This article was first published in the third-quarter 2012 edition of Personal Finance magazine.
Increasingly, the case for investing in Africa is made on the basis that this “last frontier” is now in a strong position to develop, to urbanise its growing and relatively young population, and to foster a large middle class.
The opportunities for individual South Africans to access investments elsewhere in Africa remain fairly limited. Even retirement funds and unit trust funds with mandates that enable them to invest in Africa’s markets have been slow to venture into this new frontier. Recent poor performance from showcase African funds and indices has not helped the cause, but could this be all the more reason to invest now?
Traditional investment markets, such as the United States and Europe, remain troubled, and many emerging markets that have transformed their economies are so popular they are almost mainstream. Intrepid investors are looking for the next best thing and increasingly they are looking to Africa as one of the few remaining investment frontiers.
Traditionally regarded as rich in resources but otherwise a basket case, Africa is now attracting more attention because its demographic profile is working to its advantage, and its economic and political conditions are improving.
International Monetary Fund (IMF) forecasts indicate a real (after-inflation) gross domestic product (GDP) growth rate of some 5.4 percent for sub-Saharan Africa in 2012 and 4.2 percent for the Middle East and North Africa – significantly higher than for many other areas of the world.
The IMF forecasts an average GDP growth rate of 1.4 percent for advanced economies in 2012.
The demographic trend in Africa’s favour is that much of its young and growing population will move to urban areas in the near future.
The economic woes of developed markets are aligned closely with their greying populations. Higher standards of living have resulted in longer life expectancies, presenting policymakers with serious social challenges, Pieter de Wet, head of research at Novare Equity Partners, a private equity fund manager focused on sub-Saharan Africa, says.
“In richer developed countries, more and more older people have to be supported by a younger, shrinking workforce,” De Wet says. In contrast, Africa has an estimated population of more than a billion people, and the median age is 18.6 in sub-Saharan Africa, lower than that of any other region.
Between the 1960s and the 1990s, growth of the labour force exceeded growth of the total population in most East Asian countries, especially South Korea and Japan, De Wet says. Termed the “demographic dividend”, a young workforce did not have the burden of supporting non-contributing members of society. As a result, economic growth was stellar, he says. The United Nations projects that the future demographic trend in Africa is likely to be the same as that experienced in Asia between the 1960s and the 1990s, De Wet says.
The UN’s population division forecasts that the working-age population of Africa will increase from 56 percent of the population now to 66 percent by 2050, he says. Against this background, the pace of urbanisation is increasing, De Wet says.
Stanlib’s “Letters from Africa” (first quarter 2012) newsletter quotes the McKinsey Global Institute, a management consultancy that advises businesses, governments and institutions around the world, as saying that just 28 percent of Africans lived in cities in 1980. Today, 40 percent of the continent’s one billion people do – a proportion close to China’s and larger than India’s, and one that will expand, the newsletter says.
“The rapid increase in the size of the African workforce from a low base relative to the rest of the world is expected to result in strong demand for consumer goods and services. And improvements in infrastructure are making it is easier to reach consumers,” De Wet says.
In the issue of “Letters from Africa” quoted above, Xhanti Payi, an economist with Stanlib’s Africa franchise, writes that Africa will have a working population of 1.1 billion by 2040, while per capita income will rise from US$1 600 a year to US$2 100 a year over the next 10 years.
Of particular interest to investors is the growing middle class in Africa. In a September 2011 report on the global population, Euromonitor International, which researches consumer markets, noted that almost 60 million households in Africa were classified as middle class towards the end of the previous decade. This number is expected to increase to over 100 million by the end of 2014, De Wet says.
Eric Kibe, chief executive officer of Sanlam Investment Management Kenya and portfolio manager of the Sanlam African Frontier Markets Fund based in Nairobi, says urbanisation, the rising middle class, rapid growth of the retail and fast-moving consumer goods sectors, increasing intra-regional trade and the growth of telecommunications have added to the positive outlook for African frontier markets.
