INVESTING IN AFRICA RISKS AND OPPORTUNITIES
SOUTH AFRICAN institutions have been investing in Africa for more than a decade, with SA retirement funds having been granted a specific 5% allowance for investments in Africa (outside of SA) some years back.
The recent increase in the 5% allowance to 10% has raised the ante, as to whether Africa should be considered as a destination for a significant portion of SA institutional investors’ capital. In this quarter’s Asset Manager Review, we look at the African investment landscape, to explore what the opportunities and risks might be.
Views on Africa tend to be quite polarised, with some investors swearing off investing in the continent on the basis of various examples of failing states, political instability, corruption and regulatory uncertainty. But the reality is that, while there are certainly plenty of jurisdictions and also companies to steer well clear of, for political, regulatory or governance reasons, there are also places where investors are likely to be rewarded over the long term, provided they have the right long-term mind set.
Ironically, it is this “lovehate” attitude towards Africa which actually contributes to the attractiveness of many of the investment options, with sentiment-driven outflows of capital often driving prices down in the short term, due to the relative illiquidity and small size of the investment markets involved.
To give some perspective, the total size of the global stock markets is around US$90-trillion dollars, depending on exactly what you choose to include (and noting that this fluctuates daily as prices move and companies list or de-list). Our JSE accounts for about US$1-trillion of this, and the whole of the African-ex-SA markets are about a quarter the size of the JSE.
While there are more than 50 countries in Africa, there are probably only a dozen or so markets which really warrant serious investment attention, the most prominent being the North African countries of Morocco and Egypt, with the other larger markets being Nigeria and Kenya.
Besides being smaller in size and range, listed companies also tend to be more tightly held, with the so-called “free float” of shares available to outside shareholders being a lot lower than we are used to in SA. The trade or liquidity in most of these markets is also a fraction of the JSE’s, with the big stocks in SA sometimes trading almost as much as the whole of Africa combined!
To make matters worse, the costs of trading are much higher, with expenses or brokerage being as much as 1% (more than five times what most big investors would pay in SA). The consequence of the smaller size and higher cost makes it quite difficult for larger investors to enter or exit from positions (especially if they make a mistake and want to sell in a hurry).
The opportunity in Africa is often described as being about faster growth in Africa, on the back of a growing middle class (the so-called “bottom billion” thesis) and improving corporate governance and political stability over time. The reality is that while at a headline level the African economy is projected to grow at around 4-5% per year over the next five years (based on IMF projections), the link between economic growth and investment returns is quite weak (China has exhibited the fastest economic growth of any large economy over the past two decades, but its stock market has been quite disappointing).
There is also quite wide divergence between the prospects of individual countries and regions, and the underlying companies available vary widely in terms of their investment attractiveness, even within a particular country.
While there are certainly trends (such as rising internet access and cheaper mobile data) which are likely to boost some sectors, a deeper look suggests that the listed equity markets probably offer more “idiosyncratic” rather than “thematic” opportunities, so that an investment thesis built from a bottom-up country or company level is likely to be more robust. Put another way, there are some very solid, quite attractively priced businesses that operate in the most demanding jurisdictions, and conversely there are some terrible, overpriced businesses listed in the best managed economies.
While much of the focus has been on listed equity, many investors are looking beyond stock markets for returns. Higher yielding assets such as infrastructure, debt and property are receiving growing attention.
The World Bank estimates that Africa has a massive infrastructure backlog, with around US$100-billion investment needed each year. The energy sector in particular, has emerged as one area ripe with potential, with the success of the SA renewable energy programme being very favourably viewed by foreign and local investors, and there are attempts to replicate this north of our borders.
While investors in SA infrastructure projects are looking for returns of the order 6-8% above inflation in Rand terms, real returns in the mid-teens in US dollars are often on offer in Africa. Of course this is not a “free lunch” – there are risks associated with all these investments, and examples of projects that have gone wrong. Across the board, investors should take careful account of the environmental, social and governance (ESG) risks associated with all investments, including but not limited to those in Africa.
In comparison with SA, many African countries also have massive shortfalls in the supply of formal industrial, retail and office space. The lack of finance has constrained the sector, but the relatively attractive rents and demand from stable tenants (in many cases multi-nationals) has resulted in several Africa-focused property investment funds being raised.
The long-term success of the listed property sector in SA (despite a very poor recent period!) also bodes well for the future of this asset class elsewhere in Africa. Africa-focused property funds commonly talk about targeting dollar returns of close to 20% p.a.
On the debt side, there is increasing funding being raised at very attractive dollar yields by high-quality borrowers often backed by their governments, multi-national corporations, or supra-national agencies. Declining inflation and improving fundamentals make even local currency debt worth considering, in some countries.
Bond markets are estimated to be growing faster than the listed equity markets, and several SA managers are broadening the scope of their mandates to include Africa debt, or launching products which specifically invest in this sector.
Over the last decade, the results from investing in listed Africa-ex-SA equities, as measured by the widely followed MSCI and S&P Dow Jones Africa indices, have been pretty poor, with negative returns in US$ terms being registered for Africa. The three- and five-year numbers are also negative, with the promising recovery in 2017 unfortunately faltering more recently, with negative returns so far in 2018.
The very long term numbers show Africa in a more favourable light with low double digit growth, but the ride has been pretty wild with big sell-offs being experienced especially when liquidity conditions tighten.
Very few investors are getting exposure through index-tracking products, and the results achieved by active asset managers have tended to be better than the market indices, with many consistently beating the headline indices. This is a seeming paradox - part of the answer probably lies in the fact that these markets are less well researched and therefore inefficient, although it is also likely that the available indices fail to track the opportunity set very well, with managers tending to invest very differently to the benchmark-cognizant approach, which is quite common in SA.
Most managers will say that the biggest index stocks are often less attractive, with the opportunities lying in the midsized and smaller companies. Of course this does mean that these investment funds are even more illiquid than the indices would suggest, with many of them closing (turning away new money) from time to time.
Unrealistic and illiquid pricing makes it imperative that the manager treats clients fairly, and many investment funds regularly close to ensure fairness. A significant challenge currently is how to deal with exposures in Zimbabwe, where prices have moved far from what managers would regard as fair value, but where exchange controls and illiquidity make it unrealistic to value these stocks at full market price.
As to whether SA investors should include an allocation to Africa, this will likely come down to investor risk appetite and objectives, as well as governance considerations.
For some time, we have noted that, on a risk-adjusted basis, selected exposure to Africa looks attractive compared to some of the developed markets which have “run very hard” over the last few years. For truly long-term investors (simply put, those who don’t get scared at the first sign of trouble and those who can commit their money for a number of years at a time), this offers scope to diversify and boost returns, albeit perhaps not with the full 10% allocation.
This view of course comes with the “health warning” that the path will not be steady investors need to be prepared for significant volatility, at any time but especially in the current environment.
Finally, while passive investment seems to be worthy of serious consideration in developed markets given their efficiency and highly competitive nature, we believe that investors will likely be better off with an active management approach in African markets for the foreseeable future.