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By Todd Micklethwaite*
The story of Africa’s growth potential is brought to life by 1.2 billion inhabitants and an urban population estimated to increase by 24 million people annually. Yet many local retirement funds have been slow to allocate to African countries outside of South Africa. But, with listed South African assets no longer offering attractive returns and with a better understanding of how best to implement strategies on the broader continent, there’s a case for retirement funds to reallocate a portion of their traditional South African growth assets to pan-African mandates – a move encouraged by Regulation 28.
Learning from the past
While few funds have fully embraced the limits allowed by the regulations, a number have tread the path to some degree before. A number of key themes have been evident in cases where investors have struggled to earn the returns they expected. The first is that African frontier stock markets have exhibited elevated volatility, as they are often driven more by the whims of impatient and skittish foreign retail investors than by underlying economic growth. The second arises from private equity investors buying into what they believe is the next African entrepreneur success story, only to find it more challenging to positively affect businesses and to exit investments than in more developed markets. Finally, local economies have found it difficult to weather currency volatility in areas where they are reliant on foreign investment. Real estate funds, for example, have felt the impact of the limited foreign exchange risk that tenants are able to bear before their ability to trade and meet their rental obligations is hampered.
Latest approaches to Africa
The accumulated experiences of investors in Africa are helping to shape the market such that investors are now better equipped with adapted models, local knowledge and tested expertise to benefit from Africa’s growth than ever before.
Skilled asset managers who have “paid their school fees” over the years and understand the idiosyncrasies of the various listed markets are better positioned to deliver value for investors. These managers recognise the need to cap the size of their funds to enable them to most effectively capture performance from the limited nature of frontier market stock exchanges. They also manage funds with liquidity limits in place, in order to protect investors from the volatility resulting from significant withdrawals by other investors (historically a big factor in the destruction of value).
Certain markets have developed to the extent that high quality private market assets can be aggregated to a sufficiently diversified degree. Regulators are supporting private market structures which allow more flexibility for local and foreign investors to access assets. Fund managers have innovated to offer flexible regional and pan-African platforms and collaborated with local specialist partners to manage assets in-country. They have also recognised that, for certain asset classes such as real estate, additional income can be gained through various value-adding initiatives rather than purely through greenfield or brownfield development.
Additional benefits of allocating to Africa
Besides the wider opportunity set, geographic diversification and attractive growth narrative, a significant benefit of allocating to Africa is that retirement funds are able to gain an additional 10% US Dollar exposure (beyond the 30% which Regulation 28 allows to global assets).
Using the regulatory Africa allowance to reallocate between interest-bearing assets (as opposed to growth assets) is also gaining traction. In particular, African private credit (senior, secured credit) is a good fit for institutional portfolios and it’s not difficult to see why when considering:
- the stability of returns from the regular, contractual cash flows;
- the fact that loans are self-liquidating through contractual exits (with invested capital typically being repaid from the first year); and
- protection in the form of security and seniority in repayment order.
African senior secured private credit has consistently delivered 8-10% in US Dollar terms, with volatility for South African investors almost entirely a function of the USD/ZAR exchange rate. Including African private credit in a portfolio increases the expected return of the portfolio for a given level of risk, irrespective of the overall target return.
A commitment to Africa
As a constituent of Africa, it is important for us to remember that uplifting the economies across the continent indirectly benefits South Africa, developing the overarching financial ecosystem of which we form part. Investing in Africa enables growth and economic development that is much needed across the continent and, when carefully considered in an investor’s portfolio, can offer strong returns with significant diversification benefits.
- Todd Micklethwaite is head of Distribution: Alternatives at Sanlam Investments.
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