[miningmx.com] — INCREASED institutional flows into Africa’s financial markets will aid the continent’s economic development substantially and put it on to a sustainable path towards self-sufficiency and improved prosperity.
However, for that to happen, portfolio flows will need to increase substantially – and institutional investors are an important source of such flows. It’s believed that a relaxation of exchange controls on South African institutional investors – which will allow them to invest more of their funds in Africa – will be a significant step in the right direction and a catalyst for an investment renaissance on the continent.
With initiatives regarding the African Union and Nepad gathering momentum, it’s imperative that the development of African capital markets keeps pace to support that process. As historical economic development clearly indicates, capital markets are the basis for economic development and growth, as they facilitate the development of SMEs, infrastructure development and research and technology transfer.
The level of capital flight from sub-Saharan Africa is estimated at $148bn – representing about 33% of the continent’s private wealth, compared with less than 10% in Asia and Latin America. Investing in markets outside the continent has historically offered better risk-adjusted returns and there’s been a dearth of instruments in which to invest.
An improvement in Africa’s capital markets would create a number of virtuous cycles. On the one hand, small African businesses would find it easier to obtain funding and it may also help convince Africans to repatriate their savings. The Commission for Africa (in conjunction with Nepad) recently established an Investment Climate Facility for Africa. It was designed to improve the investment climate in Africa by removing obstacles such as institutional deficiencies and ambiguity concerning property rights.
An improvement in Africa’s capital markets would create a number of virtuous cycles
While those hurdles are currently hampering South African pension fund flows to Africa there’s also a 15% limit on pension funds’ ability to invest funds offshore. Currently, that 15% includes investments in Africa, which means that Africa has to compete with developed markets in order to attract investments.
With fund managers for institutions feeling that they already have substantial emerging market exposure through being in South Africa, the result is a very limited allocation to African capital markets from that source.
In line with the aims of Nepad, South Africa’s government recently relaxed forex controls for African investments, currently allowing R2bn for capital flows into Africa, as opposed to R1bn elsewhere. That has already spurred more fixed direct investment flows into the continent.
However, with institutional investors still limited in terms of their cross-border allocations, portfolio flows into Africa’s capital markets are largely ignored in that equation and will remain limited.
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The most powerful force in the race to meet the Millennium Development Goals for Africa will be to unleash the effect of the private sector on the continent. That enormous pool of funds dictates where and how economic growth will be accelerated. The need to find optimal investment destinations drives investment decisions – and Africa is no exception. Or is it? Taken together, African markets (excluding Zimbabwe) posted an overall average index return of 41% in 2004 in US dollar terms. By comparison, the figure was 34% for other emerging markets, 22% for developed markets, 9% in the United States and 16% in Britain. According to the World Bank’s 2003 global development finance report, Africa offers “the highest returns on foreign direct investment of any region in the world.” Then why does only around 1% of the private capital that’s sloshing around the globe find its way to sub-Saharan Africa? The answer may be more to do with the mechanics of investing in Africa than one may think. In order to tap into these exceptional African returns, the normal impediments of investments – such as risk/return ratios, correlation of investment and classes and volatility – need to be adequately addressed before funds are committed.
But, on top of that, further unique impediments are at play. Low liquidity severely deters investors and you often find that an investment might well perform at the spectacular rates mentioned but it’s almost impossible to sell out of a position due to that. Diverse financial reporting criteria between countries and capital markets further add to the cost of investing; and so does the inability of institutional investors to hedge positions and currencies. So what will address that situation? Many initiatives are currently under way and, notably, the Investment Climate Facility for Africa will certainly have that on its agenda.
However, there’s one issue that still needs to be addressed and that’s economies of scale for investors. That will only be achieved if more investors are interested in Africa, thereby establishing adequate financial infrastructure and, more specifically, investment infrastructure.
One specific thing that South Africa can do to improve that situation and achieve the critical economies of scale necessary for institutional investment, is to increase the foreign allocation limit for South African investors into Africa.
By differentiating between African and other foreign investment destinations, more portfolio flows to the continent would be encouraged. The current 15% limit on foreign investments could be increased to 25%, of which the additional 10% will be specifically earmarked for Africa. That will address the current satiation, whereby only 1% of the foreign allocation of 15% finds its way as portfolio investments into Africa. If you take into account the total assets of R830bn under management by SA’s insurance industry, that move could see a potential flow of R83bn to Africa. That might be extremely optimistic and a more realistic figure would be to work on assets under management for South Africa’s 18 largest pensions funds. That currently stands at R194bn but excludes the GEPF (Government Employees Pension Fund). The more realistic potential flow of R19bn then comes into play.
As seen in other emerging regions, portfolio plus other investment flows are the fuels needed to power the virtuous cycle of economic development, poverty reduction and sustainable economic self-sufficiency. Given the right impetus, it could be Africa’s turn to benefit from that process.
* Muller is regional fund manager at Business Linkages Challenge Fund and Lamprecht is analyst for developing markets at RMB.