An article in Forbes magazine late last year, “Top five investment opportunities in Africa for 2012”, quotes the McKinsey Global Institute as forecasting that Africa’s consumer spending will reach $1 trillion this year. The article identifies a huge and ever-growing opportunity for manufacturers and retailers of fast-moving consumer goods, such as food, beverages, and home and personal-care products.
Thabo Ncalo, who co-manages the Standard Bank Africa Equity Fund with Humphrey Gathungu, writes in “Letters from Africa” (first quarter 2012) that Africa’s key consumer-focused sectors – telecommunications, consumer goods and banking – present the largest opportunity and are already growing two to three times faster than those in developed countries. Consumer growth in Africa will create markets large enough to attract multinational companies, he says.
Gathungu says Stanlib likes the shares of brewery and beverage companies, because beer and beverages sales volumes rise even through political crises, and these shares therefore prove to be more defensive. Some breweries, he says, are growing their profits by 30 percent a year.
Ncalo and Gathungu also like bank shares, because the penetration of banking products is low in many African countries and much innovation has occurred to get the unbanked banked.
Gathungu says many African banks are well capitalised, with capital adequacy ratios of about 15 percent, compared with ratios of less than eight percent among European banks. Some African banks have returns on equity of more than 20 percent, they have low non-performing assets, and they fund their activities from deposits and not through the use of credit markets as is the case in Europe, he says.
In addition to the positive demographic trends, commentators say the political and economic situation in Africa is improving.
De Wet says that 16 countries in Africa were deemed “democratic” in 1987. This number had increased to 44 by 2007.
Payi says that over 18 emerging African countries are shedding the scourge of conflict, stagnation and dictatorships, achieving deepened democracy and political stability.
Kibe says sub-Saharan Africa has emerged from the global financial crisis in a more stable economic position than many developed economies.
Improvements in governance – championed by the IMF and the World Bank in the 1990s – democratisation and sound macro-economic policies enabled sub-Saharan Africa to enter the recent economic crisis with relatively low debt, and its GDP growth remained resilient throughout the period, Kibe says.
Payi says that in 2005 Africa’s collective GDP was some $974 billion. That number is estimated to have grown to $1.8 trillion in 2011, and, according to the McKinsey Global Institute, will rise again to $2.6 trillion by 2020 – driven by consumer spending as per capita income increases exponentially and economic development continues. At the same time, national debt levels and debt management have improved significantly in African countries with the help of the IMF and other initiatives that led to debt relief and better financial management, Payi says.
Many African economies have national debt below 50 percent of GDP and therefore below the IMF’s and the World Bank’s thresholds, whereas much of the developed world is buckling under its debt burden, Payi says.
As Africa’s economies grow, they are expected to improve their infrastructure – roads, railways, harbours, power supply, communications.
Identifying infrastructure and related industries as an investment opportunity, Forbes quotes the World Bank’s 2008 “Africa country infrastructure diagnostic study” as saying the continent needs about $80 billion annually to cover its infrastructure needs.
The need for, and increasing development of, infrastructure has made Gathungu and Ncalo lovers of cement company shares.
Another sector in Africa that Forbes singles out as one that will do well is agriculture. According to the McKinsey Global Institute, Africa has 60 percent of the world’s uncultivated arable land, which will be required as the world’s population increases rapidly, the magazine says.
Gathungu says agriculture is a sector that Stanlib likes, because Africa has much arable land that has yet to be developed for large-scale commercial projects.
The fourth sector Forbes focuses on is tourism. It says several African countries, such as Kenya, Mauritius, Seychelles and Tanzania, have become some of the world’s favourite tourism destinations.
According to the UN World Tourism Organisation, the number of tourists visiting Africa is expected to exceed 50 million in 2012.
Fifth, Forbes suggests that investments in mining could prove lucrative. The article says several African countries have vast deposits of mineral resources that have been left largely unexploited because of a lack of technical know-how, as well as the financial incapacity to embark on capital-intensive projects.
The investment case may be strong, but recent performance has not been that great.
