Q&A with Damitha Pathmalal, CIO, Nabo Capital
'I'm never a pessimistic guy, you can't make money if you're pessimistic, but I would advise an overabundance of caution' - Damitha Pathmalal
Damitha Pathmalal is Chief Investment Officer at Nabo Capital, a Kenyan boutique investment firm that specialises in public equity and fixed income investments. Damitha joined the firm in 2021 and has previously worked in the US, Europe, and Asia.
Chipo Muwowo: According to your company website, Nabo Capital “seeks to leverage its private equity expertise to identify and seize significant minority stakes” in listed African securities. What does this mean in practice?
Damitha Pathmalal: At Nabo, we create what are called all-weather funds. Regardless of seasonality, the funds tend to perform well. For equities, we tend to pick securities that are underpriced. “Price” forms the first 'P' of our '4P' column. The others are Potential (history of positive economic profits), Profits (future market potential), and Partners (strong reputable partners). The part where Nabo is most informed by its private equity heritage is that we look for partners in management. We're not looking for firms that we'd have to actively cajole but rather we're looking for hidden gems that are under the radar. And then as markets become more efficient and more people hear about the security, the price will hopefully reach what we feel is a fair price.
Chipo Muwowo: As a company, Kenya is your home. It's where you have most of your investments. How do you go about picking attractive and undervalued assets?
Damitha Pathmalal: In terms of where we have our investments, that's not exactly true anymore. When I first joined Nabo in January 2021, that would've been right on the money. But since then, we've changed tack. I peered into the tea leaves so to speak and looked at where the economic fundamentals were going. It was then that we decided to de-risk from Kenya.
"In terms of equities, we now have near-zero Kenyan exposure."
Nabo had a pan-African mandate before I arrived and our parent company Centum, which is very well known in Kenya, also had a pan-African heritage. That's really what I leveraged. So since 2021, allocation to Kenyan securities has been on a downward trend.
Chipo Muwowo: What key factors drove the decision to de-risk from Kenya?
Damitha Pathmalal: Kenya was doing well but according to our forecasts, it looked like there were going to be some major headwinds coming. Right now, our forecasts on interest rates are starting to look like best case. But when we made the prediction back in 2020-2021, we were really an outlier and many folks didn't believe us. We've become increasingly bearish and unfortunately I don't think the fundamentals have caught up yet with where we see secular weakness. So the good news is we started prepping for the storm early. The bad news is the storm's just begun.
Chipo Muwowo: So where did you reallocate that capital?
Damitha Pathmalal: Those funds went to a bevy of geographies such as the Bourse Régionale des Valeurs Mobilières (BRVM), Uganda, and Egypt. Our equities did quite well as an asset class but there were some serious headwinds.
“Our top three performers achieved US dollar returns of somewhere between 44% to 99.6%. They were a mix of very boring, very stable investments such as utilities and fertiliser producers, nothing particularly sexy.”
Chipo Muwowo: So is that where the bright spots are?
Damitha Pathmalal: The truth is there aren't very many bright spots. What I'm really trying to do at Nabo is focus on hunting down individual securities that are attractive rather than specific sectors or industries. I think most emerging markets are facing a bunch of headwinds. The US dollar is going to continue to have negative impacts on our markets. We are also in a rate tightening regime. If you stick to economic theory, a tightening cycle lasts about 18 months after the peak rate is achieved. So if you look at Kenya, if the central bank rate (CBR) hit its peak last year, then we have 18 months of that regime left. I don't want to sound pessimistic because we've done well, but I also don't want to say that there are particular bright spots because truthfully, there aren't many.
Chipo Muwowo: Typically how long are you holding your stocks for?
Damitha Pathmalal: We're medium-term investors. This means a roughly strict window of around 3-5 years max on the long side. Unlike some asset allocators that tend to hold on to a position even after it has hit its fair value price, our '4Ps' strategy dictates that if the price is fair, we get out. And that discipline has worked out well for us.
