Investors eager to access African equities

The stellar stockmarket performance of some sub-Saharan frontier markets and the diversification benefits they offer are firmly bringing the African continent to investors’ attention.

“Many investors have traditionally seen the 54 African economies as one big basket of war-torn, poverty-stricken countries undeserving of their attention, let alone investments,” says Robert Ruttmann, analyst, investment office at Bank Julius Baer. “But this thinking is shifting fast, and Africa is increasingly popping up on investors’ radar screens.”

Nigerian and Kenyan stocks have returned 43 per cent in US dollar terms over the past 12 months, and Ghana’s market has climbed more than 99 per cent, according to S&P Dow Jones Indices.

Powered by the consumption growth story and rising middle class, African real GDP has increased on average by 6 per cent per year since 2002, versus just 3.7 per cent globally, according to the International Monetary Fund.

The investment case is based on three main pillars – demographics, natural resources and infrastructure spending, the latter “being more of a catalyst for change, rather than a direct theme you can tap into,” says Claire Peck, client portfolio manager at JP Morgan Asset Management.

However, despite being one of the fastest growing regions in the world, Africa remains one of the most underpenetrated areas for investment, she says. African equity markets are difficult to access: there are still very few listed companies, and beyond few exceptions, market caps are small. Excluding South Africa, there are about 250 investable companies across 17 exchanges worth roughly $250bn (€185bn), according to Ashmore, which makes the overall market smaller than Denmark.

Trading volumes are low, liquidity is a key concern and the collapse of the New Star Heart of Africa fund in 2008 remains a painful reminder of the consequences of illiquidity to investors.

As a result, Africa-dedicated equity funds are often criticised for being too concentrated in a few stocks and countries. Nigeria and Kenya are the only two key frontier markets investable today, according to JP Morgan AM. This is due to  a lack of sufficiently liquid investment opportunities and a scarcity of analytical resources to cover the breadth of the continent.

Many equity funds tend to be small, often closing when they reach $100-$200m of assets. This makes it difficult for wealthy investors to allocate to Africa, says Bernard Van Wyk, director at Stonehage Investment Partners in South Africa. Also, the management fees Africa funds charge are “much higher” than traditional global long-only funds, as they range from 1.5 to 2.5 per cent plus performance fees, reports Mr Van Wyk.

 “For clients interested in the African growth story, a small, satellite exposure to the continent makes sense from a diversification point of view,” says Julius Baer’s Mr Ruttmann. Frontier markets are often considered long-term investments and are excluded by significant global portfolio flows. This tends to make them more resilient in times of crisis.

At Julius Baer, clients willing to access the African growth story are recommended to invest via a diversified Africa fund, while they are advised against taking any direct exposure through individual stocks, as illiquidity, political uncertainty and weaker corporate governance remain key risks, says Mr Ruttmann.

Another route to Africa is through global equity funds, but these vehicles often have a very low exposure to the continent.

In particular, high conviction managers who manage concentrated portfolios tend to take sizeable positions in large, mid-cap companies. But most companies in Africa are small, with the average market cap estimated to be $500m, and the free float can be considerably lower. This can be an issue for European Ucits funds in particular, as they would end up owning more than 10 per cent of an individual company, which regulations forbid.

For example, in the Skagen £5bn (€6bn) Kon-Tiki emerging market fund, sub-Saharan Africa represents 1 per cent of assets. This percentage increases to around 5 per cent when considering companies that source revenues from the continent but are listed in more mature markets.

These stocks offer investors better corporate governance standards and deeper, more liquid capital markets but are unlikely to generate the same returns as direct investments and their correlation to equity markets is much higher.

Investing in global multinationals with exposure to Africa is the route preferred by multi-family office Stonehage, where the emphasis is on client wealth preservation. However, recent interest from wealthy families has driven the international firm to start a due diligence process aimed at selecting a handful of Africa-dedicated funds.

