Investing in Africa – Reasons and Risks [Clear Finances ]

Investing in Africa is not for everyone but offers excellent opportunities. The continent’s role in the world economy will increase over the coming decades. This is why it is essential to make an analysis of the reasons for, and against, investing in Africa.

Introduction

Africa is the second most populous continent in the world, with about 1.3 billion inhabitants. It also has the highest population growth rate on the planet. Therefore, experts estimate its population will top 2 billion people by 2050.

Africa is also the poorest and least developed continent. Its life expectancy is low compared to that in other regions, but its has the youngest demographics of any place on earth.

While Africa will face some challenges throughout the 21^st century, there will also be incredible opportunities. For those with vision, patience and risk tolerance, investing in Africa can be extremely interesting and profitable.

The great economic success since 1980 has been China’s spectacular growth. As a result, hundreds of millions of people who previously lived below the poverty line have come to enjoy a relatively good standard of living. The world’s middle class grew as a result.

India is the other great country that is set to experience an equally incredible rate of growth and development over the next few decades. And such growth can come hand in hand with spectacular returns for those who have invested in those regions.

Consequently, there are many reasons to be optimistic about the economic future of Africa.

Reasons for Investing in Africa

Let us discuss the most important reasons for being bullish on Africa’s economy:

Demographics

One of the most important differences between the developed world and Africa is demographics. While Europe, including its emerging countries, North America and East Asia have stagnant or declining populations, Africa’s population continues to increase at a very significant rate.

In fact, we could argue that, in most African countries, the rate of population growth is too high, making it difficult for them to significantly improve the standard of living of their population. This is because the number of dependents in society is very high, a similar but opposite situation to what we see in the West.

And although we might think that this is a disadvantage when it comes to investing in Africa, it is one of the reasons to be bullish. This is because population growth is tailing off and will stabilize at some point.

A young population means many people able to acquire skills, work, start businesses, save, consume and invest. All very positive factors for Africa’s long-term economic growth.

Emerging Markets

Although certain regions of Africa are rich and developed, the vast majority of the continent is not. This means pretty much everything still has to be build. That presents very good opportunities and potentially high returns.

Interestingly, even some of Africa’s most advanced countries, such as South Africa, are still emerging markets.

A potentially high return usually comes with an additional level of risk. Emerging markets are less efficient and more vulnerable to a severe market crash. For this reason, if we are willing to invest in Africa, we should do it for the long term.

Vast Natural Resources

Many countries in Africa are blessed with vast natural resources. Whether it is oil in Nigeria, precious metals in South Africa, or cobalt in Congo, the continent has huge reserves of valuable commodities.

Having natural resources is not necessary for a country to be prosperous. We all know the example of countries like Switzerland or Japan. And having resources is not a guarantee that a country will grow rich, as we can see in places like Venezuela.

But it is undeniable that having resources is a great strategic advantage since it can ensure foreign currency revenue that will help develop the country’s infrastructure and keep the domestic currency relatively strong.

If we look at the macroeconomic projections, it seems that the 2020s may be highly inflationary. Some of the best asset classes in such a scenario, in addition to emerging market stocks, are commodities themselves.

Attractive Valuations

Finally, we should mention that most international investors do not invest in Africa yet. This leads to stock market valuations being significantly lower than in developed markets.

For most institutional investors, almost their entire exposure to Africa can be reduced to South Africa’s weight within the emerging markets indices. And, to put that in perspective, South Africa only accounts for about 1% of the global MSCI Emerging Markets Index.

In other words, investing in Africa is still very rare and a contrarian bet. History shows us the largest returns are achieved when we invest in things that have been overlooked by most investors.

Risks of Investing in Africa

Next, we will discuss the biggest risks of investing in Africa:

Political Instability

The most important risk when it comes to investing in Africa is that some countries are very unstable. Civil wars, wars between countries, nationalizations, etc. Plenty of bad things can happen that we are not used to if we usually invest exclusively in developed markets.

Leaving aside the humanitarian aspect of those occurrences, which is obviously the most important, as investors this can affect us in two different ways:

On the one hand, some of our investments run the risk of being nationalized, either overtly or covertly.