Chipo Muwowo: You mentioned the BRVM and North African stocks. What are some notable differences between those markets and Kenya?
Damitha Pathmalal: The longer I work in asset management the more I learn that it's essentially the same game being played in different places. It's not necessarily the case that Morocco or the BRVM are doing something fantastic whereas Kenya is not. It's just that when we look at our target universe of securities, I have potentially 701 securities to select from on the equity side, so it's more about seeing which geographies have the right tailwinds coupled with the best securities to take advantage of those tailwinds. I can give you an example. For one stock we bought, a fertiliser company in north Africa, the investment thesis was super easy. We were expecting the Egyptian pound to depreciate and crucially, this company had an export licence. This meant as the national currency went down, the company was able to export more of its products thus raising revenues significantly. So even if a sovereign like Egypt is facing more severe economic pressure than Kenya, there might be opportunities within it. It's more about getting to that individual security and not throwing your hands up in the air saying, 'we expect losses because it's a bad market'.
Chipo Muwowo: Do you prioritise dividend-paying companies?
Damitha Pathmalal: There are different sources of returns – for example capital gains and dividends. There's a concept in valuation called dividend irrelevance theory, which essentially means that if you're compounding your cash at the breakeven market rate, it doesn't matter whether you receive your dividends now. What you're discounting is your cash flows. And the biggest determinant of your discounted cash flow (DCF) valuation is your terminal value of the firm. Which essentially is a long way of saying that the firm can either pay the dividends throughout the holding period or it can pay the dividends at the time of terminal value dissolution of the company.
“So, we don't prioritise dividends because according to economic theory, as long as the firm's compounding the cash above the cost of capital, it doesn't matter whether they pay dividends or keep the cash in the firm.”
Chipo Muwowo: What about fixed income securities? What's been your approach to that?
Damitha Pathmalal: Yes, Nabo is a diversified asset manager so we also have a fair amount of bond exposure. As rates were rising last year, and foreign exchange was proving to be a serious headwind, we de-risked from local currency bonds and went into eurobonds instead. We did quite well in that space generating returns of between 33-35%. Once again, when the price reached what we call a fair price, we exited those positions. We still have some local currency bond exposure but are paring back on that.
Chipo Muwowo: About a year ago, the Kenyan Capital Markets Authority reported a notable increase in the number of unit trust holders using collective investment schemes. What other interesting trends have you observed within the Kenyan investment management industry?
Damitha Pathmalal: I think dollarisation (i.e. the conversion of your securities to dollar positions) is one of the more interesting trends that I've seen. I think more people moving into unit trusts is a sign of an economy becoming more developed, with financial services permeating through the economy, and a normalisation of an investment mindset. We recently partnered with a fintech player and they're using one of our unit trusts as the underlying investment. We have around 87,000 users, up 45% since 2022. So alongside a dramatic increase in CIS investments through our fintech partners, I think that folks are simply becoming more financially savvy.
Chipo Muwowo: Looking ahead to the next 12 months, what are some reasons for optimism across your markets and some reasons for caution?
Damitha Pathmalal: As I look ahead, I propose an overabundance of caution. There's a lot of uncertainty over the next 12 months. Many bonds are maturing within the next 6 or so months, and we're facing a rising rate regime. The primary drivers of global growth for at least the last decade have been China and India. You're now seeing some weakness there which should give folks pause.
One thing I really like right now is fixed deposits. If you do your due diligence and you understand the underlying riskiness of a particular bank, you can keep your money there, making a relatively attractive return of around 16% in cash. This essentially crowds out bonds and even equities because at a return of 16%, that's higher than the long-term return profile for equities and bonds.
So we're in a period where allocators use the term bearish disequilibrium. So if equity, as the riskiest asset class, is supposed to have the highest return profile then I can always make the most money by allocating to equities. But if you look at the last 2-3 years, that's not how things have panned out. I'm never a pessimistic guy, you can't make money if you're pessimistic, but I would say most folks should approach this environment with an overabundance of caution.
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