Generating sustainability alpha in

African equity markets

Greg Barker, Director, Head of Research and Portfolio Manager

SUSTAINABLE CAPITAL

TBLI CONFERENCE 2010

5. TELECOMS

4. RETAIL / MANUFACTURE

2. COPPER MINING

1. BANKS

3. STEEL

Case studies of

sustainable

investment practice

in Africa ex-SA

(Source: Sustainable Capital,

proprietary in-house research)

‘Sustainability alpha’ case studies

• In-house, proprietary research conducted in-situ by Sustainable Capital

• 250 management interviews / site visits over 2 year period in Africa ex-SA

• Detailed company sustainability assessments covering > 100 companies

• Country sustainability assessments across Africa

• Measuring ‘sustainability alpha’: Portfolio attribution

• Time periods: Since inception or event-driven

• Total returns in USD, relative share prices in common currency

1. Nigerian Banks: Sustainability analysis

• Human capital: Talent, sustainability intelligence, management

• Quality of corporate governance: Transparency and alignment

• Sustainability footprint of loan book: Underlying exposure

• Integration of ESG into lending practices

• Stakeholder capital: Central Bank, regulatory interventions

Nigerian Banking Crisis (2006-2010)

Peak of the equities

bull market

US / European

financial crisisNigerian

banking crisis

NIGERIAN BANKING CRISIS:

• Margin lending (stock market)

• Downstream oil and gas

• Loan book quality: NPLs 19-48%

• CEOs and Exec Directors fired

Nigerian Banking Crisis (2009-2010)

Nigerian

banking crisis

GUARANTY / INTERCON

Nigerian

banking crisis

1. Nigerian banks: Lessons learnt

• Major divergence in corporate governance

• Chronic mispricing of material sustainability risks (measured by PB ratios)

• Nigerian banking crisis: Catalyst for recognition of quality

• Sustainability reflected in financial performance (loan book quality)

• Shareholder value destruction / creation (PB ratio x book value of equity)

• Stock selection: Sustainability alpha

2. Copper Mining: Sustainability analysis

• Sustainable investment in mining companies: A contradiction in terms?

• Business quality: Management ethics, anti-corruption / bribery practices

• Sustainability footprint: Life cycle impact, mining method, rehabilitation

• Country sustainability risk: ‘Title, title, title’ (contract enforcement)

• Political stability, control of corruption, rule of law, infrastructure quality

• Stakeholder capital and licence-to-operate: Secure energy / water

• Impact on society, safety track record, community / government relationships

Copper Mining

Commodities boom

Kolwezi DRC USD787m

asset expropriated

Country

sustainability

alpha

Katanga moves into

loss-making position,

USD250m rights issue

DRC Government

‘reviews’ mining rights

EQUINOX (ZAMBIA) / KATANGA (DRC)

EQUINOX (ZAMBIA) /

KATANGA (DRC)

Katanga mining:

• Exceptionally high country risk

• Poor sustainability practices

• Material value destruction

Katanga moves into

loss-making position,

USD250m rights issue

2. Copper Mining: Lessons learnt

• Country risk: Rogue governments and contract enforcement

• Where ‘doing the right thing’ makes no difference

• Supplement company and industry-specific analysis

• The case for selective negative screening

• Poor quality company + Peak of the cycle = Value destruction

• Sustainability analysis = Focus on downside risk

3. Egyptian Steel / Aluminium: Sustainability analysis

• Energy security: Nile upstream political risk of hydro

• Competitive landscape (gas vs. coking coal)

• Eco-efficiency: Energy prices, water security, raw materials

• Technology: Arc vs. Blast, Scrap vs. Ore, hot vs. cold rolling

• Product life cycle: 2 tons CO2 per ton ore, Fe purity

• Legacy environmental liabilities: Off B/S

• Disclosure and transparency

Egyptian Steel / Aluminium Industry

Commodities boomPeak of steel

rebar prices

Ultra low-cost

producers gain

market share

Bottom of

commodity

cycle

Egyptian Steel / Aluminium Industry

EZZ STEEL / EGYPTIAN STEEL

EZZ STEEL:

• Family owned and controlled

• Ultra low cost in ‘conversion’ terms

• World class technology, asset quality

• Fe purity 67.5% converted 94%

• 6,500 employees make 5.8mt steel

Egyptian Iron and Steel:

• Parastatal, operationally inefficient

• Resource hungry (Fe 13-16%)

• Fundamentally uncompetitive

• Reliant on government business

• 14,000 employees make 1.0mt steel

3. Egyptian Steel / Aluminium: Lessons learnt

• Management quality: Paint the building white!

