Investing in Africa: Not Just Natural Resources Anymore

For Peter Thoms, founder and portfolio manager of Africa Capital Group in Coronado, California, the idea of investing in Africa as a natural resources play is somewhat passé.

Sure, the continent is blessed with an abundance of metals and is rich in bauxite, salt, oil, cocoa beans and wood, but in recent years, the massive global demand for those commodities from China and other nations has created new wealth for numerous African countries and given rise to different growth dynamics that make for compelling investment themes. Thoms' favorite: The rise of the African middle class and the growth of the consumer economy.

"We want to invest in growth, and we believe the greatest growth in Africa is happening within the consumer sector," Thoms said. "Our fund invests in 20 to 30 companies from across the continent, and we look for little segments where a company has a competitive advantage. We find that the best opportunities are in the consumer sectors."

Take South Africa's Calgro M3 Holdings, for instance.

The real estate developer is "fulfilling a desperate and unmet need in South Africa for affordable housing," Thoms said, "and while the broader South African economy is puttering along, Calgro is growing very quickly."

Ditto for Choppies, Botswana's dominant supermarket chain, which not only has a 34% market share in that country, but is now expanding into South Africa and eastward into Kenya, taking advantage of "the general trend in Africa toward formal retail," Thoms said.

As wealth has increased in Africa, Thoms said "people want to go into stores and shop. They want to know that their food is clean and safe, so as a broad category, formal retail is increasing."

Finding Gems Where American Investors Don't Tread

But finding companies like Calgro M3 Holdings and Choppies isn't easy. Uncovering such opportunities requires being willing and able to engage deeply with Africa and put in the legwork to dig up interesting investment stories, a process that, with the exception of South Africa, most American investors have not undertaken, Thoms said. This is also why, aside from a handful of specialized funds like his, a few broad-based Africa ETFs and a smattering of South African ADRs that can be bought directly in the U.S., there aren't a lot of investment vehicles for Africa.

Thoms has an edge over many of his peers because of his longstanding relationship with Africa: His father was a U.S. diplomat and Thoms spent his high school years in Addis Ababa, the capital of Ethiopia. He's traveled extensively in Africa (he insists that everyone on his team does, too) and he feels very comfortable on the ground there. But that isn't the case for most U.S. investors, he agreed, mainly because of the physical distance between the U.S. and the continent that still shrouds Africa in mystery. Many investors have yet to learn the basics about Africa, he said; that it is a continent made up of 54 different and diverse countries, each with its own colonial history and legacies, and all at different stages of development.

Still, in a world that's getting flatter and where growth opportunities are harder to find, Africa has plenty of potential, says Vito Sciaraffia, co-CIO of Innealta Capital.

The New Latin America?

Sciaraffia said he likes to compare Africa today to Latin America 30 years ago. "No one was interested" in Latin America as an investment opportunity then, he recalled, "and now there are over 15 ETFs for Brazil alone," Sciaraffia said. "I see the same thing happening with Africa over the next few years."

Undoubtedly, the broader African story is compelling for the longer term. Natural and mineral wealth apart, Africa has 60% of the world's uncultivated arable land, said Seelan Gobalsamy, CEO of STANLIB, a Pan-African, multi-specialist investment company based in Johannesburg. That means the continent will play a key role in meeting the world's rising food requirements in coming years.

Sub-Saharan Africa has an estimated population of 949 million, with an average age of around 20 years (in Asia, the median age is just under 30), he said, and at around 37%, the region's urban population remains extremely low by global standards.

Africa, particularly sub-Saharan Africa, has managed to sustainably lift its economic growth rate, Gobalsamy said.

"From 2000 to 2014, the region was able to achieve a GDP growth rate of more than 4% in each year, including during the global financial market crisis, with an average of 5.6% for the entire period," he said. "This has made Sub-Saharan Africa one of the fastest growing regions in the world after Asia, with GDP expected to reach $3 trillion by 2022."

On the equities side, Africa has very low correlation to other markets, both developed as well as emerging, which is great for portfolio diversification purposes, Sciaraffia said.

"If you take the MSCI USA index and compare it to the EAFE index, there's a 90% correlation over the same time period, but the correlation between MSCI USA and the MSCI Frontier Markets Africa Index is only 40%," he said. "The correlation between the emerging markets index and the Africa index is also only 45%, so if you want to diversify and get high returns, that seems to be the way to go."

The Risk Side of the Equation

Nevertheless, Sciaraffia would not go whole hog in Africa just yet. He believes it will take another decade for the many issues the continent faces to be ironed out and to translate into greater and more sustained economic growth.

Transparency and investor protection are sorely lacking in many jurisdictions, he said, and corruption as well as political risk remain huge problems across the continent.

A lack of infrastructure, massive income inequalities and issues such as public health are also a big drag on potential economic improvement, said Stuart Quint, senior investment manager and international strategist at Brinker Capital. Sub-Saharan Africa has the highest HIV and AIDS rate in the world, he said, and this is a huge impediment to economic growth.

Many African countries are also suffering because of their over-reliance on commodity exports and the slump in global prices as a result of a serious fall in demand from China. The economies of Zambia and Congo, for instance, depend heavily on revenues from exports of copper and other base metals, Quint said. Ivory Coast is a huge exporter of coffee, and countries like Nigeria and Angola, which are big oil exporters, are struggling to cope with weakening export earnings as oil prices have fallen and rapidly deteriorating fiscal positions.

Those African countries that have developed a broader and more diversified economy are currently in a better position, and they are poised for better prospects going forward. Kenya tops the list for Thoms: By virtue of being more diversified across industrial sectors, its economy has not been impacted by the commodities downturn. In fact, because Kenya is a net importer of commodities and energy, the country's been able to take advantage of lower global prices, he said, and this has also contributed to its economic growth.

Many investors also say that Kenya is a cut above most other African nations with respect to key issues like governance, transparency and accountability.

In Kenya, increased political stability has allowed for better economic and development planning. The government's Vision 2030 plan aims to transform the country by promoting growth and development in an inclusive manner, Gobalsamy said. Ethiopia and Nigeria have similar blueprints, with their respective Growth and Transformation Plans 1 and 2, and Vision 2020 plan, he said.

The Financial Sector

Continued financial sector reform will also go a long way toward bringing much-needed capital into Africa, and will encourage creators of investment products to innovate, Gobalsamy said. Kenya, for example, has introduced a number of regulatory reforms in an effort to deepen and develop its capital markets. The Kenyan Capital Markets Authority recently granted STANLIB regulatory approval to launch East Africa's first REIT, he said, in a bid to align Kenya's listed property sector with international standards and enhance governance. Thus far in Africa, only South Africa, Nigeria and Ghana have REITs.

Although Ethiopia does not yet have a stock exchange, the Ethiopia Commodities Exchange, which operates on an electronic trading system, was founded for the trade of agricultural commodities.

Gobalsamy added: "We have seen the opening of alternative exchanges with less stringent rules for smaller companies looking for access to capital, such as the Ghana Alternative Exchange; the Alternative Investment Market Segment in Kenya; and in Mauritius, the Development and Enterprise Market."

Foreign ownership restrictions have also been dropped in many African countries, including Tanzania and Kenya, and in recent years, a number of African nations have been issuing sovereign bonds to fund infrastructure investment and increase their international reserves. Issuance is likely to continue on the corporate side as well, Gobalsamy said. Furthermore, the fact that several African countries now have a formal credit rating helps seal their place in the global economy.

Investing in Africa: Not Just Natural Resources Anymore