As told by Oliver Bell.
As the portfolio manager for the T. Rowe Price Africa and Middle East fund, I look for investment opportunities across two large regions — more than 60 countries in all. Since there’s much less research than usual written about the companies and countries the fund covers, it’s critical for us to visit the countries and meet with management. On average, I’m traveling once every four weeks.
Africa represents what we like to call “frontier” markets. To provide some perspective, you can think about global markets in three distinct segments. “Developed” markets like the U.S. and Europe sit at the top – they have strong regulation, a lot of liquidity, and broad, diversified industries. “Emerging” markets like China and India are a level down from there in terms of development. And “frontier” markets, like most of Africa and the Middle East, are areas where people haven’t really invested before—they’re nascent markets that have been very illiquid. Historically, you haven’t been able to get much exposure to them, but now they are becoming investable thanks to greater integrity in the general business environment, a number of infrastructural improvements, and greater stability overall thanks to social, economical and political reforms. And because these markets are starting from such a low base, they’re growing very quickly.
Right now frontier markets in Africa have between 5-7 percent GDP growth annually, as opposed to the developed markets, which aren’t growing much at all. In the emerging markets there’s a mix of faster and slower growing economies, but in the aggregate they’re not growing as fast as the frontier markets.
What makes Africa so interesting in particular is that there is massive change taking place. This is a region with one billion people, and by 2040 the continent will have the largest population of working-age people on the planet. There is very little debt and a large amount of resources. Recent growth has been broad-based across all sectors, and investment in infrastructure is visibly picking up. Things have changed dramatically, and I believe structurally, which makes this an exciting investment destination.
Opportunity on the Heels of Modernization
Africa is comprised of 54 countries. If you go back to the 1970s, around two-thirds of the countries on the continent were considered to be at war—either with their neighbors or internally. Now, some 30-40 years later, there are probably only three countries in that state, which is quite a big change.
Politically, you see dictators being effectively overthrown, and elections taking place, sometimes for the first time. You’re seeing transitions of power, again sometimes for the first time. This year and last year, about half the countries in Africa will have had some form of a democratic election. In the 1970s, that would have been unheard of.
There’s still a long way to go, of course. I recently read a paper by Adam Przeworski and Fernando Limongi called “Modernization: Theories and Facts,” that suggested that once a country reaches $6,000 per capita, its politics become more stable. Also, very few free economies that get to $6,000 per capita revert to a state of political instability. A lot of African countries are currently only $1,000 per capita, but the momentum is positive.
Discretionary Income Building an Emerging Consumer Class
The emergence of a “consumer class” in Africa is similar to what we have seen in Asia, however, this is on a very different scale. In Asia, you’re talking about people being able to buy things like cars. In Africa, you’re talking about people moving from, basically, a hand‐to‐mouth existence to having $1 a day of discretionary spending power. According to a recent African development bank report, approximately one-third of today’s Africans can now be classified as “middle class”—meaning they have $2 or more a day of discretionary spending power. While that doesn’t sound like much, if you think about a billion people, and add it up, it becomes quite a powerful movement. Furthermore, a recent McKinsey report said that by 2020, more than 50 percent of African households will earn at least $5,000 a year, and that’s the level at which they typically start spending half their income on items other than food. That’s a big trend.
Consumer packaged goods companies like Unilever and Nestlé have already been in Africa a long time. The brewing companies, such as Heineken and Diageo, have major investments in Africa, and in local subsidiaries. These markets are now contributing a great deal of growth overall to those companies.
Unilever, for instance, sells sachets of shampoo, and Colgate sells “penny packets” of toothpaste —what in a developed market would be given away as a sample. In Africa they sell them, because people have one dollar a day to spend. This shows how they’ve learned the market and are adapting to this new consumer. (For more about the emerging consumer class in Africa, see “The New African Consumer.”)
South Africa: Gaining Exposure to Growth
There’s another parallel with Asia from an investment perspective. When you look at countries like China or South Korea, one of the best ways to gain exposure to those markets has been indirectly—through companies like German manufacturers and Australian mining companies that are benefiting from growth in those economies.
In Africa, we’re looking especially at South Africa, which has woken up to the potential of this billion or so people on its doorstep. Instead of investing abroad in places like Australia, Europe, or the U.S., some South African companies are focusing almost entirely on the African continent.
In South Africa you have a more mature market, with very well managed and liquid companies. You see situations where, say, 10 percent of a South African company’s sales might currently be coming from the rest of Africa, but in two or three years they’re aiming for 30 percent. A lot of them have just reached that inflection point where they’ve figured out how to make profits in Africa—because there are a lot of challenges and obstacles—and now they just need to increase volume or capacity.
So South Africa has become a way to get indirect exposure to the whole African growth story.
Nigeria: A Rising Star?
Nigeria stands out because it’s so big: 160 million people. There’s a fairly strong government in place, it’s starting to make reforms, and so I think it has real potential to become like a BRIC—the growth economies of Brazil, Russia, India, China—in 5-10 years time.