• Transparency: ‘Where there’s smoke, there’s fire’

• Legacy socio-environmental liabilities: Capex implications

• Operating and resource efficiency: Position on cost curve

• Quality premium emerges when commodity prices fall

• Protectionism and tariffs can unwind quickly

0.0

7.0 7.0

3.3

4.4 4.3

0.2

2.2

3.1 3.3 3.5

6.35.9

-2.5

0.0

2.5

5.0

7.5

10.0

1-Nov-09 1-Dec-09 1-Jan-10 1-Feb-10 1-Mar-10 1-Apr-10 1-May-10 1-Jun-10 1-Jul-10 1-Aug-10 1-Sep-10 1-Oct-10 1-Nov-10

Alp

ha

(to

tal r

etu

rns,

USD

) AFRICA SUSTAINABILITY FUND: ALPHA (MSCI AFRICA EX-SA)

13.1

16.3

7.1

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

1-Nov-09 1-Dec-09 1-Jan-10 1-Feb-10 1-Mar-10 1-Apr-10 1-May-10 1-Jun-10 1-Jul-10 1-Aug-10 1-Sep-10 1-Oct-10 1-Nov-10

Tota

l ret

urn

s (U

SD, %

)AFRICA SUSTAINABILITY FUND: PERFORMANCE SINCE INCEPTION (1 YEAR)

AFRICA SUSTAINABILITY FUND (gross of trading costs and fund expenses)

AFRICA SUSTAINABILITY FUND (after trading costs)

MSCI AFRICA EX-SA

0.0

7.0 7.0

3.3

4.4 4.3

0.2

2.2

3.13.3

3.5

6.3

5.9

0.0

3.9

1.8 1.82.1

2.5

-2.1

-0.9

0.0

0.9

-0.5

-0.9

1.4

0.0

3.2

5.2

1.5

2.3

1.8

2.3

3.2 3.1

2.4

4.0

7.3

4.6

-2.5

0.0

2.5

5.0

7.5

10.0

1-Nov-09 1-Dec-09 1-Jan-10 1-Feb-10 1-Mar-10 1-Apr-10 1-May-10 1-Jun-10 1-Jul-10 1-Aug-10 1-Sep-10 1-Oct-10 1-Nov-10

Alp

ha

rela

tive

to

MSC

I Afr

ica

ex-S

A (t

ota

l ret

urn

s, U

SD)

AFRICA SUSTAINABILITY FUND: SUSTAINABILITY ALPHA

TOTAL ALPHA

FUNDAMENTAL ALPHA

SUSTAINABILITY ALPHA

Fun

din

cep

tio

n

Performance (USD, total return,

gross): 1-Nov-2009 to 1-Nov-2010

MSCI AFRICA EX-SA

FUND RETURN 13.1%

BENCHMARK RETURN 7.1%

FUNDAMENTAL ALPHA 1.4%

SUSTAINABILITY ALPHA 4.6%

TOTAL ALPHA 6.0%

PORTFOLIO BETA 74.9%

TRACKING ERROR 6.5%

INFORMATION RATIO 0.92

SORTINO RATIO 1.56

STANDARD DEVIATION 6.50

DOWNSIDE DEVIATION 3.82

SINCE INCEPTION (1 YEAR)

AFRICA SUSTAINABILITY FUND

Conclusions

• Major divergence in company sustainability performance

• Chronic and material market inefficiencies

• Unlock mispricings over long-term time horizons

• Integrating sustainability performance into portfolio construction

• Performance attribution: Measuring ‘sustainability alpha’

• Downside risk protection: Reflected in risk-adjusted returns

• The good news: Above-normal ability to generate alpha

• The bad news: No stuffed chairs!

Generating sustainability alpha in African

equity markets

Greg Barker, Director, Head of Research and Portfolio Manager

SUSTAINABLE CAPITAL

TBLI CONFERENCE 2010

Questions and Discussion

4. Retail / Manufacture: Sustainability Analysis

• Sustainability practices: Integration into core business strategy

• Measured against best international practices

• Product life cycle impact: Supply chain, positioning for consumer trends

• Governance and family businesses: An African paradox

• Ownership of physical shares, minority risk

Consumer Retail / Manufacturing

Regulatory risk

poorly mitigated by

management

Structural shifts in demand for end

products linked to product life

cycle impact

Anti-smoking bill passed in Egypt

New tobacco tax

increase prices by

100%

Disclosure: Opportunities of imperfect information

PZ CUSSONS / EASTERN TOBACCO

Eastern Tobacco:

• 66% Government owned

• Protected monopoly

• 40% of Men over 15 years smoke

• > 80% of smokers 16-20 cig per day

• Children smoke tobacco shishas

• USD0.80 per pack of cigarettes

PZ Cussons:

• Family controlled

• Progressive approach to sustainability

• Focus on long-term shareholder value

• Resource efficiency, product life cycle

• Low staff turnover

4. Consumer retail / manufacture: Lessons learnt

• Management blind spots: Sustainability intelligence

• Long-term physical share ownership: The best alignment?

• Governance black holes

• Government is not always a rational shareholder

• Pay attention to long-term structural industry trends

• Mean reversion: Seen this movie before?

5. Telecoms: Sustainability Analysis

• Management quality and corporate governance

• Stakeholder capital: Licence-to-operate, regulatory intervention

• Asset quality: Technology obsolescence

• Earnings quality: Stakeholder capital, brand, pricing regime

• Electromagnetic radiation: Reminiscent of tobacco lung cancer link

• Control of illicit content: Cultural context of internet

Maroc Telecom (Morocco), Safaricom (Kenya), Orascom (Algeria)

Commodities boomPeak of steel

rebar prices

Ultra low-cost

producers gain

market share

MAROC TELECOM /

ORASCOM TELECOM