x Abu Dhabi, UAEWednesday 24 January 2018

The search for material rewards

Most sub-Saharan economies are dominated by mining. So why do many analysts advocate investing in other sectors?


Sub-Saharan Africa remains terra incognita for most investors, but stock markets across the region have begun to appear on the radar screens of intrepid global money managers. They are coming to believe that the potential exists for healthy returns, albeit with some risk, underpinned by a new-found economic dynamism and political stability and the commodity wealth that has been there for aeons. Bourses exist in more than a dozen countries in central and southern Africa, and commodities are the star attraction. Gold, silver, platinum, diamonds, copper and other basic substances are what drive the region's economy, and they account for much of the market capitalisation, trading volume and foreign investor interest.

One stock market dwarfs all others. South Africa, the region's dominant economy, is the only one that attracts something close to a widespread following. It is considered the only emerging economy in sub-Saharan Africa (all others are regarded as frontier economies, if investors give them any thought at all). The value of shares listed in Johannesburg easily exceeds that of the other African markets combined.

Advocates of investing in the region say that investors who go to South Africa and make no further inroads on the continent are missing an opportunity. The case for investing throughout sub-Saharan Africa "is founded on the notion that politics and economics are improving", said Larry Speidell, chief investment officer at Frontier Markets Asset Management, a firm that has invested about half of its portfolios in Africa.

He pointed out that the dictators who poisoned societies and economies across the region have been dying off, replaced by leaders who are benign if not always paragons of democracy. Peaceful transitions of power have occurred most notably in Ghana, Zambia and Botswana, he said. A heartening economic development across Africa, meanwhile, is the initial stirrings of a middle-income consumer class. "People are getting out of the poverty trap," Mr Speidell observed. "They can buy cell phones, and they're starting to seek more things like household staples."

One indication that this trend will persist and expand is that the new consumers have institutions that are willing to front them some money as they hone their acquisitive ways. "Banks are starting to realise that the credit risks at the bottom of the pyramid are not that bad," Mr Speidell remarked. "We'll see mortgages, car loans and personal loans." The countries south of the Sahara may seem like much of a muchness from an investment standpoint, but Mark Mobius, executive chairman of Templeton Asset Management, finds considerable variation from one place to the next. Moreover, there are certain aspects of the region, in his view, that set it apart from others.

"There are big differences" among countries in sub-Saharan Africa, he said. "Botswana is a diamond-rich country that has a fairly high standard of living, Ghana is a big exporter of cocoa, and they have just discovered oil, so things are going to change there rapidly." He expects things to change rapidly all over Africa because the continent has just been discovered by China. Chinese enterprises have been entering into numerous arrangements in which they invest capital and expertise, most notably by building railroads, seaports and other infrastructure, in return for the commodities that make China's economy go.

"China is a big investor in Africa, as the US was in Asia in the Cold War," Mr Speidell explained. "China wants raw materials and it also wants friends. Those things combined could produce a lift-off in southern Africa." Commodities and the companies that produce them are likely to remain the primary destinations for foreign money, and not just from China, but stock exchanges display more diversity than might be imagined, knowledgeable investors say.

In Nigeria, for instance, Mr Mobius has stakes in some banks and in an affiliate of the Swiss food producer Nestlé. On the opposite coast, Templeton's portfolios hold shares in British American Tobacco Kenya. That sort of partnership, between a multinational and a local business, is fairly common in Africa and indeed across emerging markets. Hugh Young, head of equities for Aberdeen Asset Management, has made a habit for years of investing in them. He holds BAT Kenya and Nigerian subsidiaries of the British beverage company Guinness and the Anglo-Dutch food producer Unilever.

