Funds declining Africa investment

[] — EARLIER this year the South African Reserve Bank announced a relaxation of exchange control regulations, allowing investment funds in South Africa to hold an additional 5% of assets offshore – provided they were invested in Africa. That effectively pushes up the percentage of offshore assets allowed to 20%.

Given the view that long-term asset allocation calls for diversifying a large enough component of assets into hard currency to hedge against potential inflation pressure in South Africa and the subsequent value of the rand, you’d think that the 5% allowance would have been snatched up by industry in South Africa.

Well, not so. In fact, very few advisers or fund managers have taken this opportunity to increase their exposure overseas beyond the current 15% levels. Why would that be?

The main reasons for that are a lack of liquidity, settlement issues, difficulty in valuing assets and – largely – due to a lack of knowledge with regard to opportunities and countries.

Despite those issues, the historic performance of African assets clearly indicates that investors would have achieved some of the best global returns on offer had they been exposed to African capital markets. Africa might be full of uncertainties but it’s also full of opportunities.

So how should fund managers go about including those high performing – but pesky – assets on their books? The first point is to understand the different available asset classes: not to see them in isolation but rather as a portfolio of complementing assets.

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The reason for that is the limited stock of assets within a specific asset class and the subsequent lack of liquidity within those markets. In many cases it’s not strange to see returns of 40% on an individual share – but then only to find that you can’t find a ready buyer for this gem of a share when you need liquidity in your portfolio. And then it’s difficult to conclude settlement in many of the smaller exchanges – further compounding the issue.

Fixed interest assets equally have quite unique attributes, where risk doubles and returns react inversely when liquidity increases. That’s largely due to a larger proportion of local currency T-bills needed to provide liquidity at below six-month cycles. As a result you’re forced to take on more currency risk – at lower yield – just because of the added maturity on the shorter end of the scale. Frankly, not worth it.

Liquidity and return issues make it extremely difficult for fund managers to blend African assets into their existing portfolios. In addition, issues such as the reliability of frequent valuations come into play. That of course isn’t easily married with existing administrative systems of large funds.

So should consistent returns of around 15% or more in US dollar terms be ignored because of such difficulties? The answer is a resounding “no” and the solution is in finding a balanced portfolio of complementing assets with a liquidity horizon of around six months. So how should such a balanced portfolio look?

It’s a bit like the Goldilocks story, where it’s all about finding the right mix of assets and asset classes. Any African portfolio should have fixed income, listed equity and money market instruments in it – structured in such a way that it maximises overall returns but also has acceptable liquidity and risk. Adding other structured securities (such as structured trade) to the mix will enhance the balance further.

So what can investors expect of such a balanced fund? Returns are very close to those of the better international hedge funds, while risk and correlation attributes are actually lower. A balanced portfolio should slot in below private equity returns and slightly above those of hedge funds. However, liquidity will be on a six-month cycle, which will be below those of most traditional asset classes, excluding private equity and property (see graphs).

Highlights of the portfolio will be: diversified portfolio of T-bills and hard currency bonds, such as some Egyptian T-bills (9%/year; stable returns), Algerian hard currency bonds (10%/year, including capital upside), Mauritian structured bonds (10%/year; stable returns), a diversified portfolio of listed equities across different sectors and exchanges on the continent, with a bias towards more liquid exchanges, such as Egypt’s Orascom Construction (15%/year expected), Kenyan Safaricom telecommunications shares (25%/year expected ) and trade-related instruments with typical returns of up to 30%/year.

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The final and most important point is to invest with people who know their way around Africa’s fledgling capital markets, have the right contacts with brokers, banks and primary dealers and understand Africa’s unique risks and opportunities.

Burger Muller is a Member, Secretariat for the Investment Climate Facility for Africa

Johan Lamprecht is an emerging markets investment analyst