A Time to Invest in Africa
Africa Investing: The Benefit of a Diverse
Continent
Larry Seruma
Chief Investment Officer
Nile Capital Management, LLC
152 West 57 Street, 32nd Floor
New York, NY 10019
Telephone: 1-646-367-2820
Email: [email protected]
June 2011
INTRODUCTION
Twenty years ago, far-sighted investors focused on the emerging and frontier markets of Asia –
especially China and the “four Tigers” of Hong Kong, Singapore, South Korea and Taiwan. Most
investors in these markets have been richly rewarded, especially if they bought early and held
patiently.
Today, there are signs of comparable opportunity in the emerging and frontier markets of Africa. For
example, economists project that several African markets have the potential to approximate the
sustained GDP growth rates produced by China and the four Tigers over the past two decades, with
Africa as a whole expected to grow by more than 5% over the next ten years.
In fact, the potential for investing in Africa has already begun to be realized. In the past decade, an
investment in an Africa Composite benchmark has significantly exceeded the performance of the S&P
500 Index, and even outpaced the MSCI Emerging Markets Index on a buy-and-hold basis, as shown
below.
Historical Performance
Comparison
(Hypothetical Value of
$1,000 Invested)
$8,000.00
$7,000.00
$6,000.00
$5,000.00
$4,000.00
$3,000.00
$2,000.00
$1,000.00
$Dec-00
Dec-02
Africa Composite
Dec-04
Dec-06
MSCI Emerging Markets Index
Dec-08
Dec-10
S&P 500
Source: Bloomberg, MSCI, Reuters. The Africa Composite includes South Africa, Nigeria, Kenya, Mauritius, Ghana,
Egypt, Morocco, and Botswana, on an equal-weight basis.
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Although GDP growth and a decade of strong stock market performance are compelling, we believe
comparisons only go so far between Africa today and the Asia of twenty years ago. There are
significant differences between these opportunities, and investors who recognize them will be best
positioned to capitalize on Africa’s potential.
Africa encompasses more countries (53) than Asia and offers significant economic diversity. The
nations of Africa currently are at a range of stages of development, political maturation, and
urbanization. Unlike China and the Four Tigers – all of which depended on manufacturing or techdriven export economies – Africa is a mosaic of industries driven by vastly different dynamics. The
same trend that leads to market turmoil in one African nation, such as food price increases in Egypt,
can be a growth catalyst in resource-rich countries such as South Africa and Nigeria.
In Asia, virtually any investor could have been successful over time, even those who picked index
funds at random, because the same tides lifted all boats. However in the diverse continent of Africa,
we believe the key to success will be active management with a selective focus. As we will show, a
discerning portfolio manager can take advantage of Africa’s diverse characteristics to avoid the
continent’s highest risks, while choosing to pursue opportunities which are justified by exceptional
performance potential.
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L ESSONS FROM THE
REVOLUTION IN EGYPT
In January of 2011, a political revolution spread across Egypt like a wildfire. No politician,
economist, or market analyst predicted the revolution’s timing, or projected its huge impact on the
nation’s economy and markets. On January 20th, Egypt’s stock market began falling as the revolution
gained momentum. A week later, the market was closed by authorities and did not re-open until
March 24th. From January 20th through March 24th, the Egyptian stock market lost 27.8%.
Prior to the revolution, Egypt had the second largest market capitalization in Africa (about $70
billion), and it is one of two African markets (along with South Africa) included in the MSCI
Emerging Markets Index. As might have been expected, Egypt’s shuttered market had a ripple effect
on other emerging markets, and between January 20th and March 16th, the MSCI Emerging Markets
Index fell by 5.0% on concerns over Egypt and other Arab markets.
However, the diverse continent of Africa suffered less “Egypt impact” than did emerging markets in
far-off corners of the globe. The graph below shows the performance of African national markets
during the period of Egypt’s turmoil.
Africa Market
Performance (USD
Return)
Jan 20 – Mar 24
10.0%
5.0%
0.6% 0.7% 1.2%
4.7% 4.9%
3.5% 3.6% 3.7%
2.4% 3.1% 3.2%
6.3%
0.0%
-5.0%
-2.9%
-10.0%
-10.7%
-15.0%
-15.2%
-20.0%
-18.5%
-25.0%
Zambia
Botswana
Mauritius
Zimbabwe
Ghana
Namibia
Tanzania
Swaziland
South Africa
Tunisia
BRVM
Morocco
Malawi
Nigeria
Uganda
Kenya
Egypt
-30.0% -27.8%
Source: Bloomberg
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This event revealed two interesting dimensions of Africa’s diversity.
