Tune out bad news about Africa and chase lucrative investments

• Use new pension fund limits to diversify portfolio and take advantage of higher growth rates

The news flow from Africa typically focuses on the worst issues and incidents that occur on the continent. A foreigner following the news from SA over the past few years could not be blamed for thinking that the only game in town in the country is state capture and corruption.

However, on the ground across the continent, growth is continuing, infrastructure is improving and business conditions are getting better. As investors who travel across the continent regularly we observe these trends first hand, but these are also clear from surveys and economic measures.

The prudential limits that allow pension funds to invest a portion of their members’ funds outside SA were raised by then finance minister Malusi Gigaba when he made his budget speech in February.

Specifically, the limit for African investing was raised from 5% of a pension fund’s assets to 10%. These allowances are in addition to the normal offshore limit, which was raised to 30%. So why should South Africans use these new limits and allocate some of their retirement funding to African equity markets? There are many reasons, but we believe some of the key considerations are:

It makes sense to invest in a region that is growing quickly and industrialising and where economies are transforming their infrastructure and middleclass consumers are growing;

Getting returns from a region that, because of its transformation, is not as connected to global events and markets as most other investment destinations, which allows you to diversify your returns;

The improving investor sentiment that is emerging for the continent will mean increased focus on these markets, and share prices should recover from oversold positions, providing additional returns over and above the strong growth outlook; and

You can take advantage of the current strong rand-dollar exchange rate to invest in offshore assets.

Ashburton uses the IMF’s GDP growth forecasts to illustrate the relative growth expected in Africa and elsewhere. The continent, especially countries that have equity markets and are typically more developed, is expected to grow faster than the rest of the world over the next five years and faster than advanced economies, or even SA, over the period.

Of course there are also quite a few countries in Africa that are not performing as well. However, even though they tend to make the news more often, they are usually smaller economies that are less developed than those that have equity markets. An African (excluding SA) equity fund would typically not be invested in these countries.

To illustrate the diversification benefits we have calculated the correlation for the US dollar returns of the respective indices on a rolling 12-month basis from June 2 2002 to January 10 2018. Over this extended period, Africa (excluding SA) has a very low correlation to global markets of 0.24, and to SA it is even lower. To further illustrate the diversification benefits of investing across the continent, we can see that the two biggest markets, Nigeria and Egypt, also have a low correlation to each other of 0.16.

Because of SA’s position in the world and global emerging markets, investing offshore in these markets has much lower diversification benefits. The correlation between SA and world markets is 0.77 and to global emerging markets is 0.85.

To further illustrate how Africa is marching to its own drum, we can look at the inflation outlook for African countries with equity markets.

While global inflation is rising, many African economies are just coming out of an inflationary spike. As inflation declines through 2018 we expect local interest rates to decline. This is expected to create further demand for equities as domestic money managers shift their portfolios more towards equities and away from fixed-income assets such as bonds and Treasury bills.

The less developed nature of African equity markets lends itself to active fund management, meaning that selecting shares can add value over investing in an index (by 3% to 4% per annum).

In conclusion, we believe that South African (and other) investors should diversify their returns by investing in the rest of Africa. The finance ministry clearly agrees as it has allowed additional investment. With many economies across the continent on a recovery path and inflation declining, we expect interest rates to start coming down soon.

This will be positive for equity markets, which will also start anticipating the generally improved economic outlook for the continent in 2018 and beyond.

The strong rand also provides a good entry point into this dollar-denominated asset class.

IT MAKES SENSE TO INVEST IN A REGION THAT IS GROWING QUICKLY AND WHERE THE ECONOMIES ARE TRANSFORMING