outweighs the need for change.

Xi has made his intentions clear and the blueprint to 2020 along with recent political developments reaffirm the Party’s view that reforms are the best way to tackle China’s structural problems. The key remains implementation, but we are already encouraged by Xi’s initiatives and will be watching events closely through 2014. Within our Chindia Equity Fund, we continue to focus on strategic policy response beneficiaries (agriculture, clean energy, insurance, oil and gas) where visibility and the prospect of positive structural change are greatest. /

The African business environment

risk protection

How much do politics and government decision making matter to businesses operating on the African continent?

PAUL CLARK,

Fund Manager, Ashburton Investments.

Kathy Davey,

Equity Research Analyst, Ashburton Investments.

If you had asked the Asian business community in Uganda this question in August 1972, when they had been given three months to leave the country by Idi Amin, the answer would have been – a lot! However, in many countries the political environment in the last decade, although not providing a very business friendly environment, has been rather benign to business.

Adapting to compete

The longest iron ore train in the world between Zouerate and Nouadhibou, Mauritania, Africa, Corbis

Businesses across the continent have adapted their operations to accommodate the environment in which they find themselves. They have, for example, learnt how to operate in conditions where infrastructure is poor, where service providers are unreliable or non-existent and have adapted their business practices to avoid using the judicial system.

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Mauritius Commercial Bank, supplied by GEUSTYN & HORAK (www.g-h.co.za)

“Politics and government decision making matters less if businesses manage to manoeuvre themselves around punitive government policies, laws and regulations.�

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Global Perspectives

risk protection

> In essence, politics and government

decision making matters less if businesses manage to manoeuvre themselves around punitive government policies, laws and regulations. However, if for instance, a government decided to address poor investment in the power sector, this would mean that the cost of doing business would reduce, thereby causing a positive effect on existing businesses. Businesses could even consider new product lines made possible by the changing environment. Think of the current cost of managing the cold chain for ice cream distribution in Nigeria: without stable grid power the expansion of this product line for consumer companies is limited.

However, as power improves over the next few years in Nigeria this should be a strong growth area for FMCG companies.

Enforcing legislation The enforcement of existing legislation can be poor, especially at borders, and this can affect businesses negatively.

A common theme when visiting tobacco companies across the continent is the level of contraband or counterfeit goods entering the markets without duty or excise taxes being paid on them. Even though the government and formal business interests are aligned in this case, implementation can be weak. There are, for example, estimates that up to 30% of all cigarettes sold in Egypt early in 2013 were illegal in some form or another, but improved border controls have reduced this to 5% in 2014 – a boon for both the formal economy and the taxman.

So is it easier to run businesses in Africa today and is it going to get better?

There is certainly a correlation between improved government policies, a more stable political environment and the ease of doing business in Africa. Let’s look at

the World Bank and IFC survey on “Doing Business” globally to get an idea. We have chosen the distance to frontier measure from the data, which shows how far on average an economy is from the best possible performance in the world – an increase therefore shows improvement relative to the global business environment. This is depicted in the chart below for the years from 2006 to 2013 where we have combined data to show an Africa ex South Africa trend as well as some selected African countries.

In all eight years we have shown the “Global Best” country for ease of doing business, which improved from 90% to 92% over the period. We show Mauritius, which is reported as the easiest place to do business in Africa in every year from 2006 to 2013 according to the survey.

It has improved from 63% to 74% over the period, putting it ahead of Spain, >

Distance to frontier (percentage points) The distance to frontier measure shows how far on average an economy is from the best performance in the world.

95 85 75 65 55 45 35 25 2006 2007 2008 2009 Global Best Mauritius Rwanda Egypt, Arab Rep.

Sierra Leone Africa ex SA Mali Burkina Faso

2010

2011

2012

2013

Source: The World Bank and IFC, Doing Business 2013

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risk protection

“There is certainly a correlation between improved government policies, a more stable political environment and the ease of doing business in Africa.”

So how different can it be?

Why invest in African listed equity markets now?

African equities historically provide strong risk-adjusted returns 25.0% Egypt

Annualised return

20.0% 15.0%

Africa ex SA

10.0%

SA

Emerging Markets Frontier Markets

5.0%

S&P 500

Nigeria

World

0.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% Annualised risk Indices used: Africa ex SA = MSCI Emerging Frontier Markets Africa ex. South Africa; Egypt = Cairo and Alexandria Stock Exchange (“CASE”) Top 30; SA = FTSE/JSE Africa All Share; Emerging Markets = MSCI Emerging Markets; Nigeria = NSE All Share; Frontier Markets = MSCI Frontier Markets; US = S&P 500; World = MSCI World.

Source: Ashburton, Bloomberg, 2013

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Switzerland and Israel. On the other hand, countries that have emerged from quite difficult domestic situations, like Rwanda, Sierra Leone and Mali, have shown significant improvements over the past few years. But most encouraging is the trend we see for the continent as a whole (excluding South Africa) – a change from 43% to 51% over the period.

This data shows that even as the world has become easier and easier to do business in, Africa has improved faster than that.

Of course the continent is not a uniform space and Nigerian traders in Zimbabwe who now have to find a local partner for their business may be finding things trickier. However, we are encouraged by the trend in the leading economies and regional leaders where the pace of improvement tends to be increasing.

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Global Perspectives

Concluding expectations Going forward, as governments get better at policy making and more importantly at implementing policy, we will see effects on the business community. Some of these will not be well received in the short term, for example better tax collection with fewer opportunities to avoid taxation as legislation is tightened to remove loopholes.

On the other hand, better enforcement of existing legislation by, for example, reducing the smuggling of illegal imports or counterfeit goods, will have a positive impact on businesses that are negatively affected by these goods.

But, in general, the costs and ease of doing business should improve, allowing businesses scope to expand and flourish on the African continent. /

Let’s use sin taxes as an example East African Breweries (EABL) – a Diageo subsidiary based in Nairobi, Kenya – introduced a low priced and low cost beer in 2004 called Senator. This was a joint project with the government of the day to try and reduce the drinking of illicit brews, which was causing severe health problems and deaths in poorer communities. For this reason it attracted no excise duties and was sold primarily in informal settlements in draft format. After a successful constitutional process, the new Kenyan government decided to tax Senator at half the rate of normal beers, but this resulted in a more than 60% increase of the retail price. At some point this is said to have had the effect of reducing volumes by 85% in October last year, severely impacting EABLs profitability.

On the other hand, in Egypt, where the excise duty on cigarettes is based on the recommended retail selling price, the new Egyptian government noticed that retailers were selling above the recommended price. They issued a new price list to harmonise the official and market prices and to reduce tax evasion, thus implying higher government tax revenue, but this also allowed the listed monopoly producer (Eastern Company) to lift their ex-factory prices. As a result revenue forecasts for the company have been raised by 8% and earnings forecasts by as much as 40%.

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