Africa closes the economic gap, investors should act now

Almost the entire African continent was ruled by dictators backed by money and guns from their superpowers of choice. They ruled with impunity.

Corruption, instability, inefficiency, and ideological excesses were the norm. Human rights abuses and economic mismanagement were rife.

Africa’s gradual integration itself into global markets will slowly chip away at the region’s frontier market premium

In contrast to other countries, Tanzania experienced little violence, but the economy was a disaster zone.

The black market exchange rate paid 80 times more shillings per dollar than the official rate. Dar es Salaam was ringed with roadblocks to prevent free trade in goods, and only the black markets thrived.

The situation in Tanzania and many other African countries during the cold war era gave birth to a stubbornly stereotypical image of African countries as anarchic economic backwaters – an image that still retains a hold on some investors to this day.

Yet Africa has moved on. Africa’s biggest attraction is its enormous convergence potential.

The numbers

Low income per capita and political transformation – 75 per cent of African countries are now functional democracies, compared with just 12 per cent in the late 1980s – have combined to produce an extremely rapid economic catch-up.

The IMF expects African countries to deliver 6 per cent real GDP growth in 2014, one of the highest growth rates in the world. Today Africa promises to close the gap in living standards with richer countries faster than any other region has ever done.

Astute investors today look to Africa for a variety of reasons. The diversification is amazing – Africa houses 55 of the world’s 200-plus countries, many of which are richly endowed with natural resources.

Government debt levels are modest at 34 per cent of GDP, down from 53 per cent of GDP a decade ago.

Aid dependence has been cut in half and Africa’s urbanisation and population growth rates produce the best demographics on the planet.

Africa began to appeal to a broader investor base in the late 2000s. Ghana’s inaugural sovereign bond in 2007 and the creation of Nigeria’s local bond markets were major milestones that did much to put Africa onto global radar screens. Today 12 of the 61 issuers in JPMorgan’s Emerging Markets Bond Index are African.

African countries also account for seven countries in the MSCI Equity Index, and the S&P Pan Africa Index includes 12 African stock markets. There are active markets in direct private lending, private equity, trade finance, and structured credit. Consumer and mortgage markets are spreading.

The dangers

Still, investing in Africa is not without risks. Africa’s markets are among the most inefficient in the world; asset prices and risks often part ways. Pension funds, insurance companies, and other underpinnings of local capital markets are still relatively immature.

Liquidity can be low, even non-existent. And research coverage is poor.

This matters, because Africa is still a poor continent prone to shocks. Low incomes per capita translate into narrow tax bases and relatively undiversified economies. African countries are easily destabilised by weather, commodity, or political shocks.

Low levels of ethnic fractionalisation correlate with increased risk of civil war, although many African countries are highly diverse and tend to be as stable as ethnically homogenous societies.

At a time when the outlook for developed market fixed income is extremely cloudy, UK pension funds should open their eyes to the full range of global investment opportunities, including Africa. Diversification, higher yields and stronger growth all favour a foray into Africa.

But Africa’s gradual integration into global markets will slowly chip away at the region’s frontier market premium. Now is therefore the time to engage.

The best way to approach it is through active management with a strong focus on liquidity and fundamentals.

Start by jumping on a plane and go on safari in Africa – you will find it a much-changed continent. The only thing that has stayed the same is the warm greeting: “Karibu! Safari njema!”

Jan Dehn is head of research at asset manager Ashmore