3 ETFs for Investing in Africa

Includes: AFK, EZA, PMNA
by: Frank J. Constantino

Africa may be the next and final frontier in investing. With a population of about one billion people, slightly less than 15% of the world's population, Africa is full of opportunity and risk. Investors are taking notice.

The attractiveness of Africa comes from its growing middle class. According to a recent article in the Wall Street Journal, Africa's middle class has grown more than 60% to 313 million people in the last decade. These middle class Africans spend between $2 and $20 per day. Still, huge income disparities exist in the world's poorest continent.

Investors and companies are becoming well aware of the opportunities that exist in Africa. According to the same Wall Street Journal article, companies such as Wal-Mart (NYSE:WMT), Yum Brands (NYSE:YUM), Google (NASDAQ:GOOG), and Microsoft (NASDAQ:MSFT) are forging their own paths into the continent. Wal-Mart recently acquired a 51% stake in South African discount retailer, Massmart Holdings. Yum already has 600 KFC outlets in South Africa and plans to double that in the next several years. Both Microsoft and Google are funding African entrepreneurs in the technology space.

South Africa is representative of what other African countries could become. South Africa is far ahead of many of its African neighbors. Still, opportunity abounds throughout the continent. Mobile communications is one of the fastest growing industries in Africa. In 2009, Africa had an estimated 350 million mobile subscribers. That's more than the approximately 300 million subscribers in the United States.

The largest limiting factor of business investment in Africa continues to be political risk. As we witnessed in January, even nations such as Egypt are not immune to the risks. Many countries in Africa do not provide the necessary protections for business investment afforded by more developed nations. Still, Africa's growing middle class and increasingly educated population can no longer be ignored.

The easiest, and in my opinion, best way for retail investors to invest in Africa is through exchange traded funds. Investors can certainly gain some exposure to Africa through companies such as those listed above, but the percentage of their income from Africa is still very small. There are a few ETFs that offer exposure to Africa. Below are the three that, in my opinion, have the most favorable risk/reward profile.

Market Vectors Africa ETF (NYSEARCA:AFK)

The Market Vectors Africa ETF seeks to track the performance of an index called the Dow Jones Africa Titans 50 Index. This fund invests in securities of companies domiciled in Africa, primarily listed on an exchange in Africa, or that generate at least 50% of their revenue from Africa. This fund is not limited to equities, as it may also invest in derivatives such as options, futures, swaps, warrants, currency forwards and participation notes. The fund was established by Van Eck in July 2008. AFK is down 20% since inception, but one must consider that this was immediately prior to the global market meltdown.

AFK has assets of $115 million. Shares are thinly traded at times with an average of less than 9,000 per day. Limit orders are a must when buying a fund such as this. Van Eck charges an expense ratio of 0.78% for AFK. The fund has a distribution yield of 1.13% and distributions are paid annually.

Currently AFK holds 44 securities. The top countries represented are:

Country % of Holdings
South Africa 27.97%
Nigeria 22.64%
Egypt 19.29%
Morocco 14.11%
Kuwait 5.19%
Australia 3.14%
Mali 2.53%
Kenya 1.93%
Luxembourg 1.62%
Canada 1.01%

Top Ten Holdings

Name % of Assets
Nigerian Breweries PLC 5.93%
Attijariwafa Bank 5.63%
Mobile Telecommunication Co 5.19%
First Bank of Nigeria 4.73%
Commercial International Bank Ltd 4.61%
Zenith Bank PLC 4.59%
Maroc Telecom 4.55%
Orascom Construction 4.52%
Guarnaty Trust Bank PLC 4.24%
Sasol, Ltd (OTCPK:SASOF) 3.68%
Top Ten % of Portfolio 47.67%

PowerShares MENA Frontier Countries Portfolio (NASDAQ:PMNA)

The PowerShares MENA Frontier Countries Portfolio seeks to track an index called the NASDAQ OMX Middle East North Africa Index. The fund invests at least 80% of its assets in securities of companies that are domiciled or principally traded in a Middle East or North Africa frontier country. PMNA was established in July 2008 and is down 51% since inception. The fund was hit hard during 2008, and has traded in a relatively flat range since.

PMNA has assets of only $27 million. Its shares are also thinly traded, about 21,000 per day. PowerShares charges an expense ratio of 0.70% for PMNA. The fund has a distribution yield of 1.93% and now pays distributions quarterly.

Currently PMNA holds 45 securities. The countries represented are:

Country % of Holdings
Qatar 20.36%
Kuwait 19.52%
Egypt 19.35%
United Arab Emirates 17.61%
Morocco 9.82%
Jordan 7.43%
Oman 3.23%
Lebanon 2.67%

Top Ten Holdings

Name % of Assets
National Bank of Kuwait 7.70%
Arab Bank 7.43%
Qatar National Bank 6.17%
Mobile Telecommunication Co 6.01%
Emaar Properties 5.95%
Orascom Construction 5.15%
Maroc Telecom 4.69%
Commercial International Bank Ltd 4.40%
National Bank of Abu Dhabi 3.62%
DP World Ltd 3.11%
Top Ten % of Portfolio 54.23%

iShares MSCI South Africa Index Fund (NYSEARCA:EZA)

Investors wanting to "play it safe" in Africa may want to consider the iShares MSCI South Africa Index Fund. This fund seeks to track the performance of an index called the MSCI South Africa Index. The fund invests at least 90% of assets in securities or depository receipts of companies that are primarily traded on the Johannesburg Stock Exchange.

By investing in EZA investors may remove some of the political risk associated with much of Africa. The fund was established in February 2003. EZA is up 24% over the last five years.

EZA has assets of $660 million. It is very liquid, trading about 385,000 shares per day. The expense ratio is 0.61%. EZA has a distribution yield of 2.3% and pays distributions semi-annually. EZA currently holds 50 mostly large cap securities.

Top Ten Holdings

Name % of Assets
MTN Group Limited (OTCPK:MTNOY) 11.45%
Sasol, Ltd (OTCPK:SASOF) 11.17%
Naspers Ltd. 6.94%
AngloGold Ashanti Limited (OTCPK:AULGF) 6.12%
Standard Bank Group Ltd (OTCPK:SBGOF) 6.11%
Impala Platinum Holdings 4.89%
Gold Fields Limited 4.22%
Firstrand Limited 2.80%
Sanlam Limited 2.58%
Remgro Ltd. 2.38%
Top Ten % of Portfolio 58.66%

Each of these Africa funds offer something different for investors. All three of them are substantially invested in Africa, with EZA being invested in more developed South Africa. The chart below compares the one year performance of all three funds.

Investors must always keep in mind that investing in Africa is risky. There are plenty of opportunities, but the risks make it very hard to pick individual stocks. Using an ETF is beneficial to diversify an investment in Africa. Even when investing through an ETF, most investors should allocate no more than 2% of a balanced portfolio to Africa, especially the frontier countries. Unless you have a high risk tolerance, EZA may be your best bet.

Disclosure: I am long YUM.