•
Most leading national stock markets of Africa showed no impact from turmoil in Egypt. In fact,
the majority of markets in Africa increased during the interval when the Egyptian stock market
was weakest.
•
Those markets that declined did not do so because of Egypt. The drop in the markets of Uganda
and Nigeria was largely due to other risk events, apart from Egypt, especially political unrests
and capital outflows surrounding national elections. In Kenya, the market fell because of an
inflation surprise on the upside and unanticipated interest rate increase by the central bank. This
pattern of diverse risk impacts in different African markets also is typical.
Despite the far-reaching geopolitical implications of the Egyptian revolution, the lack of impact on the
continent’s markets as a whole was as expected for those of us who follow Africa closely. The graph
below shows correlations between leading African stock markets over the past decade.
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CORRELATIONS BETWEEN
AFRICAN MARKETS
Correlations Between
African Markets
Dec 2000 to Dec 2010
South Africa
South Africa
Nigeria
Kenya
Mauritius
Ghana
Egypt
Morocco
Botswana
0.19
0.26
0.33
-0.14
0.45
0.21
0.04
0.20
0.29
0.06
0.29
0.25
0.13
0.46
-0.04
0.39
0.06
0.07
-0.09
0.47
0.17
0.08
0.00
-0.01
-0.12
0.23
-0.11
Nigeria
0.19
Kenya
0.26
0.20
Mauritius
0.33
0.29
0.46
Ghana
-0.14
0.06
-0.04
-0.09
Egypt
0.45
0.29
0.39
0.47
0.00
Morocco
0.21
0.25
0.06
0.17
-0.01
0.23
Botswana
0.04
0.13
-0.07
0.08
-0.12
-0.11
0.01
0.01
Source: Bloomberg
U.S. investors have become accustomed to correlations of 0.90 or higher among styles of domestic
equities, and also between the S&P 500 Index and benchmarks of developed stock markets abroad. In
fact, the correlation between the S&P 500 and the MSCI Emerging Markets Index often has been
above 0.80 over much of the last decade. Such high correlations mean that the same macro-economic
forces and money flows are driving stock markets and styles all over the world.
However, in Africa, the average correlation between all the above pairs of markets over the last decade
has been just 0.15. In other words, the average correlation between these markets has been
approximately the same as between U.S. stocks and U.S. bonds. Clearly, the same forces and flows are
not driving the diverse stock markets of Africa.
Africa’s low correlations create the potential for efficient portfolios, with relatively high risk-adjusted
returns. The graph below shows the risk/return profile of a hypothetical portfolio equally weighted
among all eight of these African markets (“Africa Composite”), with annual rebalancing between the
markets, over a decade.
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Risk vs. Return
25%
Dec 2000 to Dec 2010
Africa Composite
20%
Annualized Return
MSCI BRIC Index
15%
MSCI Emerging Markets Index
10%
MSCI Frontier Index
5%
0%
-5%
10%
S&P 500
15%
20%
25%
30%
Annualized Standard Deviation
Source: Bloomberg
Adding the equal-weight Africa Composite to a bigger equity portfolio has the potential to lift the
“efficient frontier.” It’s important to note that a passively managed index fund with market-cap
weightings would not have the same impact. Three countries – South Africa, Morocco and Egypt –
account for about 90% of Africa’s market capitalization, so a market cap-weighted index fund would
not be exposed to the diversity encompassed by the eight-country equal-weight Africa Composite.
The same factors that explain low correlations between leading markets of Africa also create
competitive advantages for portfolio managers equipped with high-quality macro-economic and
fundamental research. Nile Capital Management has the on-the-ground research capabilities to invest
confidently throughout the eight markets of the “Africa Composite,” as well as smaller, less widely
researched markets wherever we see compelling risk to reward opportunities. In this manner, Nile
pursues natural diversification between African markets with the advantages of focused, active
management.
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WHY CORRELATIONS
BETWEEN AFRICAN MARKETS
ARE LOW
Nile Capital Management has identified six dimensions of Africa’s diversity, each of which helps to
explain: 1) why correlations between markets are so low; and 2) why active portfolio management can
create an edge in managing and balancing risks.
1. Resource Diversity
A big economic story in Africa is the extraction, development and allocation of natural resources and
each market has a different “resource profile.” For example, the nations of northern Africa are
vulnerable to higher commodity prices because fresh water is scarce and food must be imported. Only
Libya has extensive oil resources that can be extracted and sold to generate hard currency, economic
growth, and employment. In Egypt, 60% of an average worker’s wages go for food, and the global runup in food prices during the second half of 2010 was a catalyst for revolution. However, the same
commodities price boom helped oil exporter Nigeria and mineral-rich South Africa and Botswana.
