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By Tom Minney
25 May 2010

Enthusiasts cite Africa’s growing economic potential while bears fear capital outflows. But the biggest constraints on Africa’s equity markets are poor market infrastructure and a lack of liquidity

Africa’s stock market rally, which resumed when global risk appetite returned with a vengeance a year ago, has been cut brutally short.

African equities, once the preferred asset class of many an emerging markets investor, have underperformed relative to mainstream emerging markets: the MSCI Frontier Markets index have trailed the MSCI Emerging Markets index by 27% since March 2009.

The brakes were slammed on Africa’s stock rebound by one key factor: an overwhelming bias among investors for liquid stocks in other fast-growing emerging regions, despite Africa’s relatively rapid growth recovery.

The IMF estimates that economic growth in Africa will reach 4.7% this year and 5.9% in 2011, compared with 2.1% last year – laudable given the severity of the global downturn. In contrast, Latin America – which saw a staggering equity market rally before the Greek debt crisis ate into this year’s gains – is set to grow at 4.1%.

But investors say market technicals (the daily market dynamics that shape investor preferences) rather than fundamentals (stock valuations and the economic climate) are likely to govern Africa’s equity prospects in the years ahead.

Pioneering investor Mark Mobius, executive chairman of Templeton Asset Management, tells Emerging Markets: “African stocks now offer better value than other markets in developing economies, so we will soon see more investors increase their exposures.”

Experience counts

Antoine von Agtmael, chairman of Emerging Markets Management, which oversees up to $14 billion of stocks globally, warns: “Many mainstream investors would like to up their exposures to African stocks, but you need experience on how to deal with the [volatile] daily market conditions” and illiquid environments.

Therein lies the rub. African markets typically offer stronger returns, but mainstream investors – who count their returns in risk-adjusted terms rather than headline gains – favour more developed emerging markets that offer less risk. For example, stocks included in the MSCI Frontier Market index traded at one and a half times book value, paid a solid dividend yielding 4.2% and earned a respectable return on equity of 10.4%, according to State Street Research – and yet underperformed the MSCI Emerging Markets index.

According to the IMF, Africa’s inability to attract equity capital is not down to unattractive valuations or poor growth that eats into return on equity – but the poor liquidity. “The small size [of bourses] and lack of liquidity deters foreign investors: the exposure of foreign institutional investors is typically negligible until a market reaches about $50 billion in size or $10 billion in shares traded annually,” said the IMF in its annual World Economic Outlook for the African region, published in April.

On this basis, just Nigeria and South Africa – which ranks in the world top 20 in terms of market capitalization – fit the benchmark. Elsewhere, market liquidity is less than 10% of the value of shares actually traded each year. “Such low business volumes make it difficult to support a local market with its own trading system, market analysis, and brokers,” the IMF notes.

The number of stock markets in sub-Saharan African countries has risen from five in 1989 to only 16 today. Although stock markets on the African Stock Exchanges Association (ASEA), led by commodity-rich, heavyweight Nigeria, are surprisingly well-regulated, it’s the sheer lack of equity capital invested in the first place that weights on the outlook. The lack of foreign penetration into these markets has triggered a reliance on domestic institutional investors, such as pension and insurance funds, whose buy-and-hold portfolio strategy has strangled secondary market liquidity.

As a result, urgent measures are needed to tie up illiquid bourses either through linking exchanges, or through dual listings. Talks are taking place between African securities regulators and policy-makers on this issue, but progress has been slow.

One solution is to create regional stock exchanges. In mid-April leaders of the Nairobi, Uganda and Tanzania and Rwanda capital markets held their 16th meeting under the East African Securities Exchanges Association. The talks were under the purview of the political and economic project to create a common market, known as the East African Community.

At present, consultations are underway to deepen equity market liquidity and efficiency – but it’s not clear if and when full trading links between the bourses in the region will be established. Instead, securities regulators are concentrating on dematerialization – the conversion of share certificates into electronic securities in trading platforms – and greater harmonization.

Elsewhere in the continent, progress has been even slower. Discussions over creating a central African stock market have stalled since 1998. Meanwhile, it’s not clear if putative cooperation between West African exchanges, principally Nigeria, Ghana and potential new exchanges such as Sierra Leone, established at a December 2009 African Stock Exchanges Association summit, will materialize.

