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BLOG: Africa – an investment risk worth taking?

Darius McDermott
Written By:
Darius McDermott
Posted:
Updated:
10/12/2014

Darius McDermott analyses the case for investing in Sub-Saharan Africa.

Since the Fed’s comments back in May about scaling back, or “tapering,” its quantitative easing programme (the printing of money to encourage people to buy risk assets), the surge of hot money that had flooded into emerging markets has promptly reversed and left many investors with a headache.

This has been compounded by markets taking a closer look at the emerging market economies and finding out that many of them are not living up to the hype.

Take the example of the BRICs; once the poster boys of emerging market investing, they are now struggling due to a collapse in global commodity demand, a lack of economic reforms or trying to manage the difficult transition from an investment-led to a consumption-led economy.

Some investors may feel that the current slump represents a buying opportunity, given that many of the long-term investment drivers are still in place and valuations are cheap, but they will be disappointed as two of the largest and most successful emerging market franchises, Aberdeen and First State, have announced that they are closing their flagship vehicles. It is perhaps no wonder then that more and more investors are looking towards the frontier markets. One area we are seeing increased interest in from our clients are the frontier markets of sub-Saharan Africa.

Sub-Saharan Africa (with the exception of South Africa, which has now achieved a level of sophistication that means it is no longer considered a frontier economy) had long been considered an investment no-go area that was stricken with corruption, political instability, poor infrastructure and extreme poverty.

However, over the last year, the region has provided two out the top ten stock markets in the world, with the Kenyan Nairobi index up 28% and the Nigerian All-Share up a whopping 58%. What has brought about this change? Firstly, over the last three years the region’s GDP growth rate has been in excess of 5% p.a. and, over the past decade, Africa has produced six of the world’s ten fastest-growing economies. While the 5% growth rate is below the 7% that China is currently growing at, the demographic profile makes Africa a more interesting long-term proposition. For instance, half the people in the region are under 20 years old and by some estimates the population of Nigeria, Africa’s most populous nation, is expected to double by 2040. Secondly, perceptions of Africa are changing – where investors once saw poverty and inefficiency they now see opportunity. For instance, McKinsey, a consultancy, estimate that by 2020 more than half of African households will have enough income to buy non-essential items and Nigeria’s finance minister thinks that, in time, Africa will become the preferred destination for labour-intensive manufacturing, potentially taking over the mantle recently shed by China.

A big limiting factor on investment in this region is the relative immaturity of the region’s stock markets. Even the biggest market in Nigeria only lists around 200 companies, with only around 25 of sufficient size to attract mutual fund managers. After the two biggest markets in Nigeria and Kenya the level of sophistication deteriorates dramatically, so much so that in the third biggest market, in Zimbabwe, the trading day often only lasts an hour, with perhaps only six companies of sufficient size to attract foreign investors. Also, the old risks remain. The most recent election in Zimbabwe, which by today’s standards was concluded peacefully, led to a drop of 11% in a single day on the news that Robert Mugabe had been re-elected.

There are many obstacles to investing in Africa, notably the lack of liquidity in their stock markets, ongoing political uncertainty and a dependence on natural resources, but given what’s going on in the established emerging markets it is no surprise that adventurous and long-term investors may feel that allocating a small proportion of their portfolios to these markets is a risk worth taking.

Darius McDermott is managing director of Chelsea Financial Services