Frontier market investing has moved from institutional niche to the mainstream, at least as far as financial media exposure is concerned. Particularly investing in Africa is garnering attention. Whereas Goldman cleverly coined the term BRICS, The Economist speaks of the Lion Kings (African version of Asian Tigers). One of my colleagues recently made the Case for Investing in Africa on Seeking Alpha, and the growth opportunities on the African frontier are increasingly resonating with investors. However, unless you are a large institutional investor, how can you participate in this opportunity? Thankfully, there are a number of mutual fund and ETF options available to U.S. investors today. Ryan Hoover's Seeking Alpha article "11 Africa-Focused Mutual Funds and ETFs" goes into greater detail on the various funds.
The biggest flaw I see with what is available today is the lack of exposure to what I consider to be the two biggest pillars that underlie the Africa opportunity: the growing middle class and the Sub-Saharan Africa region. When you look at the various funds' Sub-Saharan Africa exposure and exclude South Africa and the oil and mining sectors, you are left with Africa exposure between 0 and 25%. Hardly a laser focus on what I see as the true opportunity: the Sub-Saharan consumer and the high growth Sub-Saharan economies such as Kenya, Nigeria, Ghana, and Ethiopia, to name a few.
A partial explanation for the lack of exposure to Africa's true growth is the fact that products run by larger multi-asset class managers run in to size and liquidity constraints. Size matters and in this case smaller is better. A boutique investment manager might be able to buy a $150m market cap name that trades less than $20,000 per day (an example of a recent stock I looked at) and not take up multiple days of liquidity; T. Rowe Price would have more difficulty with that trade.
Another explanation for the funds' underweightings to the Sub-Saharan non-commodity theme has to do with indexing. The major indices have substantial weighting to Energy and Materials and Middle East/North Africa (MENA) and South Africa, which has led funds to follow a similar diversification. For example, the iShares MSCI South Africa ETF (EZA) , has a 26.5% exposure to Materials and Energy, compare that to investing in the SPDR S&P 500 ETF (SPY), where you would only have a 14.5% exposure to those sectors. Granted, EZA is a country specific fund, but if you look at some of the major pan Africa funds, you see similar Energy and Materials exposure, in addition to a bias towards MENA and South Africa. The Market Vectors Africa Index ETF (AFK), for example, has 40.8% of its assets outside of the Sub-Saharan region, and if you further exclude South Africa and Mining and Oil, that number increases to 79.2%. In fact, out of the 11 funds that Ryan Hoover identifies in the aforementioned article only one has less than 75% of its assets allocated to the trifecta of Oil and Mining, South Africa, and MENA.
Now does it matter that the investment products available to U.S. investors are concentrated with regards to sector and geography? I believe it does for 3 reasons: 1) commodity and energy prices - and therefore commodity and energy stocks - correlate strongly on a global basis, by their very nature (natural gas a possible exception). Therefore, adding an Africa fund might have greater impact on your portfolio's commodity and energy exposure than on its exposure to the growth story of (African) frontier market economies. 2) While past performance is no guarantee of future returns, it appears that at least over the last 3 years non-commodity African stocks have significantly outperformed their indices. As a proxy, I have looked at the 3-year performance of various sectors in the FTSE/JSE Africa Index, which shows clearly that the real growth has come from the non-mining sectors and particularly from consumer goods and consumer services:
Returns (local currency) as of 12/11/12
Year to Date Return
And finally, 3) Geography matters. South Africa and MENA, due to their more mature market status, have lagged the performance of Sub-Saharan frontier economies. To illustrate that, below are South Africa and MENA's returns vs. some of the other major markets:
Returns in USD as of 11/30/12
Year to Date Return
To be clear, investing in the African consumer is not without risk, but it appears that investors have been rewarded for taking that risk. Most funds with Africa exposure - due to their overweighting of MENA stocks and Energy and Materials stocks - march to a different drum beat (lower growth, higher commodity exposure) and investors that are excited about the prospect of the African Lions are well advised to take a good look under the hood of any Africa fund before committing capital.