An active portfolio manager can capture changes in the resource profiles of African markets. For
example, Ghana was a net oil importer (and vulnerable to oil price increases) until 2010. But in
December, the first crude oil began flowing from Ghana’s vast Jubilee offshore field, which contains
an estimated 1.2 billion barrels of reserves. Now, and perhaps for the next decade, Ghana will be
positioned to benefit from strong oil prices and commodity trends.
2. Political Diversity
Although Egypt has Africa’s second largest economy by GDP (behind South Africa), it was a politically
repressive nation under Hosni Mubarak, with restricted human rights and prohibited free assembly.
Some investors assume the rest of Africa has similar vulnerabilities. Yet, the market contagion when
Mubarak fell from power was far greater in Middle Eastern nations than across the rest Africa – for
good reason.
Most leading markets in Africa have advanced well beyond Egypt in developing more democratic
political systems and institutions. For example, Nigeria was notorious for military coups and
repressive political regimes until the late 1990s. In 1999, a new constitution was adopted and
democracy emerged under a strong elected President, Olusegun Obasanjo. In 2011, President
Goodluck Jonathan was re-elected in an vote that was considered the most transparent in Nigeria’s
history, with enthusiastic voter participation. On a broader scale, Freedom House categorizes 10 out
of 13 countries (77%) in the Middle East as “Not Free”, while only 21 out of 53 countries (40%) in
Africa were categorized as relatively free.
3. Financial and Banking System Reforms
In addition to improvements in its political progress, Nigeria also has transformed its banking sector
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to reduce corruption, strengthen regulations, and increase services to consumers. Long before Egypt
erupted in revolution, Nigeria had sent a positive message of financial system reform to global capital
markets.
Although high inflation and cost-of-capital are common across most of Africa, some markets have
developed strong central banks and effective policies for managing inflation. For example, the Bank of
Mauritius recently raised its key repo rate by 50 basis points (to 5.25%) to cool off 4.4% headline
inflation. By way of comparison, the Bank of Mauritius has been more aggressive in tightening
monetary policy than the Bank of England, which has retained a 0.5% Bank Rate through early 2011,
despite projections of 5% headline inflation.
Again, selectivity is key because in other parts of Africa central banks are less proactive, and inflation
and a high-cost of capital remain significant risk factors that most investors should avoid.
4. Population, Urbanization, and Consumer Market Development
With 160 million people, Nigeria has the seventh largest population in the world and by far the
largest in Africa (about double Egypt’s). On the other extreme, Botswana has just 1.8 million people
and Mauritius 1.3 million.
Consumer market growth is emerging in pockets of Africa where population growth converges with
the trend toward urbanization – the movement from rural areas into cities. According to the
McKinsey Global Institute, there are 52 African cities with more than 1 million people (in comparison,
there are 52 in Europe and 48 in North America). With urbanization comes job and income growth,
along with a better educated and upwardly-mobile labor force. McKinsey has projected that over the
next 30 years, Africa’s labor force will grow from 500 million to 1.1 billion, at which point it will
exceed China’s and India’s. Collectively, McKinsey says, Africa will then represent the largest labor
force in the world.1
However, urbanization and consumer market growth will not be evenly distributed across Africa, in
part due to lack of available water and food. Most Africans spend about 60-70% of their incomes on
food, and McKinsey projects that 11 coastal countries with significant uncultivated cropland will
account for 72% of Africa’s agricultural growth potential over the next 20 years.
5. Communications and Infrastructure
Until now, South Africa has led the continent in developing modern communications and
infrastructure, but countries such as Nigeria and Kenya are starting to catch up, often by leveraging
relationships with foreign companies. An example is Safaricom, a public company that began as a
joint venture between the Government of Kenya and Vodafone, a UK corporation. In 2007, Safaricom
launched M-PESA, a money-transfer service that operates via cell phone. In less than four years, the
M-PESA subscriber based has soared to more than 17 million and modernized business transactions
across sub-Sahara Africa. For the first time, services such as insurance can be sold into remote areas
of Africa through the M-PESA service.
Another example of infrastructure empowerment is MTN Group, a publicly-held South African
cellular network operator that now operates in 21 African countries. A joint-venture subsidiary
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between MTN and Nigerian partners has become the largest telecommunications network in Nigeria,
with more than 38 million subscribers. In less than a decade, this network has reached 85% of
Nigeria’s households, virtually all of whom lacked any reliable phone communications before. MTN
essentially has pioneered a model for selling mobile services to middle-class and poor households all
over Africa.
