Africa's untapped potential

Africa's untapped potential

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For most of this decade, Africa has displayed similar characteristics to China and India in the run-up to their boom years with several countries achieving multi-year spurts of growth of in excess of 7%. Many countries possess abundant natural resources and have young and rapidly urbanising populations with rising purchasing power. African countries, in the main, are also more politically stable than in living memory and there have been sustained improvements in corporate governance.

For the most part, however, the high expectations for the continent’s growth have so far failed to materialise. From a relatively low aggregate level of economic development (from which rapid growth is achievable) the average growth rate of African countries was 4.4% over the past 10 years, according to African Economic Outlook.

For the most part, however, high expectations for the continent’s growth have failed to materialise. Growth in Africa is at its slowest for sixteen years, and the IMF recently cut its growth forecasts by more than any other country bar Brazil. For sub-Saharan Africa it forecasts growth of 4% and 4.7% for 2016 and 2017 respectively, and for South Africa 0.7% and 1.8%. This primarily reflects the adjustment to lower commodity prices and higher borrowing costs, which are weighing heavily on small and large nations alike.

Nonetheless, Africa remains one of the preferred frontier markets for investment opportunities – at least according a PwC report, The Africa Business Agenda, based on the insights of 153 CEOs and public sector leaders across the continent. The 2016 report, published in May, reveals the huge efforts African businesses are putting into ramping up their strategies to stimulate growth in a difficult global environment.

Regulatory support

Governments have also been looking at ways of generating alternative revenues to compensate for drops in crude oil and other commodity prices. Prominent among these are initiatives to promote best practice in asset management and financial product distribution which, especially in the context of flat global investment markets, are designed to encourage foreign inflows.

For example, South Africa’s Financial Services Board (FSB) has extended the Collective Investment Scheme Control Act (2002) to hedge funds. The legislation beefs up compliance and safeguards for hedge funds such as requiring a trustee on either side of a transaction and for every hedge fund to be registered with an objective, similar to the Key Investor Information requirements for UCITS funds. The move is expected to encourage pension funds and others to invest.

Applicants were initially slow to apply, but in April the FSB announced that 188 hedge fund portfolios had received collective investment scheme approval and a further 31 portfolios had obtained provisional approval. Additionally, a number of unit trust funds are expected to register so they can operate as so-called hedge funds lite.

There is also pressure on fees. Regulators are driving down charges on retail financial products. Likewise, wealth managers and pension funds are looking at collective investment structures as platforms to deliver lower fee levels.

The continent’s $1trn pension fund market has been particularly criticised for its high charges, complex policy conditions and exit penalties. In July 2015 South Africa’s National Treasury responded by issuing draft regulations encouraging boards of trustees to consider low-cost passive funds as the default choice.

This has given rise to renewed interest in ETFs in South Africa, according to Duncan Smith, senior sales and relationship manager, emerging markets at Societe Generale Securities Services. He says the firm’s Johannesburg branch, as a trustee for various ETF management companies, has seen some providers using broad-based indices while others are manufacturing their own, often adopting a socially responsible investment (SRI) overlay.

Market initiatives

Stock markets across the region, of course, vary enormously. The $100bn South African stock market dwarfs its neighbours, while second-tier markets such as Egypt, Nigeria and Morocco fall in the $30-100bn range, while third-tier ones such as Uganda, Kenya, Botswana and Zambia, at $1-6bn, have scarcely begun to be exploited.

The larger markets are leading the way in making themselves more attractive to international investors. The Johannesburg Stock Exchange is migrating to T+3 mid-year, and is also reshaping the bond platform of its CSD, Strate.

A collaboration between the London and Nigerian markets should boost liquidity and turnover. Africa’s most populous country also implemented securities lending regulation, in January, and launched its first sovereign sukuk.

Countries such as Ghana, the Ivory Coast and Morocco are also trialling securities lending with local investors, ahead of opening up the practice for foreign participants.

Specialist Africa asset managers that would not typically be considered retail are looking at setting up UCITS vehicles in Luxembourg and Dublin to attract international money, but many firms are watching and waiting before committing to UCITS platforms as this is not a cheap exercise, says one local banker who preferred to remain anonymous.

As confidence grows, though, foreign investors are pushing deeper for opportunities. “Local regulation in Africa is evolving and encouraging pension funds and institutions to look beyond the usual oil, gas and bank stocks, and is opening up mid-cap stocks such as consumer staples as well as less conventional finance and resource stocks,” says Steven Shultz, head, investments and savings marketing at Momentum.

Favoured assets

Several firms are also launching niche funds in private equity, property, IT, and renewables as well as infrastructure, where there is typically a particular focus on power, energy or transport.

Agriculture is a particularly hot sector. Half of the world's uncultivated land suitable for growing food crops is in Africa but the continent generates only 10% of global agricultural output – but with annual population growth of 2.7% food demand is expected to double every 30 years. Aurorae, an agri-focused fund backed by Axa Ventures, announced a $10m fund in the first quarter.

Fixed income has also seen a massive uptick, partly because raw returns are attractive compared with other markets but also because they are not particularly correlated with other sources of bond returns.

“African fixed income markets are certainly not perfectly correlated with those in developed markets,” says Mr Shultz. “In terms of returns, there is a massive variance with South African government-issued bonds yielding around 9.3% on local currency denominated ten-year bonds, against an inflation backdrop of 6.2%. In the case of US dollar-denominated debt, annualised returns of around 4.9% are achievable over a similar ten-year term. Investor motivation varies but is primarily a combination of attractive returns and diversification at a time when broad asset classes are increasingly correlated.”

As the continent’s investment markets mature, western institutions are increasingly investing in the region’s financial services firms. In January, for example, Prudential Financial expanded its footprint in Africa with a $350m partnership with LeapFrog Investments, targeting life insurance companies in larger economies on the continent, including Ghana, Kenya and Nigeria.

Credit downgrade

Short term, the biggest blot on the landscape is the potential downgrade of South African debt, possibly as early as June, and its impact on South Africa’s inclusion in bond indexes around the world. The top 40 stocks in Johannesburg are also traded in the UK so a downgrade might encourage investors to trade offshore rather than onshore.

“It is particularly dangerous as many global institutions and hedge funds have mandates stipulating investment grade holdings, and it is just at the time we should be ramping up investment,” adds Shultz. “The ratings agencies have been exceptionally patient and level-headed, but they are now looking for plans to be implemented. If plans such as fiscal consolidation and proactive measures to encourage economic growth are successfully implemented, it may allow us to escape the downside, however any slipping could be perceived negatively and would certainly contribute to a downgrading of South Africa’s credit rating.”

Certainly, foreign investment flows have not proven sticky to date – as Thomson Reuters data (see graph) shows. “Private wealth funds investing in Africa tend to be tactical and will typically be an all-benchmark bet, very often as a satellite to a core portfolio, and this makes these allocations inherently volatile,” says Peter Preisler, director of investment services, head of Europe, Middle East & Africa at T. Rowe Price. “But there is no doubt that government and big pension funds want to diversify. Some of the newly created sovereign funds from nations such as Rwanda and Ghana will almost be development funds to support infrastructure build, which is attractive.”

The flipside is that “local institutional investors such as pension funds are looking to invest a portion of their portfolios out of the country and this shift will help to stabilise the market,” adds Preisler. “Apart from improving diversification, in recent months investing outside the country has also been highly beneficial in terms of currency movements.”

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