It is unlikely Stonehage’s house view will change to include allocation to these vehicles, although the firm now has options available to clients. “The African growth story is fantastic, we can see the potential, but it is still a high risk investment, and it is not worth the risk to have a dedicated allocation,” says Mr Van Wyk .

For long-term investors, direct private equity, as opposed to funds of funds, offers much more interesting opportunities than listed equities, states Markus Stierli, head of thematics research at Credit Suisse private banking and wealth management.

Private equity in Africa takes the form of venture capital, the overarching theme being that of giving access to healthcare, sanitation and education at an affordable price.

“Investing in Africa is not about chasing high returns in a short amount of time, by taking high risk. Africa investors need to have a very long-term horizon of 10 to 20 years.”

In this space, there is alignment of interests between venture capital and impact investing. For entrepreneurs, providing solutions to these problems could very rewarding, from both the financial side and the social impact perspective. However, implementing this type of direct private equity investments is fraught with difficulty, starting from the due diligence process that needs to be carried out on the general partner and how the capital is invested.

“Private equity will evolve over time; the opportunities are there but there must be less red tape and easier way to do business and to access resources for these local entrepreneurs. It is difficult to say when these conditions will come up,” says Mr Stierly.

In sub-Saharan Africa ex South Africa, in contrast to more developed nations, a lot of private equity is “old fashioned”, due to the relative underdeveloped nature of African debt markets, explains Andrew Slater, managing director at RisCura, investment advisors specialising in Africa and emerging markets.

This means that today returns from private equity investments come through profit growth and industry expansion and not debt leveraging, so avoiding extra risk.

Also, while currency risk has to be taken into account, private equity is somewhat
insulated from political risk, claims Mr Slater. “Businessmen take a pragmatic view of political events from a business perspective and not an emotional perspective, from which wild swings in the stockmarket,” he says.

Finally, deals in private equity can have an investment horizon as short as two to three years, which makes it comparable sometimes to the time it takes to fill out the positions in some of the stockmarkets, states Mr Slater. “This is the time needed for a general partner to take a company, enhancing the management or the branding and get it ready for a sale to a multinational company looking to set up operations in the continent.”

Passive vehicles promising higher liquidity have also become available on the market.

Old Mutual IG, in addition to two active African funds, offers a passive fund which tracks a customised index, S&P Africa excluding South Africa. The index covers 20 countries, the most liquid in the continent, which have reasonable accessibility and reasonable daily trade, and it includes 80 shares, explains Marinda Nel, head of international distribution at the firm.

There is no recognisable index on the contient, says Ms Nel, and people do not even talk about alpha for Africa. “The biggest attraction of investing in Africa is to benefit from the nominal growth from a selection of countries.”   

Look beyond the middle class

Often there is a lot of excitement about the growth of Africa’s middle class, says JP Morgan’s Claire Peck. The expectation is that by 2014 there will be 106m households in Africa with $5000 (€3700) in annual income, which is the level where people start to spend roughly half of their income on non-food items, she says.

Because of its scale, Africa already has more middle class households than India.

The rate at which the middle class is changing and growing is encouraging but it is from a very low base and it is still vulnerable to significant economic or political shocks, she says.

“Instead of focusing on the middle class story in Africa, people should still concentrate on the mass markets. We focus our investment idea on consumer staples.

“We are much more likely to invest in a company which produces long life milk for households that don’t have a refrigerator than we do in a company that makes the refrigerators,” explains Ms Peck.

In the natural resources sector, JP Morgan primarily invests in companies listed outside Africa, in countries such as Australia, Canada or the UK, which have an exposure predominantly to African natural resources.

“We still think there is strong demand from countries like China or India, but we don’t think the China-led supercycle is going to be repeated necessarily,” says Ms Peck.

The focus is therefore on stocks that have good growth prospects, driven by local domestic consumption, demand and infrastructure development themes, where the story is about volume growth rather than stocks exposed to international commodity prices.