Tumbling oil prices and political chaos have eroded Nigeria's lure for foreign investors, but they are likely to venture back if authorities will allow what some say is a much-needed currency devaluation.
The price of oil -- the source of 70 percent of Nigeria government revenue -- has fallen 60 percent since last June, pushing stocks down by a third over the same period. Local bond yields are 2 percentage points higher.
Adding to the pressure are almost daily attacks by the Islamist militants Boko Haram and political uncertainty as the country faces a closely fought election on Feb. 14.
The naira's 20 percent depreciation in the past year has further eroded the dollar value of foreign funds' holdings. But the depreciation has not gone far enough, investors say. Some reckon the currency must fall another 10 to 15 percent to reach fair value.
Malek Bou-Diab, a portfolio manager at Bellevue Fund's pan-African equities fund with $110 million under management, for instance, wants to see a devaluation of at least 10 percent before considering adding to his Nigeria holdings.
Foreign investors such as Bou-Diab pulled almost $1 billion out of Nigerian equities in the first 11 months of 2014, stock market data show. Along with the index's 32 percent fall in the past year, that has made share valuations cheap, but he is not tempted yet.
"For the short term, I understand the argument of low valuation. Yes, it is more attractive than it was -- but does it really price in the risk?," Bou-Diab said.
Investors believe that despite its decline, the naira remains expensive after more than a decade of booming oil prices.
Its real effective exchange rate (REER) -- a measure used to determine whether an exchange rate is overvalued or undervalued -- indicates the naira was 27.5 percent above its 10-year average by mid-December: http://link.reuters.com/vuf47v
For an economy that relies on oil exports, an expensive currency is a drag. But because Nigeria imports almost 80 percent of what it consumes, authorities are reluctant to allow the currency to depreciate faster for fear of inflation before elections.
So the central bank's repeated currency market interventions -- costing almost a fifth of its reserves in the past year -- have kept the naira from reaching realistic levels.
Central bank governor Godwin Emefiele has ruled out allowing the currency to float freely, because "it will lead to high prices ... the purchasing power of our people will decline."
Markets are jockeying for a post-election naira devaluation of 7 to 15 percent. Non-deliverable forwards price it some 30 percent weaker over the coming year. The steepest losses are likely in the next three to six months, just after the election, forwards shows.
"Holding anything in naira is now structurally much more high-risk than it was before," said Oyin Anubi, Sub-Saharan Africa economist at Bank of America Merrill Lynch.
"Our clients who invest in local debt and equity markets are much more reticent now," she said. "They feel like the central bank actions have become increasingly hard to predict."
BONDS, STOCKS
Central bank tactics to defend the naira have included squeezing liquidity. That has prompted JPMorgan to warn Nigeria could be ejected from its GBI-EM emerging-currency bond index -- a benchmark for $216 billion of investor money.
After joining the index in 2013, Nigeria saw the amount of debt held by offshore investors quadruple. Being pushed out could force funds to sell their holdings or avoid Nigerian debt altogether, forcing an outflow of equal size.
"If they allow the deval to happen, they will get liquidity back in the spot market," said Antoon de Klerk, Portfolio Manager for Investec's African Fixed Income Fund.
"It is very likely for them to stay in the index, and that is important to them, not just for a financial perspective, but also for a reputational perspective."
Official data show Nigeria had just below $70 billion in debt outstanding by end-September. Almost 97 percent was denominated in naira.
"As long as you are FX hedged, the bond yields themselves are quite attractive, but the challenge is if you try and hedge your currency risk today. It is really expensive," said de Klerk, who hedged his local debt position some time ago.
The crux of the matter is that investors are reluctant to forsake Nigeria entirely, pointing to the opportunities provided by a large population and the infrastructure it needs. And despite its troubles the economy is expected to grow 5 percent or so this year.
Bou-Diab, for instance, sees opportunities in stocks exposed to infrastructure, both on the banking and the industrial side.
"The challenge of Nigeria is really the infrastructure -- you need electricity, you need those roads," he said.
A devaluation may be negative for banks but their share and bond prices are already factoring in most of the downside, say investors.
For debt investors, local currency bonds will be the best point of entry once a devaluation occurs, said Kevin Daly of Aberdeen Asset Management's emerging market fixed income team, who sold all his holdings in Nigerian naira and dollar bonds last autumn.
"If I saw a big move in rates, and a big adjustment in FX adjustments, Nigeria could be a very interesting investment opportunity, but we are not there yet," he said.
