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Supplements » EM Report 2011

AFRICA: Are we too early for Africa?

Africa-CoffeeAfrica's compelling demographics and surging growth have convinced many investors to enter this market. But the continent remains a frustrating place, held back by lack of infrastructure and scarred by war. George Mitton reports

Nigeria offers a fascinating example of the promise and pitfalls of African investing. For many it is the world’s most exciting frontier market. It is rich in oil, gas and minerals, contains fertile land for agriculture, and last year its economy grew 7.4%, according to the International Monetary Fund.

And yet it is a country where firms must pay dearly for costly diesel generators because only about 40% of the population has access to electricity. In 2008, it suffered a spectacular banking collapse in which investors in the country’s previously promising banks lost all their money. Bloomberg rated its capital markets as the world’s worst-performing index in 2009.

The continent as a whole is just as challenging for investors. After the financial crisis, Africa funds posted strong growth as the continent recovered much faster than the developed world, with GDP growth in countries such as Botswana running at above 8%.

But the perilous nature of African investing was thrown into sharp relief this year when political unrest in Tunisia spread to Egypt, Libya and the Ivory Coast, having a knock-on effect on markets across the continent.

As manager of the Insparo Africa Equity fund, Jamie Allsopp saw this volatility first-hand. His fund opened to investors in February, an experience he describes as “like launching into the teeth of a gale”.

Like many in Africa, the Insparo fund is down this year, though Allsopp asserts that the damage was contained fairly well given that “everything that could have gone wrong in Q1 did go wrong”.

The events have spooked investors. Last year, research firm EPFR registered inflows of $1.3bn (€0.9bn) into Africa funds, but since the beginning of February more than $250m has flowed out again.

But despite these political risks, fund managers remain bullish about African investing. Why?

The answer is that the continent has irresistible demographics. Africa is home to a billion people and growing, thanks to improvements in healthcare that have halved infant mortality since 1960. If current trends continue, Africa’s workforce will be the world’s largest by 2040, overtaking India and China.

On top of population growth, there is a rise in consumer spending. The management consultancy McKinsey predicts that by 2020 more than half of African households will have discretionary spending power.

This will have huge effects, says Mark Mobius, Franklin Templeton’s executive chairman. “These are people, just like many others all over the world, with aspirations to own their own home and buy possessions such as cars, refrigerators, washing machines.”

Of course, Africa still has its abundant resources of oil, minerals and precious metals, many of which are undiscovered or untapped. On top of this, its expanses of fertile, uncultivated land give it huge potential as a food producer.

These are compelling figures, and yet Africa does not generate anywhere near as much investment as developing countries in Asia or Latin America. Compared with the broader emerging market story, Africa funds are still a sideshow.

According to Jeremy Stevens, a South African economist at Standard Bank in Johannesburg, this is because the continent’s growth has yet to translate into comparable economic success.

He notes that Brazil, Russia, India and China (the Brics) now account for about 18% of world trade. But although Africa has seen its share roughly double since 2001, mainly on the back of trade with these countries, it still only accounts for about 3%. This is a small number for a continent with 14% of the world’s population.

Other indicators underline how the continent is behind where it should be. Stevens notes that Africa attracts the same foreign direct investment as Mexico and less than half that of China. “Absolutely, there is no doubt that Africa has been marginalised,” says Stevens.

One of the main factors limiting Africa’s growth is its lack of infrastructure; the lack of power lines in Nigeria, for instance, that keeps most of the population off-grid. Stevens says the continent needs to attract about $100bn of investment in its transport and power networks, and is far behind. The lack of infrastructure “adds to the cost of production as it hinders economies of scale and dislocates millions of people from markets”, he says.

There are human factors too, such as a skills shortage in many African countries. Companies must fly in foreign ex-pats, many of whom take their wages home with them and fail to enrich the countries they work in. This is often a bitter consequence of conflict.

“In Angola, as a legacy of the 27-year civil war, they’ve got bottlenecks in terms of their capacity to deliver the skills needed to invigorate their economy,” says Stevens.

Conflict still scars the continent with civil wars continuing to rage in Somalia, Chad and the Democratic Republic of Congo, though the number of wars has come down dramatically since the 1980s.

These problems make investing in Africa a challenge. There are many practical difficulties, too. For instance, the continent is not well researched by brokers and contains huge administrative barriers to investing.

Many Africa fund managers believe it is essential to get their feet on the ground in the continent and do their own research. According to Malcolm Gray, portfolio manager of several Investec Africa funds, “it’s important to see the whites of the eyes of the people you’re investing in”.

This is because there is potential for fraud and corruption in these undeveloped markets. Of course, doing research has its own challenges, as many of Africa’s major cities are gridlocked with traffic during the day and it can take hours to travel from place to place.

Then there are obstacles to allocating capital. It is not possible to buy stocks in the Democratic Republic of Congo, for instance, so investors seeking exposure here must do so indirectly, by investing in African companies that do business there.

And there is another risk that haunts investors in this continent, as Chris Derksen, head of frontier markets at Investec, explains. “African liquidity is low, if you take a position it’s going to be meaningful, it’s going to be long-term.”

Concerned by the illiquidity of the small markets, many investors play safe and put money in South African equities. Though many of these companies do business across the continent, South Africa’s growth rate is much less impressive than frontier markets like Nigeria.
But there are huge opportunities. Mobile phone use in Africa is growing at about three times the global average and local firms are world innovators, particularly in the field of mobile payments.

Africa’s lack of physical infrastructure can be seen as an opportunity for investors as big infrastructure firms are likely to be busy in coming years. It should be noted that many of these companies will be from overseas, notably China. But this in itself is an opportunity. Foreign firms setting up offices in Africa will need to be banked, benefiting African financial institutions.

For these reasons, Africa’s banks, infrastructure companies and mobile phone firms are considered promising equity bets.

And there is another promising trend: the continuing spread of democracy. In 1985, four-fifths of African countries were one-party states or dictatorships. Today, about 90% are multi-party democracies.

This brings the question back to the unrest in the north of the continent this spring that shook African markets. Seen by many as a destabilising event, it is perhaps better to see these revolutions as strengthening the African economy in the long term. According to

Tommaso Bonanata, an Africa fund manager at Julius Baer: “They are a positive step towards democracy and social improvement.”

Of course, investors may ask whether they should put their money into Africa now or wait until the unrest has died down. This coincides with a question Africa fund managers admit their clients often ask: Are we too early for Africa?

Perhaps, but then the very fact that a large number of investors are fearful of the continent suggests there is a chance for returns. “To me, Africa is a classic example of the gap between perception and reality which leads to investment opportunity,” says Nick Price, emerging markets portfolio manager at Fidelity International.

No one is predicting a smooth ride – there may be fits and starts – but the demographics of growth in Africa show the continent will become an increasingly important economic power in coming years.

To return to Nigeria: though the country suffered terribly in 2009, its growth rate is back to high single figures and there is considerable optimism. Some say the brain drain that has sucked the most talented people abroad to work and study is reversing as Nigerians return home to set up businesses, flush with private capital brought in from overseas. The country just returned President Goodluck Jonathan in elections that were, for the most part, peaceful.

Sharat Dua, portfolio adviser at Charlemagne Capital’s Mena [Middle East North Africa] fund, says the country is ready to move on from its troubled past. “There’s no doubt Nigeria hasn’t achieved its potential. You’ve had a country that was cobbled together after the British left [1960], and had its problems with the Biafran war [1967-70]. It’s had military regimes, unrest, it’s not made the most of what it is. But what it is, is an oil-rich country which is now producing close to its potential. That’s what makes it so exciting.”

©2011 funds europe