According to Prescient, the MSCI Emerging Frontier Markets Africa excluding South Africa Total Return index returned minus 12 percent in US dollars and 10.2 percent in rands over the year to the end of May. Over the past three years, the figures were minus 2.6 percent (dollars) and minus 0.2 percent (rands) annually; and over the past five years, minus 6.8 percent (dollars) and minus 3.4 percent (rands). This is despite strong GDP growth in many African countries. The IMF reports that sub-Saharan Africa achieved GDP growth of 5.1 percent in 2011, while the Middle East and North Africa achieved 3.5 percent.
In Stanlib’s April 2012 “Insights” publication, the asset manager says GDP growth does not translate instantaneously into higher share prices, because sentiment about economies, socio-political issues, speculation and even company-specific issues come into play.
“Nowhere has these nuances, particularly sentiment, between GDP and market prices of stocks been more damaging than in African economies and stock markets,” it says.
Most managers cite investors’ perceptions of heightened global risk as the cause of the recent poor performance by African equity markets.
The uncertain times have left investors risk-averse, and, with African markets perceived as especially risky, these stock markets have been particularly hard hit, despite the fact that Africa is largely unaffected by the events in the developed world, managers say.
Payi says although African economies are performing very differently to those of developed countries, Africa is still coupled to the rest of the world when it comes to global events and investor sentiment. Clear evidence of this was provided in 2011, when African economies grew but markets tumbled because of investor sentiment directly related to global economic developments, he says.
Kibe says African frontier markets are relatively small, highly concentrated, relatively illiquid and have a very high participation rate by the retail sector. These attributes amplify share price movements and increase the degree of unpredictability. As a result, the opportunities presented by Africa’s demographics and urbanisation “are vastly under-represented” in the prices of African equities, he says.
Roelof Horne, who manages Investec’s Africa Fund, says the 2008 credit crisis was a disaster for African markets despite the fact that they were unaffected by global events.
Major external events last year – notably the downgrading by a key ratings agency of US government debt and the mess in Europe – made investors risk-averse and they stayed out of African markets despite the good economic growth, he says.
As a result, the price-to-earnings ratios of African markets are very low – in other words, the prices you will pay for shares now are low relative to the earnings that the shares are expected to deliver, Horne says. This makes it a very good time to invest, but whether you will earn good returns in the year ahead probably will have more to do with what happens in Europe than in Africa, he says.
Fund managers also cite recent events in certain African countries as having a negative effect on stock markets and the perceived risk of investing in Africa in general.
Fungai Tarirah, head of Africa investments at Momentum Asset Managers, says there are a number of reasons for the short-term under-performance of African equities that are peculiar to each market.
The first is the “Arab spring” or “Arab uprisings” – a series of protests and demonstrations across the Middle East and North Africa that started late in 2010 in Tunisia and spread to Algeria, Jordan, Egypt, Yemen and other countries. Tarirah says although economic growth continued in the affected countries, the political upheavals brought down share prices.
The events in Egypt have, however, created opportunities for fund managers.
Gathungu says Egypt is the meeting point of Islam and democracy. The country has been forced to be more liberal than other, wealthier oil-producing countries in, for example, allowing women to work, and, as a result of its reliance on tourism, in permitting tourists to consume alcohol.
Although the Egyptian stock market fell by 49 percent last year, it had recovered 40 percent by the middle of May this year, he says.
Further south, Nigeria was affected by a banking crisis in 2008 and 2009, which, with 60 percent of its equity market in financial shares, had a huge impact on equity returns there, Tarirah says.
Ten out of 30 banks went under, including three of the top five, Horne says. The government stepped in to ensure that no depositors lost money, but the contraction in credit meant that many businesses could not get the funds they needed. Now, he says, when you consider their expected growth, the values of Nigerian bank shares make them one of the cheapest assets in the world.
Ncalo says many of the investors who pulled out of African equity markets during the flight to quality after the global credit crisis in 2008 have not returned on the same scale as before the crisis.
Funds that invest in African markets and local investors in African markets have also been risk-averse, he says.
For example, in Nigeria, investors bitten by the Nigerian banking crisis, which followed the global credit crisis, are staying out of equity markets, and some institutional investors there have an extremely low equity exposure of less than 10 percent of their portfolios.
The Kenyan market was hit by a drought, which had a negative impact on that country’s GDP, inflation rate and exchange rate, Tarirah says.
