High Returns—and Low Volatility?

Africa's unlikely investment proposition is opening eyes

The world's unlikeliest investment boom is still going strong, with the stock markets of sub-Saharan African nations soaring to new highs. But is it for real?

Improbable though it might seem, an equity culture has begun to flourish alongside the world's most extreme poverty. In Kenya, farmers flock to the capital of Nairobi to buy stocks. In Lagos, a new demographic has emerged: Nigerians who have brokerage accounts but no bank account. In Ghana, Ken Nana Yaw Ofori-Atta, a mutual fund manager who has delivered 48% annual gains since 2002, greets a crowd outside his office waiting with cash in hand to buy shares. Imara, a pan-African asset management firm that established the Botswana and Malawi stock exchanges, is even finding opportunity in hyperinflationary Zimbabwe, where the regime of President Robert Mugabe has wreaked havoc on the economy.

It isn't only locals who are clamoring to get in. Arlington (Va.)-based Emerging Markets Management, an institutional asset manager, has boosted its public equity position in sub-Saharan Africa from $70 million in 2001 to $1.2 billion today. Portfolio manager John R. Niepold used to struggle to get U.S. institutions to invest in his Africa strategies. Those who let him twist their arms have enjoyed 30% annual gains in the past 10 years. His phone now rings off the hook.

Of course, Africa's natural bounty—diamonds, gold, oil— is its primary draw. The Chinese, in particular, have been devouring those resources, venturing into Chad, Sudan, and other flash points of controversy to lock up supplies, no questions asked. A sudden halt either to China's run or the global commodities boom could derail the momentum.

A downturn would lay bare the incredible risks of illiquid African stocks. Nigeria's stock exchange has a total market value of only $70 billion, roughly equivalent to the size of McDonald's (MCD). One New York hedge fund manager recently tried to invest $10 million in a Côte d'Ivoire stock. Even after finding a local broker, it took six months to fill the order. By then the share price had doubled. He has little hope of selling in a panic.

Yet such risks are tempered by Africa's economic idiosyncrasies, which, counterintuitively, might be its biggest selling point. As markets become ever more closely linked, investors are scouring the globe for assets that don't move in lockstep with those in the rest of the world. Mainstream emerging markets such as Brazil and India now track 70% to 80% of the market movements of the U.S. and Western Europe, up from 50% a decade ago. Frontier Africa, in contrast, tracks just 10% of emerging market moves and even less of developed markets.

"Africa could not care less about subprime," says Charles H. Wang, co-director of research at Boston-based frontier-investing firm Acadian Asset Management. He points to Côte d'Ivoire's 14% surge in August, when global stock markets fell in unison amid a credit squeeze. Says Wang: "This kind of growth and diversification are the closest thing to a free lunch." Zachary J. Pessin, CEO of Distributed Capital Group, a New York emerging markets investment firm, notes that "in some places in Africa, you can earn double-digit yields and hedge against dollar depreciation with the same investment. This has never been possible before."

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