AXIOM Africa – optimized investment portfolio construction

Africa: The Rise of a Giant

Africa is rapidly affirming itself as a global power of the 21st century. Home to 1.2 billion women and men, spread across 54 countries and rich in cultural history, the proverbial “cradle of Humanity” is constantly and reliably imposing itself as a land of opportunity.

Over the last decade, African countries have undergone a remarkable shift towards digitalization. This technological revolution has set the stage for a new era of development on the African continent. A high adoption rate and quasi-seamless socio-economic adaptation to new technologies has transformed Africa into a hotbed for current and future global leaders: pioneers in the fields of digital payment, e-commerce, e-healthcare and other high value-added sectors. It is therefore natural to see tech giants such as Google investing in African start-ups.

A Middle-class Emerges Amidst the Technological Revolution

To prepare for this historical challenge, the continent has been bridging its infrastructure gap by investing more than USD80 billion per year since the early 2000s. The information technology sector has been the main beneficiary of this regional development because of the tremendous growth it has experienced in recent years. The Industry 4.0 revolution is indeed proving to be the keystone of Africa’s investment potential.

City skyline under blue sky

Image Caption: Household consumption expected to grow 3.8% annually through 2025 to reach $2.1 trillion

MCKINSEY GLOBAL INSTITUTE

There are 5 distinct blocks on the continent which have common trading partners, and which share homogeneous socio-economic dynamics. Over the next few decades, the African continent is projected to be the epicenter of an unprecedented global demographic boom. This evidently means an increase in consumer activity. According to the United Nations Population Division (Economic and Social Affairs department), more than half of global population growth between now and 2050 is expected to occur in Africa. According to these forecasts, the African continent will be the stage of an urbanization similar to the one observed during the previous industrial revolution.

In 2018, 8.6% of Sub-Saharan Africa’s GDP was created by mobile technologies and services. This trend is expected to increase in the near future, as the number of users are forecasted to double from 239 million to 483 million by 2025.

South Africa, Nigeria, Egypt and Kenya are success stories that convincingly demonstrate the possibility of a Pan-African economic shift. If policymakers and investors take appropriate actions, other African nations should follow suit.

The Traditional Challenges of Investing in Africa 

A recurrent burden weighing on Africa remains the inefficiency of its domestic stock markets. There is also an extreme difficulty in understanding the risks and dynamics of African macroeconomics, public & institutional policies, and monetary strategies. That being said, fundamental analyses can be generated by regional companies to establish investment opportunities over time (over full economic cycles). Such analyses can also help to highlight sectoral dynamics, and are essential to enable fact-based decisions and ultimately generate value.

This two-pronged approach allows investors to capture the essence of African equities, with the knowledge that:

  • Opportunity: Different risk/reward profiles in African markets provide opportunities for active investors.
  • Liquidity: Nearly 80% of African stocks trade at less than USD 100,000 per day.
  • Diversification: The weak integration of African markets into global markets implies low levels of correlation to other asset classes, which is favorable to diversification.
  • Local Growth: Yield factors are anchored at the national level and can be easily diversified across Africa, a heterogeneous continent made up of 54 different countries.

AXIOM Africa: Portfolio construction, a keystone for extracting added-value

African equities represent an attractive solution for long-term investors. Especially those who seek exposure to the demographic dynamics and transformational changes taking place in the region. In our view, locally rooted national companies are better equipped to meet the needs of African middle-class consumers. It is evidently essential to carefully assess different risk sources, such as currency risk, and country risk, at each level of the investment. The portfolio construction process serves as a framework for managing exposure to country risks. It aims to identify optimal distribution between the various sources and risk factors that will have been measured and identified beforehand.

At AXYS, dedicated research has enabled us to design a robust quantitative model for AXIOM Africa. A salient goal of this quantitative model is the proper management of these risks. Our proprietary model is based on historical data, and is designed to define a well-balanced country allocation in a way that each country contributes the same level of overall portfolio risk.

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