MTN Group, (currently one of Nile’s portfolio holdings), has 147 million total subscribers across Africa
and generated 2010 revenues of $115 billion ZAR ($16 billion USD). The stock pays a dividend yield of
10% and the price is 30% below the average of comparable emerging market network operators, on a
subscriber metric comparison basis. Total subscribers are growing at a 13% annual rate.
Infrastructure expansion often precedes GDP growth in Africa, so MTN’s subscriber trends help to
identify future market opportunities. For example, Uganda now has 6.9 million MTN subscribers (in a
population of 33 million) and the country’s subscribers are growing at an annual rate of more than
25%.
6. Capital Flows
The surest way a portfolio manager can reduce investment risk in Africa is to buy when stock prices
dip. This situation is common because in most African markets the investor base remains local.
Lacking diversification across other holdings, local investors tend to sell at the same time, when they
perceive rising risks or looming economic austerity. This creates buying opportunities for betterdiversified foreigners.
Interestingly, there is virtually no contagion between these “liquidity events” in different African
markets. Local investors may be liquidating in Kenya at the same time they are accumulating in
Tanzania, the country next door. In fact, this may have happened during the first quarter of 2011,
when the Kenyan market lost 50% of its healthy gains from the year before while Tanzania was
rallying. Active portfolio managers who closely follow the sentiment of local investors and monitor
capital flows can add significant value to a risk management strategy.
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CONCLUSION
Nile Capital Management’s process for actively managing risk combines a proprietary macroeconomic ranking of all 53 countries in Africa with fundamental research developed by feet-on-theground analysts. We believe in spreading risks among our top-ranked national markets, all of which
have reliably low correlations to each other. We maintain a selective focus by keeping portfolio names
to about 35 companies with market caps in the $5 billion to $500 million range.
Nile portfolio holdings represent our top investment ideas across a large, diverse continent. We can go
wherever in Africa we see attractive opportunities at acceptable risk. Our strategy is unconstrained
by any country weight, sector weight or benchmark-tracking targets. At the beginning of the Egyptian
Revolution in January, Nile had only a 10% allocation to Egypt. Compared to the Dow Jones Titans
Index, with a 20% weight in Egypt, Nile was underweight Egypt due to our value investment
approach and macro-economic research.
The real difference between Africa and the rest of the investment world is that we don’t feel crowded
by “big money.” Analyst coverage of leading growth companies in Africa remains light, and local
investors still create most of the demand for the shares we hold.
However, it will not be this way for much longer. Over the next decade, more analysts and big-money
global investors will undoubtedly discover what the diverse continent has to offer, and wish they had
known to invest now.
To find out more about how to invest with us please visit www.nilefunds.com.
Larry Seruma is the Chief Investment Officer and Managing Principal of Nile Capital Management.
Nile Capital Management, the Adviser to the Nile Africa series of funds, is a New York City based
asset management firm with in-depth investment expertise that covers the entire African Continent,
from Cairo to Cape Town. By focusing on Africa, the company seeks to identify and capitalize on the
best investment opportunities in the continent and expand investor’s access to emerging/frontier
markets. Additional information is available at www.nilefunds.com
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Risk Disclosures
Mutual Funds involve risk, including possible loss of principal. Because the Fund will invest the majority
of its assets in African companies, it is highly dependent on the state of the African economy and the
financial prospects of specific African companies. Certain African markets are in only the earliest stages
of development and may experience political and economic instability, capital market restrictions,
unstable governments, weaker economies and less developed legal systems with fewer security holder
rights. Adverse changes in currency exchange rates may erode or reverse any potential gains from the
Fund’s investments. Exchange Traded Funds are subject to specific risks, depending on the nature of the
underlying strategy of the fund. These risks could include liquidity risk, sector risk, as well as risks
associated with fixed income securities, real estate investments, and commodities, to name a few. Nondiversification risk, as the Funds are more vulnerable to events affecting a single issuer. Investments in
underlying funds that own small and mid-capitalization companies may be more vulnerable than larger,
more established organizations. The Fund’s exposure to companies primarily engaged in the natural
resource markets may subject the Fund to greater volatility than investments in a wider variety of
industries. There is a risk that issuers and counterparties will not make payments on securities and other
investments held by the Fund, resulting in losses to the Fund. In general, the price of a fixed income
security falls when interest rates rise. The Fund may invest, directly or indirectly, in "junk bonds.” Such
securities are speculative investments that carry greater risks than higher quality debt securities.
Past performance does not indicate future results.
C ONTACT
152 West 57 Street, 32nd Floor
New York, NY 10019
Telephone: 1-646-367-2820
Email: [email protected]
www.nilefunds.com
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