Shares of these companies are "always a relatively safe entry point" into less mature markets, Mr Young said. Key points in their favour include "professional management, deep pockets and tried and tested products". Mr Speidell agrees. He has numerous multinational affiliates in his portfolios, including BAT Kenya, the Ghanaian unit of Unilever and the Nestlé subsidiary in Ivory Coast. Applying the same strategy to financial services, he holds shares in the Ivory Coast offshoots of the French banks Société Générale and BNP Paribas and the Ghanaian unit of Standard Chartered.

Not only do these multinational satellites "have the benefit of oversight from a global company with a reputation to protect", Mr Speidell said. They also allow his firm to "buy stocks that fit our theme of a rising consumer and look relatively inexpensive". One of the more interesting companies that he and Mr Mobius highlighted - a business that illustrates the diversity of African business all by itself - is an entirely African creation: Press Corporation. This company, a conglomerate that dominates the economy of Malawi in central Africa, has interests in numerous and diverse lines of business, including brewing, fishing, banking, ethanol production and steel manufacturing.

Press Corporation is ensconced in the heart of Africa but well connected to the rest of the world through joint ventures with several big-name multinationals, including BP, the Danish brewer Carlsberg and the British beverage maker Diageo. One curiosity about Press is that while it began as a publishing company around 50 years ago, it seems to have no media holdings these days. Despite their growth potential, the smaller markets of sub-Saharan Africa remain an acquired taste for global investors and, well, most choose not to acquire it. They find the markets just too insignificant and the pickings too slim to bother with, or else too problematic when they ponder making the attempt.

"Access to African equity markets remains difficult for many foreign investors and low liquidity is a hurdle for many," Andrew Howell, an emerging-markets strategist at Citigroup, said in a recent note to the bank's clients. The sticking points include relatively small numbers of shares available to trade in many companies, he said, along with "diverse regulations and listing requirements in different markets; limited markets in other instruments such as corporate bonds and derivatives [and] an underdeveloped domestic investor base". He added, though, that "progress is being made on all fronts".

South Africa is exceptional in the region in many ways and attracts greater appeal, although perhaps not as much as it deserves. Komal Sri-Kumar, chief global strategist for the fund manager TCW Group, called it "a big country not taken into account fully" by global investors. "It's a member of the G20 [consortium of 20 large economies], and it's more integrated into the global system," he noted. "It's a country where they need investment for the long term, not just in metals but as an emerging market serving the citizens of southern Africa."

For the short term, though, it may not be wise to invest in South Africa, in Mr Howell's opinion. He advises being underweight in the market as a result of so-so valuations and a currency, the rand, that has appreciated enough to hamper the country's economic growth. Mr Howell likes some defensive stocks, notably the telecommunications concern MTN and, in the health-care sector, Aspen Pharmacare and Cipla Medpro. The strong rand leads him to recommend shares of companies whose heavy exposure to the domestic economy will generate revenues and earnings in the currency; examples include the media company Naspers and the retailer SPAR.

Mr Young, at Aberdeen, prefers to take very long-term positions in stocks, but he, too, likes South African domestic plays like the retailers Truworths and Massmart. As a specialist in frontier markets, Mr Speidell steers clear of South Africa, but he recognises the country's importance to the rest of sub-Saharan Africa. He gives South Africa credit - but only some - for helping to drive the benign political and economic evolution across the region.

"South Africa showed the rest of Africa an alternative path, that black leadership could forge a partnership with foreign investors and create an economic growth story," he said. But he added that "a lot of African countries have better leadership than South Africa does". When it comes to driving growth of the region's economies and financial markets in the future, the biggest influence could be a dominant emerging economy to the east, not the south. If China is eager to bet big on sub-Saharan Africa, the thinking goes, maybe other investors will do the same.

China's growing involvement has certainly piqued the interest of Mr Mobius, who described it as "probably the most fascinating aspect of this region". As he sees it, the presence of China will jump-start development in a part of the world where there has been so little so far. "It's going to make Africa an even more exciting place because it means they're going to get the infrastructure that they have needed for so long much faster than they imagined," he said. "There's a different type of development taking place in these countries."