Why Africa should form a key part of your investment portfolio

The negative perspectives of Africa captured on most international media are not matched by the reality on the ground. This may well contribute to creating opportunities for international investors, in frontier African markets, not afraid to seek high returns in a relatively high risk environment.

China’s need for resources has and will continue to be a key driver of African trade, investment and economic growth. China gets about a third of its oil from Africa, notably from Angola and Sudan, and Africa also provides huge amounts of its copper and cobalt

In a bid to improve long-term resource security, China has been investing heavily in oil-producing nations like Nigeria, Angola and Sudan as well as seeking uranium in Niger and copper in Tanzania. In return China has provided a wide range of support to host countries, including debt-forgiveness, aid assistance, long-term resource deals and large-scale infrastructure projects. Collectively, these actions have supported the economic growth of the region and its stability in recent years as well as producing large net inflows of capital which inadvertently have led to higher income levels and a need to reinvest some of these in the financial markets. .

According to The Financial Times trade between Africa and China has increased ten-fold in the last decade from bn to more than 0bn hence overtaking the US and Europe as the largest trading partner with some of Africa’s key economies.

Competition for African resources is also intensifying as African countries increasingly become the object of interest from other emerging powers including India, Brazil, South Korea, and Malaysia who are showing an interest not only in the continent resources but also in its billion-strong market of potential consumers.

The limited integration of many sub-Saharan countries (with the notable exception of South Africa) into the global economy and consequent decoupling of its financial markets from the developed world may have contributed to the region’s relative resilience during the recent global recession. However, a much more important factor is the region’s improved economic strength (GDP grew by almost 6 per cent in 2010) while that in much of the developed world has stagnated. Africa currently contains over a billion people and the figure is expected to rise to almost 1.9 billion by 2050.

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An important factor from an investor’s perspective is the rising number of people on the continent with higher incomes who have the means to spend on a wider range of items. According to McKinsey, Africa has more middle-income households (those earning more than ,000 a year) than India despite having a smaller population. Thus in addition to its resource strength much greater opportunity lies in the region’s own consumption prospects. With an already huge population that is growing and steadily becoming wealthier, the region’s scope for consuming goods and services is vast thus creating enormous business opportunities in consumer goods and services industries.

However, despite the above-mentioned opportunities and potential, Africa remains a relatively high-risk environment and poses significant barriers to entry for investors. A number of countries are recovering from long periods of instability and have a high susceptibility to renewed conflict. This means that good research and in-depth knowledge of local African investment markets is necessary before venturing into these markets but such a strategy can also offer great competitive advantage.

Just like most leading emerging markets like Turkey, South Korea, Brazil and others were once considered obscure destinations for investor funds, these have gradually moved into the mainstream handsomely rewarding, albeit over time, those investors who were brave enough to take on the additional risk. However, in most recent times returns in the less lauded frontier markets like Kenya and Ghana have been much better than those of the more prominent emerging markets[1].

Further, although the region is known for its challenging business environment, particularly for foreign firms, this disadvantage is offset to some extent by a relative lack of competition, high growth and low labour costs. These can all support higher corporate profit margins. One way to take

advantage is to seek out well-managed domestic or regional firms that are market leaders in their fields, show good growth prospects and have attractive valuations.

Another reason for seeking investment in Africa is that rising correlations between developed and leading emerging markets means that investors need to look further afield for lower correlation assets. Frontier markets in Africa thus represent a case in point.

Ultimately, investors will need to find countries that offer the potential for a sufficiently high level of return at an acceptable level of risk. This can be a research-intensive and time-consuming process that is probably best outsourced to local practitioners with in-depth regional knowledge and expertise. Illiquidity and weak institutional structures continue to be a major constraint although significant variations do exist within the region between countries, which further underscores the need for good research and local expertise.

[1] While returns for the BRIC countries were -1%, 14%, 17% and 6% respectively those of frontier African markets like Kenya, Ghana and Nigeria topped 34%, 32% and 19% respectively for 2010 (Bloomberg, 2011).

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