Trading Liquidity In Illiquid Sub-Saharan Africa

Includes: AFK, EGYP, EZA, NGE
by: Belgrad Kenne

The article provides an intimate understanding of Sub Sahara African opportunities and how US investors can achieve Alpha by allocating a portion of their portfolio in these high growth markets.

One of the challenges associated with Frontier Market investing is lack of capital markets' depth. Next to the "growth story" of these markets, liquidity stands as the major obstacle faced by institutional investors eyeing on these markets.


Liquidity is the ability to get in and out of a trade without affecting the stock price. In Frontier Markets, traded volumes and values are typically low, reflecting the low turnover and high bid-ask spread of listed equities. Moreover, a significant number of transactions often resume to block trades with premia or discounts on the quoted price. Trade frequency tends to be hourly, daily or even weekly for some stocks, as opposed to minutes or even seconds in efficient, high frequency trading environments.

This has implications on asset pricing; transaction costs and most importantly expected stock returns. From our experience, first-time Frontier Markets investors often fail to factor-in these specificities in their investment decisions. Understandably, with an open-ended investment vehicle, lack of liquidity may be synonymous to lack of opportunity for those who need strong guarantees that they are able to exit a position should there be an immediate need to do so, in order to satisfy redemption claims.

The Sub Sahara African (SSA) environment

SSA stock markets are nascent, with limited market breadth and depth. We classify stock markets1 into 4 tiers using additional criteria such as: information efficiency, sophistication of stock market infrastructure, market makers' integrity, rule of law and (foreign) investors protection. The outcome2 is as follows:

Tier 1: Nigeria, Kenya, Ghana, Botswana, BRVM
Tier 2: Tanzania, Uganda, Zambia, Zimbabwe, Rwanda

Tier 3: Malawi, Namibia, Swaziland, Mozambique
Tier 4: BVMAC, Sierra Leone, Cameroon

Phase One Associates currently covers Tier 1 & 2 stock markets, which are the most accessible to foreign investors, in terms of opportunities and relative liquidity. Tier 4 is nearly non-operational given the Bourse des Valeures d'Afrique Centrale (BVMAC) and the Douala Stock Exchange (Cameroon) have not managed to unify the Cameroonian national stock exchange and the regional stock exchange (BVMAC) in order to streamline legislation and market supervision. As a result, Zero stock is quoted at the Douala Stock Exchange whereas SIAT Gabon has recently floated the only stock listed at the BVMAC to date. The Sierra Leone Stock Exchange is new with no activity yet; as ongoing efforts seek to shift informal stock trading into a formal, properly regulated stock exchange.

The liquidity challenge

From available market data, most SSA stock markets respond to what we call the 5- 95 status i.e.: 5% of listed stocks make up 95% of market capitalization (free float adjusted). Average daily traded values for the most part are around or below 50,000 USD whereas average institutional investors demand for a "long" position is twice as much to say the least. This supply and demand imbalance naturally leads to block trades and premia/discounts (5% on average) paid in various transactions. More challenging is the difficulty in finding a buyer in case of an "emergency" exit. This may take up to a quarter, depending on stock attractiveness and seller's flexibility on the price. This environment has made us think that SSA listed equities is an "improved version of Private Equity" where deal sourcing is done at the exchange and negotiations are conducted OTC.

The 5-95 status leads to liquidity being skewed towards the top 5% stocks, thus inflating prices and valuation of the most sought-after stocks while creating bargaining opportunities at the bottom. At the top, we also note that most holdings are within foreign hands. In addition, foreign-based mutual funds tend to hold the same stocks across SSA; in common themes of: banking&finance, consumer (including brewing & retail), telecommunications and material construction thus magnifying the vulnerability of these "liquid" stocks in the event of a gloomy global financial environment where flight to quality would lead to a big hit on "liquid" stock prices.

Strong records, high promises

The SSA story is changing, from an "AID" destination to a land full of opportunities. Economic growth has been strong, backed by better policies and politics. Governance is improving and the same goes for rule of law. Economic freedom and the business environment are better than they were a decade ago.

IMF statistics continue to rank SSA countries among world fastest growing economies in the decade to come. Demand for commodity is rising with the BRICs demanding more metals and oil to supply their industries, infrastructure and energy programs. Most SSA countries are thus well positioned to benefit from these trends, given they are rich with natural resources ranging from oil, gas, metals & minerals to soft commodities such as coffee, tea, cocoa, cotton, corn, rice etc. In addition, vast amount of land is uncultivated and/or unexplored. Moreover, demographic dynamics driven by a young and educated workforce, rising per capita income, urbanization and a growing middle class are contributing to diversifying SSA economies from commodities, export-led economies to domestic consumption shaping the new economic structure where value addition, manufacturing and services have greater role to play in fighting unemployment and poverty at large.

Projected growth is likely to positively impact corporate earnings and therefore stock returns.

A risky destination?

Those investors not yet exposed to the continent are less receptive to arguments put forward by proponents of the African "KE NAKO"3. Among other challenges, they cite: LIQUIDITY, small and fragmented capital markets that require different currencies (and the associated risks) for every country invested in and concerns over exchange controls and capital flows in some cases. Moreover, market volatility in the short run and inflation likely to affect long-term currency adjusted returns add to their concerns.

We believe the real risk investing in SSA is over stating the risk and missing out on today's opportunities that build high, long-term returns.

