How to Play Africa: One ETF Banks on GDP
Africa is full of both potential and turmoil. One day the International Monetary Fund forecasts that African economies will grow 5.7 percent on average this year; the next day there is a military coup in Egypt.
The Market Vectors Africa Index ETF (AFK) mirrors this volatility. The exchange-traded fund, which has a 3.7 percent yield, is up 6.7 percent in the past year, and down 8.3 percent year to date through mid-June. Since then, in less than a month, it has surged 10 percent.
AFK, the most actively traded Africa ETF, recently moved to weight holdings based on the gross domestic product of the countries it tracks -- the first ETF ever to use that approach.
The vast majority of ETFs that focus on foreign countries and regions are weighted by market capitalization. They give the most weight to companies with the greatest market cap as measured by the share price multiplied by the number of outstanding shares. Market-cap weighting captures only the shares outstanding that are freely traded, excluding shares owned by insiders or the government.
That can tilt the ETF toward a region's most developed capital markets, leaving smaller, more emerging countries and companies out of the equation regardless of their economic contribution. That's the argument for weighting by GDP.
One argument against GDP weighting is that it rewards past achievement, as GDP is reported quarterly and often revised. In addition, including companies with larger insider or government ownership increases the potential for manipulation or corruption.
Still, moving to a GDP-weighted index has made AFK a deeper, wider fund. The total number of stocks in the portfolio has risen from 50 to 108 and led to three big shifts in its allocations.
Egypt leapfrogged from a 15 percent to a 25 percent weighting, the maximum the fund allows for any country. The move came with perfect timing -- Egypt’s stock market has rallied 18.4 percent since the change took place on June 22.
The switch in weighting strategy meant that Egypt took some of the ground in the portfolio previously held by Nigeria, which went from a 25 percent weighting to a 13 percent weighting. South Africa, Morocco and Kenya stayed the same, at 25 percent, 9 percent and 1 percent, respectively.
The ETF's small-cap exposure more than doubled from nine percent to 20 percent; exposure to large-cap stocks fell from 56 percent to 45 percent. This is because the index, after figuring out its country allocation based on GDP, has had to go further down the market-cap scale to find companies to fulfill that allocation.
A good portion of the increased small-cap exposure is from smaller countries such as Sierra Leone, Zambia, Mozambique and Tanzania. Getting exposure to these countries is so difficult that the ETF does it though a back-door move. It adds companies that get a majority of their revenue from those countries but that are themselves based in developed countries including the U.K., Canada, Australia, Singapore and the U.S.
One example of this is IAMGOLD Corporation (IMG), a Canadian mid-tier gold-mining company. It gets approximately 50 percent of its revenue from Burkina Faso and Mali, two of Africa’s biggest gold producers.
The move to GDP weighting also trimmed the fund's exposure to financial sector stocks from 48 percent to 36 percent. Having one sector make up half of an ETF can be risky. The move helps spread out the exposure to different industries, including energy, materials and industrials, which all bumped up their weightings in the fund by about 3 percent.
Investors nervous about perceived volatility may find risk mitigated somewhat by the fact that Africa's stock markets don't all move in lockstep. So far this year, AFK's South African stocks are down 15 percent, while its Kenya and Nigeria stock holdings are up 47 percent and 22 percent, respectively. By casting a net over the entire continent via AFK, single-country volatility is cut nearly in half.
AFK has $95 million in assets; $17 million of net new cash came in this year. The ETF trades 52,300 shares a day and has an average 52-week premium of 0.31 percent -- meaning that on average the trade price is slightly above the fund’s net asset value, or fair value. AFK's expense ratio is 0.78, so for every $10,000 invested, investors pay $78 in fees per year.