Africa: 'playing catch up in a big way'
'We have clearly seen in the last several years that Africa has emerged in the world's consciousness. It is no longer musicians singing for the kids with flies on their bellies and on their mouth, it is real business men looking for deals to make and making profit,' Kingsley Chiedu Moghalu, author and deputy governor of the Nigerian Central Bank, told a packed audience at the London School of Economics last week.
He's right. Sub-Saharan Africa is changing, fast. There are fewer wars, macroeconomic stability is improving and the global financial crisis - a 'theatre of destruction largely in the Western world' - has driven the world's opportunistic focus to Africa, he argues.
'the stuff of dreams'
'You find a lot of multinational and global investment funds looking at Africa as the "last frontier" for wealth creation,' says Dr Moghalu. 'When the normal theatre of capitalist operation goes down, even in those parts of the world capitalism would normally sniff its nose at, if there is money to be made, they will create a new narrative to justify going there and making money.'
Although Moghalu calls the returns on the continent 'the stuff of dreams', he says the reality is more 'nuanced'.
Over three years, the MSCI World Index returned 38 per cent and the MSCI Africa Index just a third of that. But over the past 12 months, the World Index grew by just 6 per cent compared to 8 per cent for Africa. Within the last six months, the African index has consistently outperformed the MSCI World Index, suggesting a significant turn in sentiment.
'Contrary to the breathless prognostication of the 'Africa Rising' enthusiasts, Africa has become an economic opportunity in the world economy, but the continent has not fully emerged let alone risen. It has not risen as an economic presence; it has not risen as a co-creator of global prosperity.
'It has not risen because it is an opportunity for someone else, it rises because it in and of itself has brought itself to a place of reckoning and can play on an equal footing with other participants and creators of wealth in the world.'
Tapping into a resource that shoots the returns of dreams is at the top of every investors priority list, but it comes with plenty of caveats. Yet, for those who invest in the region before this 'rise', if it does occur, the returns could be substantial.
David Mcilroy, chief investment officer at Alquity Investment Management, knows his onions. His Alquity Africa fund, which employs strict environmental, social and governance (ESG) factors in the investment process, returned over 16 per cent in the year to June, and has been relatively steady over the past few months. Investing most heavily in Nigeria, Mr Mcilroy favours the banking sector.
ESG standards include lots of safeguards; the energy efficiency of a company, its greenhouse gas emissions, staff turnover, training and qualifications, maturity of work force, absenteeism rate, litigation risks, corruption and revenues from new products. Mcilroy sees this process as a way to highlight both 'risks and opportunities'.
'Managers who are au fait with the ESG responsibilities tend to be the types of management who are au fait with the other aspects of the business as well, so you can kind of use it as a proxy for good management,' he says.
Stephen Hine, head of investments at ESG research house EIRIS, does warn that retail investors screening for 'responsible' companies may increase volatility in their portfolio as they remove particular sets of companies.
'That said, this tactic has a 30-40 year track record in some of the funds in the US and the UK and many have outperformed their peer benchmarks on a regular basis. Sometimes they underperform it, sometimes they are the same.
'And there are many other investments that have an investment style that would exclude companies for a different reasons: UK growth, UK income, etc. There have been enough players in this industry for long enough to make it possible that one can make a decent return, otherwise this industry wouldn't exist,' he explains in defence of ESG.
Hine thinks responsible investing has crossed a tipping point, garnering much mainstream strength. And while he notes that it is still relatively new on the African continent outside of South Africa, he remains confident that it can be successful across the continent.
'There are a number of different ways you can be exposed to Africa,' explains Hine. 'You could be investing in non-African countries that have an exposure, or you could be investing directly into the equities issued on the various African exchanges. In theory, you could also be investing in sovereign debt or, if you are a high net worth individual, into private equity.'
Investing in Africa
While some environmental damage is unavoidable in the mining sector, Mcilroy does not immediately blacklist these companies, as long as they adhere to ESG principles. In fact he invests in Tullow Oil, due to its high ESG standards and it trading with a 'reasonable' net asset value.
'We are looking for companies that offer the full range... so a highly profitable company but with some attractive blue sky and potentially exciting exploration base over the next 12-18 months.'
He also has a holding in 'topical' Afren. 'They are experiencing a bit of short-term volatility at the moment because the chief executive and chief operating officer have been suspended for allegedly making unauthorised [payments], but it looks like the company itself is not implicated. But, normally speaking, corporate governance standards in the more developed markets are a bit higher than in the smaller African ones.'
Following the South African Marikana disaster, where 34 protesting miners were killed, he has left platinum well alone, which has been of benefit to the fund due to the mining sector's less-than-stellar performance. And unlike most who want exposure to Africa as a commodity haven, Mcilroy focuses on the emerging consumer class.
The banking sector is one of the top performing in Africa, and Mcilroy takes advantage of what he calls the 'big sustainable story', with over 32 per cent of his holdings coming from the area.
'The banks in Africa are infinitely better run than some of the banks run here in the developed world,' he says. He looks for banks that are conservatively run, like Guaranty Trust Bank or Zenith Bank, which have high asset quality and post sustainable returns of 25-30 per cent.
'Historically it has also been a very good way of playing the growth in the African consumer. I have been doing emerging markets for 20 years... when GDP per capita reaches a certain level, the demand for banking services increases exponentially.'
Nairobi-listed Equity Bank Kenya has grown to be one of the biggest in Kenya and relies on mobile and agency banking - stalls providing banking services in markets, for example.
'When I go home to Glasgow all the bank branches have been turned into pubs or restaurants because you don't need a branch network anymore, people want to do things on a mobile phone and Africans were doing it first in many cases.'
This leads into another sector Mcilroy is bullish on: telecoms. He has a holding in Safaricom, another Nairobi-listed stock that has been with the fund since inception.
'In Africa it [mobile phones] adds a real value to your life, farmers can check where the best crop prices are, fishermen can check prices of boats, because Africa has started from a relatively low base, the modern technologies have given African society a massive leg up.'
Although historically tough for investors to get into, Mcilroy is able to indirectly tap into the agriculture market through Orascom Construction Industries, the largest construction company in the Middle East with a large fertiliser division exporting into Africa.
Alquity Africa's largest holding is in Nairobi-listed Dangote Cement, which takes advantage of the infrastructure deficit on the continent and is expected to build the second-largest cement business in the world. 'The market is growing consistently at double digit rates' Mcilroy explains, adding that earnings before interest, taxes, depreciation, and amortisation margins are above 60 per cent and he is confident of its growth potential.
'For a retail investor, it is not our position to give advice, but if you are taking a high ten-year view and buy something like that [Dangote Cement] and tuck it away, look at it once a year. I think in ten years' time you won't be sorry.
'It doesn't matter to a great extent what Spanish property prices are, what Greek bond yields are, what Janet Yellen is going to say next week, because these themes are going to continue to play out as people continue to move from the countryside into the cities.
'Urbanisation and industrialisation will take place, it is taking place elsewhere in the world and Africans are no different, they have just been held back for various reasons, some of their own making but some not of their own making. With 21st century technology, they are playing catch up and they are playing catch up in a big way and for us that is the big excitement,' he concludes.