African equity exchange-traded funds (EFT) have soared over the past year, as the resource-rich continent is growing quickly, with low debt levels and a youthful and increasingly middle class demographic, but there are near-term risks to consider.
Global consultancy Ernst & Young believes Africa is the second-most-attractive investment destination, behind the U.S. According to Arthur Childs from advisory firm Arch Financial Planning, a number of asset managers believe Africa should be part of a mainstream equity portfolio for long-term investors. In a note to clients, he gathers five points from asset managers Alquity and Neptune Investment Management to state why investors should take note of this continent.
1. Africa has an Exciting Resource Story
Africa has rich resources in oil, natural gas, minerals, food and arable land. It has a land mass equivalent to Europe, the U.S, India, China and Argentina combined. Non-oil output is also expanding thanks to reforms in the energy sector.
2. Expanding Economy
The International Monetary Fund predicts that seven out of 10 of the world’s fastest-growing economies between 2011 and 2015 will be in Africa. Many sub-Saharan countries’ growth is predicted to rise from 5 to 5.5 percent per year as they emerge from the financial crisis.
3. Low Debt Levels
Africa has better debt to GDP levels than some developed countries. Alquity said that while the U.K.’s debt level is 77 percent, Nigeria’s is just 16 percent.
4. Growing Workforce
Africa is enjoying a growing middle class and a youthful workforce, already equivalent to that of India. A growing consumer base will also be a positive for the economy.
5. Low Correlation to Other Markets
Africa is relatively uncorrelated to developed and emerging equity markets, with a correlation of 0.27. According to Alquity, stocks are more driven by domestic factors. However, if China has a slower landing than expected, there will be weaker demand from African exporters and a knock-on effect on commodity prices.
However, there are near-term risks in Africa to consider, including the rolling out of tighter monetary policy. An inflation target and more exchange rate flexibility is needed. There is also a vulnerable greater fiscal debt situation, especially in the countries that rely on foreign capital inflows.
Arthur Childs warned that only clients with a higher risk appetite and a long-term horizon should consider investing a maximum of 3 to 6 percent of their portfolio in Africa.
“It will hopefully be clear from what has been said that investors with a very cautious attitude to risk or whose capacity for loss is small should not consider investing any of their money in an Africa fund, or indeed in an emerging market fund,” Childs wrote.
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