Africa: an investment class of its own

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Africa’s population is growing fast and the United Nations (UN) has forecast that 22% of the world’s inhabitants will be living on the continent by 2050.
Being nearly as urbanised as China, Africa has 52 cities with in excess of one million inhabitants, as at 2010.

These demographics, coupled with a burgeoning middle class, mean that spending power on the continent has been rising at a fast pace.

The resultant internal economic demand, coupled with capital from international investors and companies seeking a new repository in places such as Africa, has resulted in robust GDP growth on the continent and the region becoming largely viewed as a unique investment destination.

“African markets are classified as frontier destinations due to their stock markets having a tendency to be less developed than those of emerging markets,” says Sandisile Dlamini, investment analyst at Momentum Asset Management.

“Africa is also highly segmented and tends to have lower correlations to other regions, yet another reason for it being viewed as a separate asset class. This reduced alignment with other investment destinations offers diversification benefits for both South African and global institutional and retail investors.”

African markets, however, tend to be more volatile and flows from retail investors have a tendency to be unstable during periods of uncertainty, resulting in suboptimal fund management and a large number of Africa fund managers therefore preferring to keep this offering restricted for investors with long-term investment strategies (such as institutional clients). Volatile cash flows also result in higher trading costs, which can detract from performance.

An understanding of the Africa investment environment is necessary as associated regulatory, political and liquidity risks need to be appropriately managed. Knowledge of political risks can help one understand the inherent currency risk being taken, as well as policy stability, for example, the likelihood of implementation of sudden and adverse policies.

On the regulatory side, investment managers would need to be aware of the regulators in the different markets and whether their regulations make for a conducive operating environment for the companies in which they are invested and factor in these political and regulatory risks when evaluating these markets.

Emerging markets have been criticized for their increased correlations with developed markets, particularly during volatile periods, which is when the benefits of diversification are needed the most.

Although we have seen increased correlations between emerging/frontier and developed markets post the global financial crisis, Africa’s alignment to the developed world remains relatively low compared to other investment regions.

“Many African markets are going through structural changes which are expected to result in higher growth rates than developed and emerging economies. However, as with all investments, higher returns are often associated with higher risks,” concludes Dlamini.

“The continent has proved extremely resilient through the financial downturn and will likely continue to be an attractive and differentiated asset class option.”

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