For example, if we have invested in a gold mining company in Zimbabwe, a mine can be taken over by the government at any time, which would be a total nationalization. However, it is much more common to see a partial nationalization.

In such a case, the company would be allowed to continue its gold mining and export operations but have to pay higher taxes or fees. De facto this means that a greater percentage of the gold mined will benefit the government and not the shareholders.

On the other hand, even if we are not affected by such occurrences, what can happen is that, due to the risk of such events occurring at some point, equity valuations will remain low to reflect the fear that many investors have of investing in Africa.

Let us expand on this with another gold mining company example. When the price of gold rises, the stock price of a gold mining company usually skyrockets. After all, a 20% rise in the price of the metal can mean that the company’s profits double.

However, a higher price of gold may mean more risk of a total or partial nationalization. After all, when governments consider that companies are making too much money, they are tempted to intervene. To some degree this also happens in developed countries.

Corruption

Corruption is a problem in any country. However, corruption is especially present in many countries of the African continent. And that has to be considered by investors.

A high level of corruption is worrisome because it delays business activities, makes many processes more expensive, put companies’ profits at risk, and poses a threat to the optimal functioning of the economy.

Although significant improvements are being made in this area, corruption remains a major concern for those looking to invest in Africa.

After all, rule of law or lack thereof is as important, if not more, than economic growth itself.

Weak Currencies

Another disadvantage of investing in Africa is that most countries on the continent have very weak currencies. This is a consequence of having political systems where a small minority is in a position to take advantage of public institutions for their own benefit.

For us investors, weak currencies mean that the value of corporate profits and dividends declines when converted into a stronger currency, such as the US Dollar or the Euro.

In addition, a secondary consequence of having a weak currency is that it hinders the development of strong capital markets in the country. This makes it difficult for companies to raise capital and expand their businesses.

For this reason, if we are interested in investing in Africa and minimizing currency risk, we should look for countries with relatively strong currencies, such as South Africa or Morocco, or shares of companies that sell most of their production abroad in hard currency, such as most commodity producers.

Low Liquidity

Finally, another drawback of investing in Africa is the low liquidity of its financial markets. This is due to the low number of active participants. As a result, there are two things we must bear in mind:

First, it is not advisable to be buying and selling continuously. Transaction costs are high in illiquid markets, making returns lower for those who trade excessively.

Second, if there is an economic crisis in the world and global financial markets go down as a result, illiquid markets can experience large drops. It is important to focus on the long-term fundamentals of our investments when that happens.

Investing in Africa through an ETF

Now that we have seen the reasons for and against investing in Africa, it will be useful to discuss how to carry it out by buying an ETF. An ETF will facilitate things since it will not be necessary for us to analyze individual companies.

One thing to keep in mind is that many of the countries in Africa have very few listed companies, as a consequence of having poorly developed financial markets. Therefore, certain countries will tend to dominate African ETFs.

In general, the African countries with the largest stock markets are South Africa, Nigeria, Morocco, Egypt and Kenya.

A good ETF for investing in Africa is the AFK VanEck Vectors Africa ETF. It tracks the Dow Jones Africa Titans 50 stock index, published by S&P Dow Jones and made up of 50 of Africa’s largest corporations.

Another interesting stock index is the MSCI Frontier Markets Africa, published by MSCI and composed of about 30 companies, a number that fluctuates over time, and increases as the number of companies that meet the index’s criteria goes up.

Obviously, another option to invest in Africa through ETFs is to buy funds that focus on specific countries. Some examples would be the iShares MSCI South Africa or the iShares MSCI Nigeria.

Conclusion

I hope you found this analysis of the reasons for and risks of investing in Africa helpful. The African continent is awash with opportunities. And there is no doubt that its role in the economy of the future will increase.

Obviously, I would recommend that you always continue to learn and not forget the importance of diversification when building and adjusting your investment portfolio.

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And if you want to read more about emerging economies, check out the following analysis:
Why We Should Invest in India – Top 7 Reasons