Emerging markets have become an asset class which investors need to consider to optimize their portfolios. In 2000 investment flows into the 30 markets characterized as emerging markets were at least US$ 250 billion. Institutional investors have been cited by Africa’s largest banking groups as a critical component of the development of these emerging markets especially in terms of infrastructure development and funding. Investment in emerging markets has been driven primarily by the sluggish growth of the US and other advanced economies. These economies characterized as emerging economies have recorded impressive growth rates in their respective GDPs however deploying capital in them can be lucrative but also poses significant risks. One of the most poignant cases in point is that of Russia which is counted among the BRICS countries or emerging markets has in the space of being an investment darling to and investment pariah. The value of the currency has collapsed leaving investors in a precarious position.
Emerging markets landscape in Africa
It is a cliché to say that Africa is the last frontier in terms of investment. The continent is yet to realize its potential to create value for investors and all its stakeholders. Standard Bank Group the largest of its lenders by assets had this to say about the continent it calls home and whose growth drives it mission, “The African continent has been growing at a steady pace in recent years as its economies diversify and continuing to prove resilient in the face of Covid-19. The very large scale of Africa’s unmet infrastructure needs provides a compelling opportunity to create shared value for all stakeholder groups, including global and local investors, local businesses, and the communities they serve.” The bank made these sentiments known at the launch of its collaboration with Mercer and MIDA Advisors in publishing the second edition of the Mercer Report titled, “Infrastructure financing in sub-Saharan Africa”. This was part of its effort to make the case for investing in Africa.
The bank’s position according to its website sets the context for emerging markets investment especially in Africa. The bank views global institutional investors as central to funding infrastructural investment on the African continent. “They hold a major portion of the world’s savings and have the long-term investment horizon needed for financing infrastructure. At the same time, most governments today are facing increasing budgetary pressures that make it difficult for them to meet the public’s needs for additional public infrastructure investing.” The bank said.
This presents an interesting conundrum, African governments constrained for financial resources are not able to effectively mobilize the resources need to meet the growing demand for infrastructure by their citizens. This leaves them with one option which is to make every effort to attract and to muster foreign direct investment into their respective jurisdictions. For FDI to flow, certain conditions need to be precedent and for the most part this reality poses a significant challenge to countries on the African continent because of its implications.
McKinsey & Company in an article authored and published in 2010 posits that most international businesses are not aware of the magnitude and the extent of opportunities on the African continent. This it says is because the continent is fragmented and that information costs tend to be expensive. Surprisingly the international consulting company then called the entire continent a “fairly small economy”. This position was informed by the fact that with few exceptions most African economies were so badly run that they could not support the entry of firms of integrity. By McKinsey’s own admission in the same article there has been “a sea change” and Africa is on the move.
The “sea change” that McKinsey refers to took place between 1995 and 2005. This period was characterized by “Profound macroeconomic reforms tamed inflation and opened economies to international trade. More patchily, the regulatory environment facing international business also improved. Public ratings, such as the World Bank’s Doing Business surveys, enabled African governments to benchmark their performance and began to put pressure on those that were recalcitrant. As the global commodity boom built to its 2008 crescendo, many African countries were well positioned to harness the spike in their export revenues for growth beyond the resource extraction sector itself.”
A study of the financial performance of publicly listed companies carried out between 2002 and 2007 found that these African companies’ average return on capital was around two-thirds higher than that of comparable companies in China, India, Indonesia, and Vietnam. Another source, on the foreign direct investment of US companies, showed that they were getting a higher return on their African investments than on those in other regions. Finally, analysis of a series of surveys of several thousand manufacturing firms around the developing world found that, at the margin, capital investment had a higher return in Africa. For capital to earn the highest returns it needs to be deployed in Africa! At the risk overplaying the cliché, Africa is indeed to final frontier!
Africa for all the negative connotations it has had in the past has a canny knack for weathering economic storms very well. During the 2008 global financial crisis and ensuing Great Recession the impact on Africa was minimal. The same can be said with the most recent crisis caused by the COVID 19 pandemic. African countries have proved to be very resilient. “Led by its two largest economies, South Africa and Nigeria, most countries had built prudent fiscal positions: in a remarkable break with its past, Nigeria had freed itself from debt and built up over $70 billion of foreign-exchange reserves. Further, the adverse impact of the crisis through commodity prices lasted less than a year for Africa.” This McKinsey said in its article referring to global financial crisis.