Hub and spoke

In theory, southern Africa is fertile territory for strengthening equity trading links due to the similar regulatory and business environment. The Committee of SADC (South Africa Development Committee) Stock Exchanges has endorsed a plan to create a so-called hub-and-spoke technology model to link the exchanges. This involves the channelling of orders into exchanges through nationally regulated stockbrokers and sending clearing and settlement information using the widely-used FIX financial information computer protocol.

Sunil Benimadhu, chief executive of the Stock Exchange of Mauritius, says the project could move soon with funding in the offing. “Lots of work on how to link different markets has been done from a technical standpoint. Now we need to raise the financing,” he says. He says the most important point is to “keep national exchanges as they stand and enable their members to reach the members of different exchanges.”

But competition between bourses and fears that dual listing could further constrain already weak liquidity has put the brakes on deeper integration. In 2009 the JSE created the Africa Board, which aims to dual-list some of the continent’s biggest and best companies and create more liquidity using JSE trading and other systems. But the take-up has been slow. The first listing was Namibia’s Trustco in February 2009. The second was this April, with the arrival of Wilderness Safaris, a southern African ecotourism company, which listed first in Botswana.

Geoff Musekiwa, a business development manager at the JSE, shoots down concerns that such moves fragment liquidity. “The key objective of the JSE Africa Board was to assist in the development of the other exchanges on the continent. We have looked empirically at the benefits of dual listings, particularly regarding liquidity in the home exchange in the long term,” he says.

The JSE says its own experience of leading companies listing in London and other international markets suggested that, when it comes to trading across different markets, the more the merrier.

But for now, African companies prefer to list abroad. Offshore listings make it easier to attract international investors to African business opportunities as well as developed market risk – but at the cost of reducing market capitalization in local bourses and thereby deterring foreign investment onshore. According to a MediCapital analysis of 32 actively managed African investment funds established since 2007, one-third of their allocation is devoted to Egypt and Nigeria as well as South African firms listed in the

rest of Africa. The remaining two-thirds are African stocks listed in London and North America.

Many companies with the majority of their interests in Africa list offshore through American Depositary Receipts (ADRs). Others keep their primary listing abroad, such as African Barrick Gold, which mines in Tanzania, which listed in March on the London Stock Exchange and plans a possible listing in Dar es Salaam.

For battle-hungry investors who can stomach the illiquidity, just getting a bid/offer quote on a publicly listed stock used to be torturous. Now there are signs, however tentative, that prospects are improving. International brokers such as Auerbach Grayson, Exotix, Securities Africa and Renaissance Capital are offering a single sales front to international investors, particularly institutions. Either they have their own local stockbrokers, or they link to local exchange members and share commissions. Some local brokers, including Imara Holdings, a pan-African financial services firm, are expanding into their products and services.

pulling power

For those who can navigate the daily storm, the region’s economic credentials offer compelling opportunities. As a result, fund managers seeking out new themes in an increasingly crowded emerging market space can cast Africa’s infant equity market development as indicative of its potential.

Standard Bank’s head of African equities, Matthew Pearson, says last year African markets had a mixed year and mostly underperformed their benchmark peers. “For 2010 we believe that markets in sub-Saharan Africa (excluding South Africa) will provide some of the best global equity market performances, most notably Nigeria and Ghana.” And in recent months, investors have woken up to the potential.

For example, Nigerian Stock Exchange All Share index has surged 27% this year, outperforming a 9.5% gain in the Morgan Stanley Frontier Markets index over the same period. Mobius cites abundant natural resources, a young population, and heightened interest from rich emerging market countries – together with banking reforms – as triggers for the rally. For the same reasons, he says, a sustained structural bull market for equities across the continent is a “no-brainer”.

Investors’ hottest picks include those linked to population growth – each year there are more babies in Nigeria than across the European Union, says Dexter Mahachi of stockbroker Securities Africa. Growing populations and climbing GDP per capita feed through into soaring demand for consumer goods, telecommunications and financial services, among other things.

“We have made a huge amount of money in Africa with surprisingly little volatility – this is achievable if you have a long-term horizon,” says Agtmael. This vote of confidence from Agtmael – whose term ‘emerging markets’ penetrated the investor psyche and gave birth to a flourishing asset class – bodes well for African stocks in the long term.

For now, regulators must concentrate on the decidedly unsexy legal and accounting frameworks and shoring up the equity-trading infrastructure to court new capital. Yet, while necessary, even this is probably not enough to turbo-charge foreign equity capital investment: the ultimate driver of demand for Africa stocks will lie in democratic reforms and better governance of the broader economy.

By Tom Minney
25 May 2010