How to invest in African markets.

Author:de Giogio, Emmanuelle Moors

What are the best African stock markets to invest in? How does one calculate potential returns and who are the major players in the market? EMMANUELLE MOORS DE GIORGIO answers these and other questions in this comprehensive report on the state of the African stock market today.

Before the late-October stock market turbulences, one-year returns on Wall Street exceeded all but two African stock markets. Should it not be the other way around? Both theory and common sense agree that the higher the risk - and companies operating in Africa are riskier - the higher the return. What has happened to returns recently offered by rich stock markets vis-a-vis those of emerging markets has ben unusual. This situation, supported by low interest rates and increasing liquidity, cannot continue. Once stock markets are calmer, no risk-adverse investors should look again at emerging markets such as Africa. Putting money in funds investing in Africa is one way to do it.

Following a quick glimpse at portfolio theory, we will look at what fund managers have been doing in Africa and in which funds it is plausible to invest.

Risk can be measured by the standard deviation of historical returns. According to theory, investing in the market portfolio (e.g. FT-500 index) allows the investor to diversify away from company-specific risk (because returns are less than perfectly correlated with each other), and this reduces the total risk of their portfolio. What remains is the market risk, which in turn is affected by the interest rate, inflation, business cycle, economic policy decisions, and so forth.

Efficient portfolios maximise returns for any levels of risk (Markowitz Efficient Frontier (MEF)). The single-index model argues that the investor best achieves this by picking up a combination of the market portfolio, and risk free assets (e.g. government bonds) on the Capital Market Line (tangent to the MEF).

The risk of any asset is the risk it adds to your portfolio, measured by the co-variance of that asset with the market. The famous "Beta" is this covariance divided by the variance of the market. The required rate of return on an asset is linearly related to Beta [E(Ri)] = Rf+b[E(Rm)-Rf], forming the Security Market Line.

For all its limitations, this model, the Capital Asset Pricing Model (CAPM), still forms the basis of most portfolio management techniques. A potential investor might consider that from their perspective, the Beta of Africa is low (its markets' performances not being strongly correlated with that of rich countries), and that its price (p/e - the share price divided by the earnings per share) is cheap in view of the region fundamentals and expected growth, and hence investment in African equity markets is advisable.

Africa - the ultimate emerging market?

Increasingly, managers of emerging market funds are including African companies into their portfolio, noting that Africa seems to follow the typical pattern of emerging markets. This trend should continue as, according to the Institute of International Finance, rising portfolio investment in the Middle East and Africa could double in 1997, to $14bn.

The rationale for investing in Africa was admirably summarised under twelve points in the placing memorandum of the Simba Fund, namely: (1) Africa's resources are increasingly in demand, especially from emerging Asian economies, (2) Africa's governments are now promoting...

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