In the last crisis brought on by the pandemic Africa’s resilience was led by the bloc of countries that make up east Africa which recorded some of the highest economic growth rates post COVID. Going forward the most compelling cases for investment in emerging markets will be in Africa. The countries to watch in 2022 based on the FDI they attracted in 2021 are Egypt, Ethiopia, Nigeria, the Republic of the Congo, and South Africa. They led continent in terms of FDI flows. For these countries revenues from commodity exports have been augmented not just by high prices but also by the resource discoveries that high prices have triggered. Yet the recent discoveries are merely the beginning: the scale of what is likely to happen is not widely appreciated.
The investment case.
Investing in emerging markets offers investors with opportunities for growth and diversity. The phrase “emerging markets” was coined by economists in the 1980s and broadly refers to investment in developing economies. By implication investing in developing economies means that investments like these carry with them an unusually high level of risk inherent in them. While they also carry with them the potential for substantial rewards the risk inherent must never be ignored. BRICS countries namely Brazil, Russia, India, China, and South Africa are classified as emerging markets because of the rapid economic growth that they have enjoyed in recent times. There are numerous classifications for emerging markets and some pundits have even developed a formula to determine whether a country can be classified as an emerging market. According to Ameriprise, “…Some emerging markets such as South Korea have many consumers and a wealthy economy… Others such as areas of Southeast Asia, the Middle East and Africa are still in the early stages of developing a strong economy and stable environment.”
The Corporate Finance Institute outlines the characteristics of emerging markets as those markets with market volatility emanating from political instability and external price movements. Significantly these emerging economies expose investors to risk of exchange rate movements. Emerging markets have growth and investment potential, high rates of economic growth, and lower income per capita compared to other countries.
Why emerging markets?
The information in the graphic shows that despite being the largest economy in the world, the US economy has not been the fasted growing. The fastest growing economy in the world in the 50 years from 1969 to 2019 is China followed by South Korea and India. In the same period countries that make up the Middle East and North Africa also recorded some of the highest levels of growth. Egypt, Sudan, Libya, Tunisia, and Morocco have led in terms of economic growth on the continent over the last 50 years. The primary motivation for investors to consider this novel asset class [emerging markets] is the growth and the diversification it offers for their portfolios.
As mentioned earlier the asset class comes with risk. The risks of investing in emerging markets include political risks from unstable and even volatile governments. The most poignant of these examples is Russia which invaded Ukraine in February 2022. The country which was one of the BRICS countries has subsequently been slapped with the most severe of sanctions and has lost access to at least half of its reserves in the middle of a mass exodus of capital from its shores. Economic risks like insufficient labor, raw materials, inflation, and unsound monetary policies are some the pitfalls investors will have to contend with in deciding to invest in this area. Currency risk is another beast that plagues emerging countries whose currencies can be considerably volatile compared with the dollar.
With Africa showing so much promise as a frontier of emerging market economies how then can investors get in on the action?
There are generally two was investors can deploy their capital in this asset class. They can do so directly or indirectly. A direct investment approach will see investors through their own due diligence scouring investments selecting them and allocating resources to them and monitoring their performance and at the necessary point in time exiting them and repatriating their investments to their home nations. This method for novice investors has the most amount of risk. The second investment approach would be indirect. It is investing through a mutual fund or funds whose investment focus are African emerging markets. This method has the least amount of risk in that these funds are management by financial services firms that are highly experienced in this field. The most prominent of these companies is Mobius Capital Partners which was formed in 2018 and is led by emerging markets investment veteran Mark Mobius.
Dr. Mobius according to his company’s website has spent over 40 years working in and travelling throughout emerging and frontier markets. During this time, he has overseen actively managed funds totaling over $50 billion in assets. Prior to launching Mobius Capital Partners LLP in May 2018, Dr. Mobius was with Franklin Templeton Investments for more than 30 years, most recently as executive chairman of the Templeton Emerging Markets Group. During his tenure, the group expanded assets under management from US$100 million to over US$50,000 million and launched several emerging market and frontier funds focusing on Asia, Latin America, Africa, and Eastern Europe. In addition to open-end and closed-end mutual funds, he launched a successful series of emerging market private equity funds.
This company is by no means the only one that offers emerging market investment funds. The list is endless. This example shows the importance of managing the risk of investing directly in markets which investors would have little to no knowledge of through investing indirectly or a partnership with an experienced operator like Mobius Capital Partners. The allure of Africa is the kind investors will ignore at their peril. Africa’s time is now.