Understand Africa’s uniqueness and be rewarded in 2014

The investment prospects for Africa as a whole are exciting and offer the potential to provide great long-term returns, according to Josef Odili, head of Africa Manager Research at RisCura. “The key is to have a thorough understanding of each country’s unique situation. A frontier market like Africa (excluding South Africa) has a very different dynamic to developed markets and it’s important not to invest without understanding this dynamic.”

Josef Odili, head of Africa Manager Research at RisCura

Josef Odili, head of Africa Manager Research at RisCura

For example, Nigeria has enjoyed strong returns over recent years, but there is some uncertainty in the short term given the election next year and the appointment of a new central bank governor this year. On the positive side, assertive actions are being taken to address the country’s shortfall of electricity. Reducing electricity prices from their current levels will be a significant boost to the economy.

In terms of sectors, African consumer stocks have been a popular investment for some time. However, as some of the big consumer names are a large part of the Africa indices, they’re owned by a lot of managers, and their valuations are getting stretched by the increasing demand from foreign investors. Although quality companies, there are risks to be aware of. For example, the Boko Haram terrorist activities have presented distribution problems in northern Nigeria and it is therefore a challenging environment for businesses.

“While Nigerian companies face headwinds in the short term, the situation has had little impact on prices, and quality stocks continue to be supported by strong demand from foreign investors seeking exposure to Africa,” says Odili.

Apart from consumer stocks, the African growth story, particularly sub-Saharan Africa, will continue to reward investors, with GDP expected to expand by 5% in 2013 and 6% in 2014, according to the International Monetary Fund.

“Many investors are sold on the growth and diversification arguments for investing in sub-Saharan Africa. They’re just not sure how best to go about it,” Odili says. As a result, many focus on South Africa, with its comparatively large stock exchange and high standards of corporate governance. However, the prospects for South Africa are somewhat muted in comparison to other sub-Saharan countries, with the growth rate hovering in the 2% range.

Investors are well aware of some of the challenges that investing in Africa excluding South Africa poses, such as the issue of liquidity. “Liquidity fears can cause managers to hold onto shares such as Nestlé Nigeria, currently trading at a price to earnings ratio of 30 plus. They know it’s overvalued, but they’re afraid to offload their holdings as there is no guarantee they can buy back their shares when the company’s valuation returns to or slips beneath a realistic relationship with its intrinsic value.”

Liquidity isn’t the only risk in stock markets north of South Africa. There is a scarcity of reliable data and information. “This is a key difference between frontier and emerging markets, although the situation is improving,” Odili says. “There is also a paucity of skilled investment professionals, and tried and tested investment processes. Nor are there long-term track records to take comfort in.”

Despite the above, Odili is very optimistic about Africa as an investment destination. It is these inefficiencies that create the potential for outsized returns. The key to manager selection in Africa, says Odili, is on-the-ground research. “The speed of change in Africa is simply too fast to rely on last month’s research reports written by analysts in London or New York.” Furthermore, it’s imperative to understand the quirks and nuances of individual countries, cultures and markets if you want to avoid the many pitfalls of this fascinating continent of growth.

RisCura is a financial analytics provider and investment consultant, specialising in investments in emerging markets, specifically Africa. The company services institutional investors with over US$200bn in assets under management, as well as a significant number of asset management, hedge fund and private equity firms.