Inflation in countries such as Kenya and Nigeria has pushed yields on fixed-interest investments to double digits and this has driven capital out of equity markets, Ncalo says. However, this trend will reverse as inflation falls, he says.
Peter Townshend, co-manager of the Coronation African Frontiers Fund, says despite the difficult market conditions over the past two years, returns over three to five years will still be decent.
The African Frontiers Fund has returned 12.8 percent a year in US dollars since its inception in October 2008, he says.
Coronation cannot forecast when markets might turn but firmly believes that patient investors who put their money into quality companies in African markets at reasonable prices will be rewarded, Townshend says.
The Investec Africa Fund, one of the longest-standing local funds – it was launched in November 2005 – has returned 5.2 percent a year in US dollars and 8.1 percent a year in rands since inception. These returns have failed beat the fund’s target, the US dollar London interbank offered rate plus four percent.
Investors who want exposure to the good returns that African markets may yet deliver have to accept the risks of investing in this region.
Tarirah says the risks of investing in Africa include:
* The risks associated with the sentiment that drives investors in and out of these markets;
* Transaction risks, which arise from the difficulties of completing a transaction in another country in a different time zone;
* Political risk; and
* Currency risk, because the rate of exchange between the currency in which your investments are denominated and the currency of an African country can depreciate rapidly, wiping out any gains in the shares in which you invest.
You need to understand these risks and how the manager with which you invest can mitigate them by, for example, travelling to and understanding the countries in which it invests, Tarirah says.
Ncalo says when liquidity dries up, it is difficult to buy and sell shares effectively, and there can be a lot of mispricing of shares as a result.
Shares can lose a lot of value when just a few of them trade, he says.
Another risk Gathungu cites is that of a lack of disclosure by companies in Africa and the fact that they are not well researched by analysts. Although a number of African countries are adopting international standards of company disclosure, reporting remains poor, he says.
Townshend says Coronation measures and tracks the liquidity of the shares in which it invests and has liquidity limits in its portfolios, but the reality is that liquidity in these shallow markets is likely to dry up considerably when fund managers need it most. And, as the recent revolutions in Egypt and the Ivory Coast showed, markets can close for long periods.
Another risk is that African governments are often inefficient and immature, Townshend says.
Coronation’s portfolios have country limits and the manager closely monitors developments, Townshend says. “But the reality is that we invest in lively neighbourhoods, and while Africa as a whole is developing, this advancement is unlikely to be linear. Surprises are almost guaranteed.”
Townshend also highlights inadequate financial reporting and governance levels as risks.
“This is not to say that businesses are poor quality or their accounts dodgy, but getting comfort on the quality of a business, its management and its numbers can take a lot of effort,” he says.
Good corporate governance is an emerging concept in many African countries, as is interacting with investors, Townshend says.
WHAT IS A FRONTIER MARKET?
British financial newspaper The Financial Times describes frontier markets as a type of emerging market but with lower market capitalisation and less liquidity than many emerging markets.
It says frontier markets offer potentially high returns and have a low correlation to other markets. The expectation is that over time a frontier market will become more liquid and take on the characteristics of most of the emerging markets, the Financial Times says.
In South Africa, Africa is the focus of frontier market investing. However, there are many other countries that are regarded as having frontier investment markets.
The MSCI Frontier Markets index includes seven African countries: Botswana, Ghana, Kenya, Mauritius, Nigeria, Tunisia and Zimbabwe. The other countries in the index are: Argentina, Bahrain, Bangladesh, Bosnia-Herzegovina, Bulgaria, Croatia, Estonia, Jamaica, Jordan, Kazakhstan, Kuwait, Lebanon, Lithuania, Oman, Pakistan, Qatar, Romania, Serbia, Slovenia, Sri Lanka, Trinidad & Tobago, Ukraine, the United Arab Emirates and Vietnam.
Investec is developing a frontier market fund that will invest in Africa, emerging Europe, Asia, South America and the Middle East. Franklin Templeton has a United States dollar-denominated Luxembourg-domiciled Frontier Markets Fund that is available to local investors.