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Focus on...
Paul Clark Investment Manager

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Why you should invest in African countries – especially after the budget speech

07 Mar 2018
...across the continent, growth is continuing, infrastructure is improving and business conditions are getting better

The news flow from Africa typically focuses on the worst issues and incidents that occur on the continent. A foreigner following the news from South Africa over the last few years could not be blamed for thinking that the main game 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 of South Africa were raised by the now former Finance Minister Malusi Gigaba when he made his budget speech last month.  Specifically, the limit for African investing was raised from 5% of the pension fund's assets to 10%. These allowances are in addition to the normal offshore limit that was raised to 30%.

So why should South Africans utilise these new limits and allocate some of their retirement funding to African equity markets? There are many reasons, but we  believe that some of the key considerations are:

  • Investing in a region that is growing quickly and where the economies are transforming their infrastructure, middle class consumers are growing and they are industrialising too;

  • 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;

  • Taking advantage of the current strong rand to US dollar exchange rate to invest in offshore assets;

  • Choosing an experienced manager who knows the continent and can avoid most pitfalls and generate excess returns over the economic cycle.

We use the International Monetary Fund (IMF) gross domestic product (GDP) growth forecasts to illustrate the relative growth expected in Africa and elsewhere. The graph shows that the continent, especially in countries that have equity markets and are typically more developed, is expected to grow faster than the world over the next five years and significantly faster than advanced economies or even South Africa over the period.

Real GDP growth rate forecasts​

Real GDP growth rate forecasts - 650

Source: International Monetary Fund, World Economic Outlook Database, October 2017, Ashburton Investments 

There are also few countries in Africa excluding South Africa (SA) that are not performing as well and, even though they tend to make the news more often, are usually smaller economies that are less developed than those that have equity markets. An African (ex  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 2 June 2002 until 10 January 2018.  Over this extended period, Africa ex SA has a very low correlation to global markets of 0.24 and to South Africa 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. 

The correlation for the US dollar returns of the respective indices - 650Source: Bloomberg, Ashburton Investments

Because of South Africa's position in the world and global emerging markets (GEM), investing offshore in these markets has much lower diversification benefits. The correlation between South Africa and world markets is 0.77 and to GEM 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 illustrated in the graph.

Year-end inflation for African economies (ex SA) with equity markets (%)

Year-end inflation for African economies (ex SA) 650 v2

Source: International Monetary Fund, World Economic Outlook Database, October 2017, Ashburton Investments 

As inflation declines through 2018, we expect local interest rates to decline. This reduction in interest rates is expected to create further demand for equities as domestic money managers shift their portfolios more towards equities and away from fixed income assets like 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%-4% per annum). The following chart shows the returns for an investor in the Ashburton Africa Opportunities Fund (after all fees and costs) compared to the MSCI Index for Africa ex South Africa. This fund is available as a rand based local unit trust, so investors don't need the South African Revenue Services (SARS) clearance to engage in foreign exchange transactions, nor do they need to open an offshore account, but will still get the US dollar returns.

Fund unit price in Rand and MSCI Africa ex South Africa Index normalised to 10 on 22 May 2013

Fund unit price in Rand and MSCI Africa ex South Africa Index - 650 v2

Source:  State Street, Bloomberg, Ashburton Investments 

The fund outperforms the index strongly in upward trending markets.

In conclusion, we believe that South African (and other) investors should diversify their returns by investing in the rest of Africa (even if some people call them sh**hole countries). The former finance minister clearly agrees as he 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 that 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 US dollar denominated asset class.