As investors, we are all aware of the need to diversify our exposure because it reduces the volatility of investment returns and has the benefit of not putting all your eggs in one basket. It is for this reason that the prudential limits for South African (SA) investors allows offshore investments of 30% within a pension fund (or other product managed under Regulation 28) with an additional 10% allowance for Africa outside of SA.
Because South Africans typically have a large portion of their savings invested domestically and in what is considered an emerging market, their normal consideration is to diversify into so-called developed markets to lower their risks. They consider investing into the rest of Africa, which mostly falls into a frontier market designation, as something that will not improve their investment risk.
The chart below shows the annualised returns for different MSCI Indices as well as the Johannesburg Stock Exchange’s (JSE) All Share Index (all in US dollar terms), as well as the annualised risk or volatility.
Source: Bloomberg data from June 2002 to December 2018, Ashburton Investments
One of the more common remarks we hear when introducing Africa to potential investors is, “I know, this is a high-risk investment with a high potential return”. If we use the MSCI Index for Africa excluding SA and compare the returns and volatility of this index to a range of other global indices, this is simply not true. The graph clearly shows that over the long term, African excluding SA equity markets have outperformed developed, emerging, frontier markets and the S&P 500 Index. In addition, the volatility of these returns has been similar to those for developed markets and even less than that of emerging markets, and significantly less than those of the JSE.
Our detailed analysis shows that adding Africa excluding SA equity exposure to a SA balanced mandate improves the risk and return profile, even for lower risk mandates. One of the reasons for this is the very low correlations that African equity markets have to mostother markets as shown in the table below.
Correlation of US dollar weekly returns
Source: Bloomberg data from July 2002 to December 2018, Ashburton Investments
As expected, the JSE is highly correlated to Global Emerging Markets (GEM) and also to developed markets (due to the many dual listings of global companies on the exchange). However, the very low correlation to Africa excluding SA of 0.21 provides significant diversification benefits to SA investors.
Of course, no one would invest in Africa, or any asset for that matter, based on historic returns even though African returns have been good. Investors need to believe that the continent has improving economic growth, better business environments and more stable politics. This is another area where misconceptions arise. The news flow from Africa typically focuses on the worst issues and incidents that occur on the continent. A foreigner whose main source of information is the news media would conclude that the continent is characterised by violence, political instability and weak governance. However, on the ground and 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.
We have seen some recent data releases that confirm our thesis for Africa outside of SA as a long-term investment destination. As we have said before, the economies on the continent are transforming and it is this transformation that is driving a large portion of the growth. While global growth and higher commodity prices are supportive factors for these economies, they are not a requirement. The International Monetary Fund (IMF) released their latest World Economic Outlook in October 2018. Despite some downgrades to global growth, the outlook for African economies remains largely unchanged. The graph below shows the latest updates, as well as the previous forecasts (shown as dots).
Gross domestic product (GDP) growth rate (%)
Source: IMF, World Economic Outlook, October 2018 and April 2018 (shown as dots), Ashburton Investments
An even more important release is the World Bank Doing Business 2019 report. The following graph shows selected information and some analysis of the data from their “Doing Business” project that provides objective measures of business regulations for local firms in 190 economies. We use their “ease of doing business score” which allows us to assess the level of improvement in the ease of doing business over time.
Ease of doing business (%)
Source: The World Bank Doing Business 2019, Ashburton Investments
The graph clearly shows that our observations of improvements on the ground can be backed up by the World Bank’s detailed analysis that uses 11 indicator sets to measure aspects of business regulation that matter for entrepreneurship. The business environment for Africa excluding South Africa has on aggregate continued to improve in line with the trend experienced earlier in the century.
According to the World Bank, Sub-Saharan Africa has been the region with the highest number of reforms each year since 2012. More than a third of the reforms that they captured across the globe in the latest release were from 40 economies in Sub-Saharan Africa. As an example, the average time to register a business in the region has declined from 59 days in 2006 to 23 days. They identified 10 economies with the most notable improvements in their latest survey and the list included five African countries, namely, Djibouti, Togo, Kenya, Côte d’Ivoire and Rwanda. Kenya jumped 20 positions to be ranked 61st in the world, while Rwanda gained 11 places and is now ranked 29th ahead of Spain, Russia and France.
In the World Bank’s view, Mauritius is the easiest place to do business on the continent and is ranked 20th out of 190 countries, ahead of countries such as Canada, Ireland and Germany. South Africa ranked at 82nd in the world for doing business and is the sixth best on the continent (it was second on the continent in 2013 but has fallen 42 places in the global rankings while the rest of the continent has generally improved by about three places).
Hopefully we have been able to show that our optimism for the African continent can be backed up by data and analysis by global institutions. We also believe that investors can access this growth through equity investments in domestic African companies that will not only benefit from the anticipated growth, but also from improving infrastructure and business environments as well as better political governance.
Investing in African equity markets should decrease the volatility of a portfolio, even in difficult market periods, and provide significant diversification benefits, while generating good returns. We believe that South African investors should invest a portion of their portfolios over the medium to longer term in African equities to benefit from this strongly growing region. They can do this by using their offshore allowance and investing directly in a (typically) US dollar denominated fund, but there are also rand denominated feeder funds available that will then invest in the offshore fund on their behalf and thus make it less administratively complex.