Emerging-markets equities have had a mercurial year, with many tumbling during the second and third quarters on fears of monetary tightening in the U.S. But frontier markets in sub-Saharan Africa barely reacted. This unflappability has gotten global investors’ attention.
Investors say this sangfroid reflects strong fundamentals. Many countries in the region have rapidly rising populations and strong economic growth rates. At the same time, these frontier markets haven’t attracted sufficient investor inflows from developed markets to catch a cold when the U.S. sneezes.
“African frontier markets are driven by local rather than global factors, such as local politics and economics,” says Michael Levy, investment manager for the $25.5 million Baring Frontier Markets Fund in London, which launched in April. Levy cites Kenya, where the stock market leaped after a successful general election this year boosted confidence among foreign investors that they would be protected by the rule of law. The main Kenya stock index is up 25.9 percent on the year. He also notes that during the past five years, the MSCI emerging-markets index has shown a 0.9 correlation with the MSCI world index, but the correlation of the MSCI frontier markets index has been just 0.5. “If anything, correlations in frontier Africa are even lower,” Levy adds.
The relative neglect of frontier Africa by international investors leaves plenty of opportunities for the bravehearted. Among them is Cube Capital, a $1.3 billion London-based alternative asset manager with a $770 million multistrategy fund that primarily invests in Africa through third-party managers. One of its largest allocations is Delta Corp., a brewer based in Zimbabwe, which is up more than 60 percent on the year at $150 a share as of December 4.
Zimbabwe may not seem an obvious candidate for equity investment. The government of Robert Mugabe, who has ruled the country since it gained independence from the U.K. in 1980, has stifled dissent and ravaged the economy, turning one of Africa’s wealthier countries into one of its poorest. The U.S. and the European Union have imposed economic sanctions on Mugabe and officials and companies close to the regime since 2003, citing human rights abuses and electoral chicanery. The stock market dropped 24 percent in little more than a month following July 31, when Mugabe claimed a seventh presidential term after a disputed election, and ended a power-sharing arrangement with opposition leader Morgan Tsvangirai. But some of Cube’s managers took advantage of the market decline to increase their Zimbabwean holdings, says Scott Gibb, manager of the multistrategy fund, who grew up in the country. He says the firm has been reassured by the appointment of a cabinet that has voiced a commitment to economic reform. “Delta has significant upside potential if the new Zimbabwe government turns the country around,” Gibb adds. The Zimbabwe Stock Exchange has since recovered much of this lost ground, though it remains 8 percent below its pre-election peak.
Cube’s Zimbabwe investment reflects a pragmatic approach by frontier specialists toward local African politics. “People seem to think these days that only democracy works, but a strongman can also do very well for the country if he’s benign,” says Roelof Horne, portfolio manager for frontier and emerging-markets equities at Investec Asset Management in Cape Town; Investec has $4 billion of its $107 billion in assets invested in frontier Africa. He mentions as an example Rwanda, whose president, Paul Kagame, has been accused by human rights organizations like Amnesty International of persecuting his political opposition. Though a small, landlocked country with little natural resources, it has a business-friendly regime with ambitious plans to be an information technology and financial services hub.
Delta is one of several brewers recommended by asset managers as a play on what they regard as the most promising trend on the continent: the rise of discretionary consumer spending. Investec estimates that strong economic growth will boost discretionary middle-class consumption — spending on nonessentials — by about 9 percent a year in sub-Saharan Africa, taking it from $120 billion in 2010 to $277 billion in 2020.
As well as an expanding middle class, the age and growing size of Africa’s population are also proving attractive to investors. Levy cites as an example Nigeria’s “unbelievable demographics.” The oil-rich country accounts for 15 percent of the holdings in the Baring Frontier Markets Fund, the largest amount allocated to any single frontier market. The United Nations predicts Nigeria’s population will rise to 440 million by 2050 from 175 million today. In addition, the dependency ratio — the proportion of people too young or too old to work — is expected to drop from 0.9 to 0.7 during the same period. That means an enormous number of potential future consumers with the money to buy new goods. Against this backdrop, Nestlé Nigeria, an arm of the Swiss food and drink group, remains good value, says Levy, despite trading at a lofty 40 times projected 2014 earnings, according to Bloomberg data.
Some investors avoid such stocks because of their high multiples. Instead, they concentrate on domestic stocks that are increasingly accessible to international investors because of rising liquidity. Julie Dickson, equities portfolio manager at Ashmore Group, the $78.5 billion London–based emerging-markets fund manager, says trading volumes for global frontier markets have roughly tripled during the past 12 to 18 months, including strong increases in African countries such as Ghana and Botswana. The 20-year-old Ashmore Frontier Africa Fund invests in 17 countries; it has grown by almost $100 million in the past year, to $800 million.
Another argument in favor of a local approach is the fact that domestic commodity producers often enjoy better tax and royalty terms than foreign companies, says Chris Derksen, head of frontier and emerging-markets equities at Investec in Cape Town. He cites Afren, an oil producer operating mainly in Nigeria and listed in London, which is up roughly 20 percent on the year at £156.40 ($255.54) per share.
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