Africa: A Remote yet Viable Frontier for Adventurous Investors


The continent of Africa conjures up images of jungle safaris with lions and elephants racing across the plains. Few know that South Africa is home to a stock exchange that has been domesticated for more than 150 years or that Malawi has special tax treatment for dividends. Africa is a remote yet viable frontier for adventurous investors.

Robert Scharar, 65, serves as the senior portfolio manager of Commonwealth Africa Fund (CAFRX) and all  five mutual funds from Commonwealth Funds. Before that he worked for 31 years as president and CEO of FCA Corp Financial Planning Firm. He earned a master’s in business administration and a juris doctor degree from Northeastern University.

He explains the potential and risks of investing in the continent.

GLV: What is your outlook on investing in Africa?

Scharar: We forecast the South African economy to expand 4% to 5% in 2016 and 2017. It will be driven by the startup of new transportation infrastructure and power plants and increased regional trade.  Other African economies are projected to see similar economic improvement rates.

GLV: You say Africa is one of the biggest bargains out there.  What metrics is that based on?

Scharar: The JSE (Johannesburg Stock Exchange) is undervalued, trading at a price-to-earnings ratio of 18 with a 2.70% dividend yield.

For US investors, last year’s decline in most African currencies versus the dollars makes many African stocks cheap on a relative basis. The South African rand has not been this cheap to the greenback (10.70 ZAR = 1 USD) since 2008.  In the past six-months, rand has depreciated 8.4%. 

Sharp declines in many emerging market currencies is likely to give them boost they need to stimulate growth as it makes their exports cheaper to other countries. Stronger demand in developed countries will also add to the export-drive stimulus that has been dampened in recent years.

GLV: How does it compare to other regions’ valuations and its historic valuations?

Scharar: Africa’s equity markets traded much more closely with developed markets than emerging markets during 2013.  Despite valuations looking reasonably stretched, we suspect there is further reasonable upside likely in 2014.

The Dow Jones African Titans 50 Index (“DJAFK”) is trading on a forward price-to-earnings ratio of 12.6 versus its five-year average of 18.6.

GLV: Africa is a very remote yet viable frontier for adventurous investors. How you go about finding companies to invest in?

Scharar: We have two basic approaches. We start with an idea and find a company that embodies that idea or run financial screens that produce ‘on paper’ prospects of companies to invest in.  Our screens typically look at financial metrics such as earnings, cash flow, dividend, growth prospects and shareholder equity.

We supplement our analytics with on-site visits and direct communications with companies and people in Africa to validate our underlying thesis. We draw on our extensive network of contacts built over 20 years to validate our assumptions and strategies. It also gives us the locals’ perception of the company’s image, products and services.

Most U.S. investors would be limited to American Depositary Receipts, or ADRs, and exchange traded funds, or ETFs, traded in the United States.  We believe a portfolio should be constructed to include companies whose shares trade only on the African stock exchanges in order to get the benefit of a concentrated African exposure.

GLV: What is your investing strategy there?

Scharar: We try to buy companies that serve the African consumer markets, have a pan-African focus and/or move information, goods or people. We have tended to under-weight the resource sector as there are numerous non-Africa opportunities to gain that exposure.

GLV: What should investors know about doing business and investing in Africa?

Scharar: It is a continent, not a country. There are vast differences in politics, cultures and opportunities. Countries with functioning stock exchanges by definition must be more open to economic freedom.

Africa has 60% of the world’s uncultivated arable land, 15% of the world’s population and 10% of the world’s fresh water resources. The African consumer is seeking better education, health services and an improved standard of living and is willing to pay for quality.

Access to quality professional services like accounting is available and similar to the US although most companies use International Financial Reporting Standards, not US GAAP (generally accepted accounting principles). Legal services are available but the application of the law may differ from what you are used to.

Excessive and bureaucratic government regulation still hampers growth but conditions are improving. Inter-country commerce barriers are dropping, especially among regional areas. Building good relationships is key to engaging in direct business undertakings.  Don’t underestimate the competency of local businesses competing on their home turf.

GLV: What risks must investors consider?

Scharar: There are many exchanges in Africa. They differ greatly in size, substance and scope. For example, the JSE has been around since 1887. It is fairly liquid and transparent. Other markets can trade only by appointment, have complicated local rules, large currency exchange/trading costs and little information.  Some practical considerations and risks would include:

1. Currency fluctuations, and cost of converting to local currency
2. Delays in trade settlement and repatriating money
3. Income tax imposed by the local country
4. Financial reports not translated into English
5. Significant time zone differences, so business hours don’t coincide with the US
6. Generally higher trading costs versus the US

The Commonwealth Africa fund has $2.2 million in assets under management. It has 3% year to date and in the past year, according to Morningstar. By comparison, the MSCI Africa Index, a measure of the continent’s stock market performance, fell 9% year to date and 1% in the past year. It has returned 12%, 15% and 6% annualized over the past three, five and 10 years. Africa is indeed a remote yet viable and profitable frontier for adventurous, long-term investors.

By Trang Ho

Commonwealth Funds
Johannesburg Stock Exchange

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