The hopeful continent

From civil strife to famine, poverty, and corruption, Africa has a long-standing reputation as a troubled region of the world. As recently as 2000, The Economist ran a bleak cover story describing it as the “hopeless” continent. Most of its equity markets have been firmly relegated to immature, high-risk frontier-market status. And many global investors have historically tended to overlook or even deliberately avoid the region.

But have you looked at Africa lately? Suffice to say that the region has made great strides over the past two decades. Indeed, a mere 13 years after the aforementioned article, The Economist published a decidedly more upbeat narrative that dubbed Africa the now “hopeful” continent. Many of the negative investment perceptions persist, but we believe the time has arrived for equity investors to take a closer — and realistically hopeful — look at the opportunity set in Africa.

Africa is a vast, diverse continent

On sheer size alone, Africa is difficult to ignore. It’s a vast continent of 11.7 million square miles, home to some 1.2 billion people — more than 15% of the global headcount — and is poised to overtake China’s population within the next five years or so. However, the breathtaking diversity of the region arguably renders discussions of Africa as a single entity potentially misleading.

The continent contains 54 sovereign nations, each with its own distinct characteristics, problems, and advantages. A few, such as Mauritius, are wealthier than Mexico, whereas others, such as the Democratic Republic of Congo, struggle to maintain a simple level of subsistence. Some African economies like Morocco are largely manufacturing and service-oriented, while others are dominated by extraction of natural resources — and even that can be a very different experience from one country to another (e.g., oil in Angola versus agriculture in Ethiopia.)

Some longer-term challenges remain

Africa still faces challenges that may take years to overcome. What is still concerning? Government corruption remains widespread, as evidenced by recent data from Transparency International (Figure 1), while institutional capabilities are weak across much of the continent. Political violence continues to pose a threat, even in key developing areas. And many countries require infrastructure upgrades, including reliable electricity and other essentials.

Figure 1

Meanwhile, regional economies are growing, but with significant country-level volatility. Although a handful of countries have established sustainable growth models that are delivering results, most of Africa continues to lag its emerging Asia counterparts, in part because no African nations have effectively implemented the kind of export-driven models that have fueled some Asian economies. Africa is also not yet fully networked into existing global supply chains and needs to open up a more competitive wage gap with Asian peer countries.

But we’ve seen progress on multiple fronts

On a more positive, forward-looking note, it’s important to recognize that the big picture on Africa’s development is clearly brightening. As mentioned, we have seen substantial progress in some areas over the past two decades or so:

• The continent as a whole is far less autocratic and more democracy-oriented than it was 30 years ago (albeit from a very low starting bar). Eleven African states are now listed as being “free” under the World Freedom Index.
• Most of Africa’s young adults are now literate and armed with a basic education —something their grandparents and even many of their parents lacked. This could prove transformational from a generational-timescale perspective.
• Medical care in Africa has come a long way (again, from a low base), resulting in better overall health and well-being for much of the general population. Average life expectancies have increased, while child mortality rates have dropped.
• Business conditions in most African economies have improved dramatically in the last 15 years. World Bank “doing business” scores, which measure factors like ease of starting up a company or getting an electricity connection, have steadily risen (Figure 2).

Figure 2

There are four main countries worth looking at

So which African countries (beyond South Africa, which has a well-developed capital market) really matter to us as public equity market investors? We believe there are four — Egypt, Morocco, Kenya, and Nigeria. Together with South Africa, they form the nuclei of the continent’s main regional economic hubs.

All four have the internal scale that many investors seek, along with legitimate domestic capital markets — in the cases of Egypt and Morocco, surprisingly robust ones. The first three countries are in the process of building their manufacturing and service sectors. But they also have fiscal and reform challenges: Morocco has just completed an International Monetary Fund (IMF) program, Egypt is working its way through one at the time of writing, and Kenya is about to embark on one. In general, sovereign-debt issues across Africa are more acute than in most other emerging markets.

Of these four, we view Egypt’s economy as the most interesting and potentially promising. The country has recently moved into a budget surplus and is undergoing strong reform momentum. Its currency remains competitive after a big devaluation several years ago, while its monetary policy has made huge inroads against disinflation.

Nigeria is a special case of its own. It’s Africa’s largest economy by GDP and a major oil-producing nation, but the depth of its ongoing macroeconomic woes — an overvalued pegged currency, combined with mismanagement of economic and energy policy — present a number of daunting obstacles in the period ahead.

In terms of the public markets opportunity set, excluding natural resources stocks (which are obviously more tied to commodities), options for domestic listings with sensible liquidity are rather limited. Africa has 26 equity exchanges with more than 1,000 listings, but only six stocks trade over US$2 million a day on average (Figure 3).

Figure 3

Are there other avenues of opportunity to pursue?

Aside from stocks listed on Africa’s domestic exchanges, investors might also explore opportunities in South Africa-based companies whose businesses have exposure to the rest of Africa. Another path to pursue may lie in Africa-based companies that are listed on developed-markets equity exchanges outside of Africa, some of which may be considerably less risky than investors might imagine, thanks to diversified business models with careful management of currency risks. Each of these categories comprises roughly as large an opportunity set as Africa’s domestically listed stocks.

So what’s the bottom line on Africa?

Investing in Africa presents unique risks and pitfalls of which clients should of course be aware. However, we believe discerning equity investors can increasingly find select attractive opportunities in this up-and-coming, but often-neglected, part of the world.

Please refer to this important disclosure for more information.