December 28, 2012
Does Sub-Saharan Africa Deserve A Slice Of Your Portfolio?
"One of the most remarkable features of the global economy over the past fifteen years has been the striking surge of economic growth over much of sub-Saharan Africa," Charles Collyns, assistant secretary for international finance at the US Treasury, advised earlier this month. We've heard this story before, of course, only to discover that the investment results fell short of the headlines. Is it different this time? Possibly. For some perspective, let's spin a few numbers and take a look at an ETF that focuses on investing in the stock markets in this neck of the world.
The economies that comprise Sub-Saharan Africa are expected to post aggregate real GDP growth of 5.3% next year, according to IMF projections. That looks pretty good compared with the U.S., which will see real GDP rise by just 2.1% in 2013, the IMF predicts. China will do much better, with an expected GDP increase of 8.2%. As for the actual growth rates in the recent past, Sub-Saharan Africa's GDP expanded 5.2% last year vs. China's 9.2% rise. Both gains compare favorably with the meager 1.8% increase for the US in 2011.
"Economic conditions in sub-Saharan Africa have remained generally robust against the backdrop of a sluggish global economy," the IMF noted in its October outlook for the region. Not surprisingly, there's a wide variety of conditions within individual nations:
Most low-income countries continue to grow, although drought in many Sahel countries and political instability in Mali and Guinea-Bissau have undermined economic activity. The situation is less favorable for many of the middle-income countries, especially South Africa, that are more closely linked to European markets. Inflation has been slowing, as pressures on food and fuel prices eased following a surge during 2011. The easing of inflation has been particularly noticeable in eastern Africa, helped by monetary tightening.
How does all this translate for equity returns in the region? As a benchmark for performance, consider a Sub-Shaharan Africa ETF: Market Vectors Africa Index ETF (AFK). By several yardsticks, it boasts an impressive track record. Consider how trailing 1- and 3-year returns compare:
Matched against emerging markets generally, AFK has had a good run over the past 12 months. For the year through yesterday, Market Vectors Africa is up a strong 18.5%. That beats equities from many corners of the world, although it's been a good year for stocks generally and so return spreads aren't terribly wide. In fact, European stocks are clearly in the lead for the past 12 months--the euro crisis be damned.
The question is whether Africa's equity markets have finally come of age to the extent that they deserve a dedicated slot in your asset allocation? Possibly, but I'm not yet convinced. You can already juice rebalancing opportunities by breaking foreign equity exposure into several pieces before targeting Africa separately. Does slicing up the foreign stock beta into finer pieces beyond the usual buckets--Europe vs. Asia or developed vs. emerging, for instance—further enhance expected return and offer more control for managing risk?
Definitive answers must remain a gray area, thanks to the standard nemesis: an uncertain future. But as the Sub-Saharan GDP table above suggests, the region has a track record of growth in recent history, and so the projections for more of the same ring a bit truer these days. It doesn't hurt that there's a wider selection of investment products targeting Africa these days, of which AFK is only one. (See ETFdb's Africa ETF guide, for instance.)
Yes, many of Africa's nations are among the more hazardous spots in the world from a geopolitical standpoint. But macro success, such as it is, attracts a crowd and so it's getting easier to rationalize carving out a dedicated allocation to stocks in Sub-Saharan Africa.
Update: An earlier version of this story mislabled the years for GDP growth rates in the 2nd paragraph. The corrections now appear.
Posted by jp at December 28, 2012 11:44 AM
Here's a quick answer to your question, based on rolling 1-day and 30-day percentage price changes for AFK and VWO (Vanguard MSCI Emerging Markets) for the past four years. The correlation for the two ETFs for 1-day returns is 0.62, and modestly higher for 30-day returns: 0.88. In short, AFK exhibits a degree of independence from emerging market stocks generally. It's not a lot, but equities are still equities and so it's not surprising that the two are generally correlated.
In fact, any two broad equity indexes are going to be tightly correlated through time, albeit in varying degrees. Nonetheless, the case for breaking up one's portfolio into multiple parts is still a good idea, up to a point, for rebalancing purposes. That said, it's still debatable if AFK adds value on a strategic level vs. dividing up the foreign allocation in the usual way: developed vs. emerging, or by regions (Europe vs. Asia, for instance).
Posted by: JP at December 29, 2012 7:35 AM
Could you please address correlation between AFK and developed market broad index ETFs such as VOO and VEA? In your opinion, is there sufficiently low correlation to warrant the 107 bps gross expense ratio of AFK relative to the 10-20 bps gross expense ratio of developed market ETFs?
Posted by: M at December 28, 2012 2:25 PM