Long term is the consensus

Investing in Frontier Markets requires adopting a more adapted approach that reflects the generic characteristics of these markets on one hand and the unique specificities of each market on the other hand. It requires spanning investment horizons on the long term. Although long term means "different things to different people in different circumstances", by long term we mean an average stock holding of 3 years. That is certainly different from the short term, "trading" mentality, driven by short term speculation that not only inappropriate in a high transaction costs environment of Frontier Markets, but also does not fit the ongoing structural changes that are likely to yield high returns in the Long-term.

These high returns prospects are commensurate with the challenges. Requires awareness and subsequent mitigation strategies that will enable investors to reap first movers' advantage and be part of SSA vision 2030, an emerging continent with emerging stock markets.

Those who missed on China and India 20 years ago certainly do not want to repeat the same mistake.

Be part of the story!

Investing in Frontier Markets means access to high growth markets, projected to grow at least twice as faster than world average growth in the short and medium terms. This also means diversification of your global portfolio given these markets have low correlations with Developed Markets and Emerging Markets. Combining growth, high expected long term returns and de-correlation benefits, U.S investors are likely to maximize their portfolio's Sharpe ratio and ultimately, achieve ALPHA

Sub Sahara Africa has consistently outperformed other Frontier Markets.



1 year

3 years

5 years

10 years

RETURNS (in %)


MSCI Frontier Markets






MSCI Frontier Africa







MSCI Frontier Markets




MSCI Frontier Africa





MSCI Frontier Markets




MSCI Frontier Africa




Source: MSCI indices as of May 31st 2013.

Rf benchmarked on BBA LIBOR .

Visa to Sub Sahara African equities: passive or active strategies?

For those US investors willing to embark on the African Frontiers journey, they may adopt a passive or an active strategy depending on their profile, investment objectives and liquidity needs.

A passive strategy would imply buying into listed funds (mutual funds mainly), investment companies and other equity-like instruments (index funds and ETFs) that offer instant and diversified (sectors and geographies) exposure to Sub Sahara Africa from a single trade. This requires analyzing the fund philosophy and allocation, in order to ensure this matches your profile. Some funds are labeled "Africa funds" whereas 2/3 of their constituents are stocks generating revenues predominantly from South Africa and Egypt or even Turkey! Passive strategies highly suit retail investors as they are able to access SSA opportunities without the requirement for opening a brokerage account in those African markets where the stock is listed. Also, this strategy favors those with high liquidity requirements, as they are able to get in and out of a trade on regular frequency, mostly weekly.

Some funds I find relevant and appealing given their significant exposure to Sub Sahara Africa, their performance records and reasonable fees are: Templeton Africa Fund, Renaissance Sub Sahara Fund, Arisaig Africa Consumer, Sanlam African Frontier, Standard Master Funds. Most of them trade in the US, UK, Luxembourg and Mauritius stock exchanges are they have share classes both for retail and institutional investors for 2000 USD and 100,000 USD respectively, on average.

Entry and exit fees are relatively high compared to the US given the implied high transaction costs inherent in these markets. On average 2% load and 2% redemption depending on fund's size, liquidity frequency, and overall strategy in attracting, deploying and retaining capital. Transaction costs are indeed high compared to the US. This reflects the fragmented nature of these markets unable to achieve economies of scale and operational efficiencies that would considerably lower transaction costs. However, benefits even after currency adjustments, outweigh the costs, as highlighted by the 10 years annualized, 0.64 Sharpe ratio achieved by the MSCI Frontier Africa index. Further, most Sub Sahara market indices have consistently outperformed the S&P 500 by a wide margin, in recent years.

Most African focused ETFs are still skewed to South Africa, Egypt and Nigeria but the dynamics are gradually changing, to reflect the growing opportunities in other parts of the African continent. To date, next to the iShare MSCI South Africa (NYSEARCA:EZA) or Egypt (EGYP) ETFs, one may consider Sub - Sahara Africa focused ETFs such as the Market Vector Africa Index (NYSEARCA:AFK) and the Duet Africa Index fund (bloomberg:DVAFINE). Increasingly country ETFs are being launched focusing primarily on Nigeria. This is the case with the Global X Nigeria ETF (NYSEARCA:NGE) and Van Eck Market vector Nigeria ETF (LGOS). Currently there are 12 African-focused ETF listed on the NYSE and more on other exchanges. Choice therefore would depend on ETF's profile and investors' needs.

An active strategy would mean one of these two things or both

· Buying American Depository Receipts (ADRs) of companies listed on the New York Stock Exchange whose majority of operations and revenues are generated from Sub Sahara Africa. Similar depository receipts (DRs) can be found in other major stocks exchanges in London, Paris-Euronext and beyond. To date there are 16 African companies listed on the NYSE. This number is slightly higher in Paris-Euronext and much higher on the London Stock Exchange with major Nigerian banks such as Zenith Bank, Guaranty Trust Bank listed cross-listed on the Nigerian and London stock exchanges.

· Direct access to local Sub Sahara African equity markets by opening a local brokerage account and placing orders with local accredited stockbrokers. This requires knowledge of the markets and legislations (taxation and other restrictions) likely to affect your returns, adjusted for FOREX, fees and commissions. Contrary to passive investment vehicles, this strategy is likely to favor large institutional, well-established investors (pension funds and the likes) looking to allocate portion of their portfolio to high growth but illiquid Sub Sahara African markets.

Next to passive and active strategies, we have created the "POA multinational SSA index" to track and continuously cover a universe of multinational companies listed on local African stock markets, as we believe they offer great value and confidence to foreign investors. Such selective approach can be viewed as a middle ground between a passive index and an active portfolio strategy.

For global portfolio managers, investing in Sub Sahara Africa is no longer an option it is a necessity!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.