27four Investment Managers
11th March 2014
How do you invest in frontier markets?
For any equity investor, diversification should be a key consideration. Spreading your assets across sectors, markets and geographies is a vital part of ensuring a balanced portfolio.
Last week’s article on the potential in frontier markets looked at the argument for spreading some of your investment into these less mainstream regions where the growth potential is high. And for South Africans, the rest of Africa presents a frontier market opportunity right on our doorstep.
The number of local investors seeking exposure to African markets is, however, still relatively small. The Momentum Africa Equity Fund is the largest Africa-focussed unit trust and its assets under management stand at a little over R1bn. That is smaller than both the db X-trackers DJ Euro Stoxx 50 ETF and the db X-Trackers MSCI USA ETF.
Standard Bank’s Johann Erasmus, suggests that this may be linked to concerns around where to find the best diversification.
“A lot of investors in this country prefer to use products that focus on investing in the USA and Europe,” Erasmus says. “And I think that is because we are already quite exposed to Africa and we are an emerging economy ourselves.
“So in terms of diversifying, people would rather go into more traditional markets given that their income is quite tied to emerging markets through South Africa specifically and to Africa to quite an extent given the expansion of many local companies into the rest of the continent.”
But he believes that ignoring the potential returns from Africa would be a missed opportunity. He argues that although there are inherent risks, investors are compensated with higher rewards.
That is what is slowly encouraging a growing number of asset managers and individuals to consider placing a portion of their portfolios in African markets. Regulation 28 of the Pension Funds Act, which imposes limits on the levels of exposure to different asset classes within vehicles for retirement funding, has also given locals an added incentive.
In terms of foreign assets, Regulation 28 references the allowable prudential limits set by the Exchange Control Regulations, which are set between 25% to 35%, depending on the type of investor. However, it concedes an additional 5% that may be invested in Africa outside of South Africa. This has given institutional investors more reason to look at opportunities on the continent as it offers them added room to diversify.
“South African investors are slowly warming up to the Africa story,” suggests Addington Jerahuni, senior equity analyst at Sanlam Investment Management who is involved in managing the Sanlam African Frontier Markets Fund. “The number of pension funds looking at African opportunities has gradually been increasing, and retail investors are also enquiring about products that look at the rest of Africa.”
Although levels of scepticism remain, he argues that anyone with a long investment horizon will benefit from what is happening in these markets.
“We look at this as a long term story,” Jerahuni says. “Over five years or ten years these funds are going to grow. Valuations in the rest of the continent are still cheap in many places, and these markets can still grow substantially over the next few years.”
These views are supported by Claire Rentzke, head of manager research at 27Four Investment Managers.
“While Africa has huge challenges and these frequently dominate headlines, more and more investors are recognising that the incremental improvements being witnessed in areas like governance and infrastructure across most of the continent are having a greater and more positive impact on the ease of doing business relative to most other countries worldwide,” she says. “This is the opportunity Africa offers.”
And she also argues that many people are underestimating the size of that opportunity.
“Excluding South Africa, Africa currently hosts 17 investable stock markets, with over 600 listed companies with a combined market capitalisation in excess of USD 200bn,” Rentzke says. “In addition, there are numerous companies with listings on foreign market exchanges that offer exposure to assets located across Africa. As African countries move up the development curve, it can only be expected that the breadth and depth of its capital markets will increase as well.”
Rentzke also believes that the diversification offered by these African markets goes beyond just finding new regions for investment.
“African equities have historically displayed a low correlation to world markets,” she says. “As such, adding Africa exposure to a global portfolio leads to risk reduction and the potential for excess returns.”
While Rentzke recognises that there are risks in investing in Africa outside of South Africa, she also believes that they can be overstated.
“Often the perception of risk can deter investment,” Rentzke says. “Country and political risk across the continent get a lot of bad press, where the reality is that often these instabilities do not affect the companies doing business in these countries or hamper their ability to make good profits.”
She adds that many investors also worry about the volatility of other African currencies, but in fact the rand is generally far more volatile.
“It is the nature of investment that where there are higher risks, investors are compensated with higher returns,” she says. “And if the risks are largely more perceived than actual, then investors can do well especially if they are willing to take a longer term view and reap a liquidity premium.”
Accessing the opportunity
So how do investors get some of their money into African markets? The fund managed by 27Four is primarily aimed at institutional investors, but Sanlam recently launched the rand-denominated Sanlam African Frontier Markets Feeder Fund for retail clients, and both Momentum and Prescient also offer unit trusts that cater to individual investors.
The Sanlam African Frontier Markets Feeder Fund invests directly in the Sanlam African Frontier Markets Fund, which is domiciled in Ireland. It provides exposure to seven African countries – Nigeria, Egypt, Kenya, Morocco, Mauritius, Botswana and Ghana. It’s biggest holding is in Nigerian Breweries.
The Prescient Africa Equity Fund holds stocks in five countries – Nigeria, Egypt, Kenya, Morroco and Mauritius. It is particularly heavily exposed to the Nigerian banking sector.
The Momentum Africa Equity Fund has the widest reach of the three unit trusts, with exposure to ten countries. In is exposed to Nigeria, Egypt, Kenya, Morroco, Mauritius, Zimbabwe, Ghana, Namibia, Zambia and Uganda.
Apart from these three funds, investors also have the option of the exchange-traded notes offered by Standard Bank and Deutsche Bank. These offer a particularly appealing alternative, since they do not rely on the liquidity of the markets themselves.
The db Africa Top 50 Capped Total Return ETN is not entirely exposed to the rest of the continent, however, as around 50% of the index it tracks is made up of JSE-listed stocks. It currently only has exposure to three other countries – Nigeria, Morocco and Egypt.
The index tracked by the Standard Bank product, on the other hand, does not include any South African-listed shares at all. It includes over 170 stocks in 35 countries on the continent, including the likes of Angola, Ghana, Kenya, Mozambique, Gabon and even Burkina Faso and Senegal.
“You would find that this broad pool gives you a lot of immunisation to volatility in those individual markets, as the ETN has limited exposure to specific event risks in single countries,” explains Standard Bank’s Erasmus. “So it gives you a much smoother exposure.”
These ETNs also offer investors some further security in that although they are exposed to African markets, their money is not actually held in those geographies. Any investment is repayable by the issuer, which may itself hold these shares but will pay out any investor regardless of whether it can liquidate its position or not.
“Because our product is an ETN, investors face Standard Bank, and that is quite different to unit trusts and ETFs that hold the underlying assets in the name of the investor,” Erasmus explains. “So regardless of what happens, investors know that Standard Bank is here to pay them the performance of that index. So should capital controls change in those countries, you might have scenarios where it becomes increasingly difficult to enter or exit investments. But we stand good for any investment and will always pay you out in rand here.”
Interestingly, this counters a negative that many people highlight with ETNs – that the investor is taking on the additional balance sheet risk of the issuer. In this case, this may actually be seen as an advantage.
Having decided how to gain exposure to Africa, the next question any investor must consider is how much exposure they need. Broadly speaking, assigning 5% of your portfolio to frontier markets will provide a level of diversification without over-exposing you to their higher levels of risk. These are not core investments, but auxiliaries that can be used to support a well-rounded and balanced portfolio.
Author: Patrick Cairns
11 March 2014 02:56
Read the full article via Moneyweb here.