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In a recent article I wrote, published on Seeking Alpha, I made the case for investing in South Africa based on the following positive attributes of the South African market:

1) South Africa is a gateway to sub-Saharan Africa.

2) There is a large, underutilized labor pool that could transition from the informal to the formal (investable) economy.

3) The country has a modest to high savings rate.

4) The business culture is improving, based on metrics such as ease of doing business, competitiveness, and level of corruption.

5) Investment returns have been attractive over the last decade. Though no guarantee of future results, they may indicate that the above factors have contributed to investor success and continued improvement should bode well.

Several readers commented on the fact that South Africa's economy is a classic case of the glass-half-full, glass-half-empty scenario. In my view, South Africa is on an upward trajectory, but I agree that there are several points in the road where it could take a wrong turn. It is incumbent upon the investor to recognize when a wrong turn is made and when such a turn leads to a minor delay or a less favorable trajectory. On balance, I am hopeful that South Africa can stay on the road to prosperity. And even if it detours, I think the number one reason for investing in South Africa is the access it affords to growth outside of its borders.

Receding Headwinds

During the last decade, South Africa's GDP growth rate averaged 3.5% (World Bank). For 2012, South African GDP growth is pegged at just under 4%, compared to 5.8% for Africa as a whole (IMF). This growth has been achieved despite having the largest HIV/AIDS population of any country in the world. In 2007, 18% of people aged 15-49 was HIV positive, vs. a sub-Saharan Africa average of 5% (World Bank Indicators 2010). Though these numbers are bleak, the real story is the progress that is being made in combating HIV/AIDS. The rate of new infections among adults aged 15-49 declined by 35% in the period 2005-2008 compared to 2002-2005 from an annual rate of 2.0 per 100 susceptible individuals to 1.3. Success is partially attributed to the ramp up in antiretroviral treatment programs (ART). The effect of ART programs is assumed to be non-linear: "The scale-up of ART may have the potential to reduce HIV incidence, since effective treatment reduces viral loads and, as a consequence, the infectiousness of infected individuals"(Rehle, Hallett, Shishana, 2010). HIV/AIDS has a devastating effect on human productivity; therefore a reversal of fortunes for South Africa's working age population will pay substantial economic benefits, not to mention the alleviation of human suffering that will accompany it.

Another receding headwind to consider is South Africa's crime rate. The murder rate per 100,000 citizens in the 2010/2011 reporting year was 31.9, compared to 4.8 in the U.S. Unacceptably violent to be sure, but as with the HIV/AIDS scenario, the absolute number does not tell the full story. In the 2003/2004 reporting year, the murder rate was 42.7 and has been steadily declining since (Crime Report 2010/2011 South African Police Service).

One headwind that has not seen improvement, at least as measured by the GINI Index, is income inequality. A Gini Index score of 0 represents perfect equality, while an index of 100 implies perfect inequality. South Africa's score was 67 in 2006 vs. 57.8 in 2000 (more recent data is not available; World Bank Indicators 2010). This score is high on an absolute basis and the trend is reason for concern as well. Though its effect on economic growth is not clear- witness the combination of economic growth and income inequality in for example Russia, China, and parts of the Western World- it could breed further social unrest which would detract from South African efforts to become a more stable, cohesive society.

Receding Trade Barriers

One important source of future growth for South Africa is the reduction of trade barriers in Africa. Due to its economic heft, world class public companies, and cultural and political ties to sub-Saharan Africa, South Africa is in a unique position to benefit from increased trade on the continent. As global trade negotiations have stalled, regional trade agreements are gaining prominence as a more practical avenue through which to increase trade. Coupled with a desire of African nations for economies of scale, political stability, and increased bargaining power, the future bodes well for intra-African trade.

Four major free trade agreements (FTAs), in various states of development, include those of the Economic Community of West African States (ECOWAS), Economic Community of Central African States (ECCAS), Common Market of Eastern and Southern African States (COMESA), and the Southern African Development Community (SADC). An even bigger vision is the "African Grand Free Trade Area," which would combine three trade blocs in Eastern, Central, and Southern Africa and include 26 countries and more than 500 million people. As intra-African trade growth accelerates, investors will be increasingly able to invest in South African companies and accrue the benefits of not just local growth, but also pan-African growth.

Considerations for US Investors

Much in the way that US investors were rewarded for early investment in Japan in the 1960s and emerging markets in the 1980s, Africa represents an opportunity for above average returns in the decade(s) ahead. In fact, most US investors that invest in diversified US Large Cap Funds already have Africa exposure through companies such as Yum! Brands (NYSE:YUM) and Wal-Mart (NYSE:WMT) which are quite active in Africa. However, what keeps investors from participating more directly is very similar to what may have kept them out of Japan 50 years ago and Southeast Asia 30 years ago: lack of familiarity, misconceptions about political and economic risk, lack of rich data, and limited liquidity. Incidentally, these same factors are part of the reason excess returns can be achieved with a prudent and disciplined investment approach. Mitigating these risks while still allowing for participations in the continent's growth prospects, an investor might consider funds such as Market Vectors Africa (NYSEARCA:AFK) and iShares MSCI South Africa (NYSEARCA:EZA). Over time, an investor might want to diversify more broadly in Africa, to retain exposure to the upside of its fastest growing economies.

Source: South Africa: A Glass Half Empty Or Half Full?