Africa, particularly sub-Saharan Africa, has for decades been thought of as, at best, a volatile investment opportunity with the glamour and extreme risk of diamond mines.
By Sophia Grene
Now a different story is being told, as Ayo Salami, a former lecturer at London’s Cass Business School, suggests the continent is finally reaping the benefits of painful institutional reform in the 1980s and 1990s.
The theoretical background is a model by Olivier Blanchard, professor of economics at the Massachussets Institute of Technology, in which he points out that the growth of the private sector does not make up for the collapse of the public sector for a considerable time.
Africa is now on the upturn, according to Mr Salami, who points to the gradually widening gap between population growth and growth of economic output across the continent as a whole. This means gross domestic product per person is increasing.
Some analysts attribute this to demand for natural resources from China, which has boosted income in several African countries. Mr Salami disagrees, though he accepts that Chinese investment has helped growth in some places. “The commodities story is fine, we’ll take it while it’s there, but it’s not the central thesis.”
To take advantage of this growing prosperity, Mr Salami has launched the Duet Victoire Africa Index. The name is a little misleading: this is a fund that tracks a proprietary index of the largest stocks across sub-Saharan Africa outside of South Africa. Mr Salami designed the index, which includes all companies in the region with a market capitalisation of more than $250m that meet a minimum liquidity requirement.
“This is designed to offer low-cost access to the growth of the region,” says Mr Salami. The product is run as a joint venture between his company, the African Business Research Institute, and alternative asset manager Duet Group.
Many investors looking for high returns regard frontier markets as an ideal opportunity for active management, assuming there will be inefficiencies in an underdeveloped market they can exploit. Mr Salami thinks this is self-deluding.
“People still sell the snake oil that you can beat the index in emerging markets, but the empirical evidence is very strong that, just as you can’t beat the market in developed markets, it’s the same in Africa,” he says.
He explains that this is partly due to the structure of the markets. Most fund managers will be reluctant or unable to invest in the smaller stocks because of illiquidity. This means it may be difficult to buy the stocks in the first place, a significant investment may in itself move the price, and the investor will then be vulnerable to the large price changes that are typical of illiquid stocks.
Their investment universe is therefore confined to many of the same stocks as in the index, says Mr Salami, as such shares are sufficiently large and liquid to be as efficiently priced as in any developed market.
Even the stocks that qualify for the index suffer serious liquidity issues, he admits.
Because of this he runs the fund as an index tracker rather than an exchange traded fund. ETFs, he explains, are expected to replicate the underlying index precisely (and they trade continuously). The Duet Victoire Africa Index deals twice monthly, and is only able to achieve 90 per cent correlation with the index as some trades cannot be carried out immediately.
This illiquidity sounds the warning bell that most investors fear when it comes to investing in less developed markets, that of massive price swings. Mr Salami’s approach to this issue is to treat sub-Saharan Africa as a regional opportunity. Over the 10 years to 2006, the standard deviation (a measure of how much the market prices swing) for that region was 23 per cent, compared with 37 per cent for eastern Europe, 35 per cent for Asia and Latin America and 32 per cent for emerging markets generally.
This is due to the low correlation of African markets with each other, he explains. A chart of the correlations between African equity markets shows they do largely function independently. Mr Salami says this makes for a portfolio with self-hedging characteristics as a downturn in one market will likely be offset by gains in another.
This characteristic also applies to currency. “The fund is dollar-denominated; it is not possible to hedge these currencies, and I don’t even think it is advisable,” he says.
“What an investor is buying into is the growth of the whole region, which includes the currencies as well as the stock markets. It’s not a product we are positioning for you to trade, it’s a long-term investment.”
Although his spiel is delivered with great conviction and a wealth of expertise to back it up – Mr Salami was an African equities analyst at Nomura Securities for four years before building a large independent database of African equities – potential investors have been spooked by recent political unrest in Kenya, one of the region’s largest economies.
“We had a decent pipeline before launch, but a lot of those have invested less than they promised,” says Mr Salami, who is surprisingly optimistic about the future of Kenya. Despite the serious political problems in the past three months, Kenya’s stock exchange has rebounded. Although the currency has yet to recover, Mr Salami expects that “before the end of the first quarter, the fund’s Kenya investments will be back above water”.
While Kenya’s independent judiciary is unharmed, and has the ability to enforce contracts, he says, “I don’t see any evidence that Kenya is going to become a failed state”.