Of all the African countries, Nigeria is actually the most similar to Brazil in the sense that it’s the big oil play on the continent, it has a lot of people, and it’s getting better and better in terms of who is running its companies. You have many Nigerians who had left for the West now coming back to the country, because they see opportunity; and that’s changing the leadership situation. If all this continues, then Nigeria becomes a very exciting story. (To learn more about Nigeria and other standout economies in Africa, see “Five Countries to Watch.”)
Making the Most of Resources
Africa is obviously rich in commodities: oil, iron ore, copper, platinum, gold.
If you consider China’s investment, for instance, one-third of the country’s foreign investment in the last five years has gone into Africa and the Middle East. And if you look at a map of where China has invested, it mirrors almost exactly where the natural resources are. All of the country’s investment in Africa has effectively gone into African natural resources.
One interesting development in this area is that African governments are getting wiser. At first they were just grateful for the investment. Now, we see African governments saying; you can have access to a particular commodity, but you also have to build us, say, five schools and a hundred kilometers of roads. So the African governments are getting smarter about letting foreign investors in and getting more in return. (For more on natural resources in Africa, read “Riches in The Ground.”)
Telecom As a Driver of Growth
Right now in Africa there are more people with mobile phones than bank accounts. One of the things we see is that companies are now setting up ways of transferring money or making payments through mobile phones. This has particularly taken off in Kenya. Banking is being created in Africa on the back of the mobile phone.
The take-off of telecoms has come about as handset prices have collapsed, and increased competition has driven tariffs down to an affordable level. Mobile banking is driving usage, and mobile companies stand to make more money as data usage becomes more prevalent through the introduction of cheaper smartphones. We see tariffs for mobile phone usage coming down, and when that happens, we see the exponential usage of voice functions, with the next leg of that being data.
I’ve heard it said recently that Africans consider mobile phones to be the third most important thing in their lives, after their house and food. So it’s worth noting that while smartphones are not big yet in Africa, they will be as prices decrease. So mobile is a very important sector, and it’s driving quite a lot of economic activity.
|The Growing Modernization in Africa|
Of course, a lot of African countries rank at the bottom of indices like “Ease of Doing Business.” And much of that has to do with simple infrastructure.
One example: it takes 20 days for a container to go from the port in Mombasa in Kenya to the capital of Uganda. That’s about 925 kilometers, or 475 miles. In Europe, you can drive 1,000 kilometers in 8 hours.
In Nigeria, to cite another example, every bank branch needs its own power generator, because there’s no electrical grid. That increases the cost of doing business.
If Africa can get over these infrastructural hurdles, then there will be an economic snowball effect. In countries across the continent, they’re talking about pushing through reforms that will help ease doing business and bring costs down, and if they do, that will have a very significant impact. (See our infographic for a full overview of developmental change in Africa.)
Investing For the Long Haul
One of the reasons Africa has been one of the best performing regions during the last five years is that it isn’t a crowded trade yet. What I mean is that there is very little “hot money” invested by hedge funds in the African markets at the moment, or by funds investing off their strategic mandate. This means that when there is a reduction in risk appetite in global markets, many of the investors that remain invested in the African markets are not withdrawing their money—those markets are typically not falling as much as the wider emerging or developed markets are, so generally speaking, they are outperforming those markets. Many people and institutions that are invested in Africa do so with the understanding that change is a long-term process on the continent, and much of the money they’ve invested there is invested for the long term. Of course, past performance cannot guarantee future results.(See our infographic for a full overview of developmental change in Africa.)
Economic management, democracy, and improving institutions and infrastructure will be key in the next decade. We need to see governments controlling inflation and keeping their budgets balanced. We need to see rule of law and peaceful transitions of power. And we desperately need to see investment in power, roads, and railways to continue. There will be challenges and risks in Africa, and we should expect setbacks—there will be winners and losers, but on the whole I’m optimistic that we will see many more winners than in the past.
Africa really wasn’t on many people’s radar two years go. But this year, the frontier African markets are up 30 percent to date. So people are going to start noticing.
Investments in emerging markets are subject to abrupt and severe price declines. The economic and political structures of developing nations, in most cases, do not compare favorably with the U.S. or other developed countries in terms of wealth and stability, and their financial markets often lack liquidity. Because of this concentration in rapidly developing economies, the fund involves a high degree of risk. Share prices are subject to market risk, as well as risks associated with unfavorable currency exchange rates and political or economic uncertainty abroad. In addition, because the fund has nondiversified status, it can invest more of its assets in a smaller number of companies than diversified funds. As a result, poor performance by a single large holding of the fund would adversely affect its performance more than if the fund were invested in a larger number of companies.
Nestlé Foods Nigeria represented 1.87% Nigerian Breweries (Heineken) 1.99%, and Unilever Ghana 0.25% of the Africa & Middle East Fund as of 9/30/12. The following companies were not held by the T. Rowe Price Africa & Middle East Fund as of 9/30/12: Colgate and Diageo. The fund's holdings are historical and subject to change. This material should not be deemed a recommendation to buy or sell any of the securities mentioned.
Oliver Bell is a vice president of T. Rowe Price Group, Inc., and lead portfolio manager and chairman of the Investment Advisory Committee for the Africa & Middle East Fund. Based in London, Bell holds the Investment Management Certificate (IMC) and a bachelor of science degree from Exeter University.