Thursday, October 28, 2010

Don't Present Investment Dreams Sounding Like a Dreamer: The Case of Africa



LMG totally supports the view that Africa will be a continent of investment opportunities the next 3-5 years. But it will just be a niche in your investment portfolio. Why? Simply, because the Africa stock markets combined are still small in size. To give you an idea: in the article it is mentioned that total allocation to investment funds specializing in the region was about USD 1.4 billion. This morning we also heard here in the Netherlands that the quarterly profit of Royal Dutch Shell was Euro 3.2 billion. That gives you an idea. True, part of the low number is indicative of the market not being discovered yet. But beware: don't rush in, or you will experience an investment version of the tragic accident that happened in Kenya last week when people tried to get into a football stadium. 


African Opportunities? For Sure! But be Realistic!


And about 2/3rds of the continent's combined market cap is in South Africa and that is already a more established market and therefore probably not the one where you can score most points during that window of opportunity of 3-5 years.

The attached 2-pager is in and of itself a reasonable piece about these chances. But as so often, it is written by communication specialists and they often believe that selling investments is mainly about selling and not about investments. But experience in the institutional investment world, teaches us that this is not correct. When I am allocating to a region or a financial product, tell me about its merits and risks in an objective manner. If not, I will simply look but don't allocate or allocate to other markets or products that inform me better.

There are a few aspects of the piece that we do not really like that much and we will tell you why, since it is a useful exercise for investors in oh so many products..


Investors should always be warned about risks. And the main risks in African investments for international investors are probably: 1) Political risk; 2) Size; and 3) Liquidity risk.

The markets are small, and therefore explain to investors that this is interesting but never more than a niche in your portfolio unless you are a speculator or a direct investor who is buying firms or firm components in the continent with the idea of becoming an Africa specialist.

Liquidity is an issue, but investors who want to have Africa in the portfolio and are with you when it comes to finding opportunities here, are not allocating to your continent for liquidity sake. So: when making your case, don't destroy it yourself by then ending your enthusiastic story by saying that South Africa as liquid market has the best opportunities. Best? Best for you probably in that it will limit your own downside as a writer in case you turn out to be wrong!

When it is about a 'dream', make sure you don't sound like a dreamer. In this piece there is a reference about the South African and Mauritius stock exchange winning prizes for being the 'best regulated' and 'most innovative' exchanges on a global scale.


Look, these kind of parties/seminars/events - and we have been to many of them - are mainly just that. Parties where people from within the industry meet and help each other and either - so as to stimulate less fortunate colleagues - award prizes with nice compliments to the laggards, or - even worse - prizes can be 'bought' by sponsors.

What is the use of telling us that South Africa and Mauritius win prizes in the major league of international exchanges for regulation and innovation? This is 'evidence' of the type: 'even if we see it we won't believe it'. It will just make the big investors who invest everywhere across the globe smile. So your enthusiasm about the dream is making you sound like a dreamer! Don't do that. It is not necessary: again, investors who are looking for opportunities in Africa know that it is a politically risky environment, that this is the continent where corruption is still a problem etc. Give realistic information, since what it is in the end all about is the RETURN/RISK ratio. And that profile - in combination with relatively low correlation with the rest of the world (which will increase the diversification value of Africa within your portfolio) - is what Africa is about.

Yes it is true that information is scarce in Africa. You can learn more about let's say Apple or Google or IBM alone than over all African stocks combined these days. But what does that mean? That Africa investments will be a window of opportunity for the informed. That the markets are less efficient and that the relative value of an information advantage is larger than elsewhere on the globe. Success and failure in markets is not about the AMOUNT of information, it is about the DIFFERENTIAL INFORMATION that you have as investor.


The only correct conclusion can be that we as outsiders at a distance are less likely to be insiders in such a setting and/or are capable of running a top-down, distant strategy that allows us to create a good portfolio. This is a market where you have to appoint a specialist if you would not want to get caught by your own ignorance in this barren information landscape.

Therefore: Africa investment opportunities? Yes, but only via specialist funds. And, because of the lack of information, be ready for a bumpy and volatile ride. No quick trading, but sit still and be shaven at times but with the goal of capturing the longer-run excess return in 3-5 years. Yep, almost like how you look at private equity investments in the Western world.

A good piece of information should therefore protect the investor by making sure they understand that this is a market in which to operate via the adviser. So you shouldn't even stress to opt for investing in the most liquid stock market. No: give an overview of good advisers!

Subtle piece of information in the article: have you looked at the relative size of the markets on the one hand (South Africa is 2 times bigger than the rest combined) and turnover on the other? The turnover difference is much smaller (!!) than the size difference. Waw: that means that the most liquid market has relatively less turnover than the illiquid ones. That is the ultimate way of showing that this is not for the faint-hearted.

It is this kind of pieces that might look typical Africa. But unfortunately 9 out of 10 asset managers are also presenting their private client products in a similar way. And it is not until we - time and again - try to unravel the 'subtle information mistakes, flaws, misinterpretations etc that investors will finally get information about opportunities in a way they deserve.


But don't get us wrong: we do agree that Africa will be one of the better markets the next 3-5 years. Just don't try DIY. And for the skeptics who think LMG is selling some fund: nope, we don't run an Africa fund. We just help our client's (European institutional investors and family offices) find the best funds and allocate proper amounts to various regions in the world.


Click here for the Piece on Africa that presented the 'dream' in a somewhat incorrect fashion.


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