The impact of African Investments on your portfolio

Posted On Wednesday, 11 November 2015 01:29 Published by
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The China slowdown and current uncertainty surrounding US interest rate expectations has hit emerging markets hard.

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Africa too has felt the pressure, with the World Bank recently announcing that by the end of 2015 African growth is expected to fall to its lowest level since 2009. However, if trends over the past few years are anything to go by, African economic growth is expected to weather the storm and according to Cavan Osborne, Old Mutual Pan African Equities Fund Manager at Old Mutual Investment Group, investing in Africa through your investment portfolio could reap rewards over the longer term.

Africa, with its fast growing middle class, rapid urbanisation and lower debt levels relative to its more developed counterparts, presents significant opportunities for investors. And because there is less investment focus on the rest of the continent than say South Africa, for example, there are more undervalued companies to invest in.

In most instances, Africa is coming off a small base; meaning there is significant ‘catch up’ growth opportunity. This will be driven by Africa’s young population moving into the working age category. For example, beer consumption in Kenya is currently around 12 litres per person. As people get older and wealthier the consumption is expected to pick-up; although it will be a long time before it gets close to the almost 80 litres consumed per capita in the United States.

The China slowdown is being felt by more and more African countries that heavily rely on commodity exports, including DRC, Zambia, Tanzania and Mozambique. The drop in the oil price is having a very negative effect on places like Nigeria, Angola and Algeria. However, this drop is good for oil importers such as South Africa, Kenya and Morocco. Countries with more diversified economies – such Kenya and Egypt – are expected to perform better.

According to the 2015 "African Economic Outlook" report by the African Development Bank ("ADB"), the Organization for Economic Co-operation and Development, and the United Nations Development Program, the continent’s economies will grow 4.5% in 2015 and 5% in 2016, on average.

This is not a surprising outcome, as African economies have been steadily making progress towards fostering a more investor friendly environment. Although a slow process, corporate governance as well as political stability has improved across the continent. Just this year Nigeria had a peaceful change in government.

In addition, operating conditions have become easier as inflation is more under control. Historically at around 15%, inflation has now reached the 6% range, although it has spiked recently following widespread currency weakness. Development of the capital markets has also made it easier to get money in and out of African countries.

However, as with all investing, African does come with some key risks in addition to the usual risk associated with investment markets around the world. These are categorised as currency risk, political risk and liquidity risk.

Currency risk relates to the movement of the exchange rate as well as the risk of getting money into and out of a specific country. Political risk relates to changes in laws and regulation. For example there may be unexpected changes to tax rates. Furthermore, Africa has a history of being less stable on the political front, which can result in civil unrest. Liquidity risk, or the availability of liquid assets, also presents a challenge as many of the financial markets are less developed and less active. Liquidity becomes important as there may not be buyers if you are trying to exit a market in a hurry.

When investing, it is important to take a more holistic approach. From a company valuation perspective, Zimbabwe looks very attractive, but then there are other factors to be considered when investing in the country. Using our more holistic approach, we find that Kenya and Egypt are attractive. Kenyan companies are expected to deliver some of the best earnings growth on the continent and the stock market is showing opportunities currently. Egyptian companies are very well managed and are continuing to recover after the Arab Spring four years ago.

For South African pension funds it makes sense to be exposed to Africa right now to capitalise on the opportunities it offers. Economic growth in South Africa is currently less than 2%, while it is more than 5% for the rest of the continent. South African pension funds are permitted to invest 5% in the rest of Africa to gain access to this additional growth. However, the broader African continent is a riskier investment than local markets for South Africans given the additional currency risk. We therefore recommend that only a limited portion of a portfolio be invested in these assets to allow for the right balance between risk and opportunity.

Africa presents a unique set of challenges for investors so they should therefore ensure that their fund manager clearly understands the nuances of the different African markets in order to make the right investment decisions in the current climate.

Last modified on Friday, 20 November 2015 07:05
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