Tuesday, October 17

Africa!?

A friend of mine likes to throw out interesting ideas from time to time. Lately he asked me about stocks in Africa.

His thesis: Africa is mineral/commodity-rich and a number of countries have signed important trade agreements with China.

My views:

Similar to all other investments, there are pros and cons:

Pros

  • Rising with commodity prices: countries such as South Africa has experienced a big rally, thanks to both the increase in gold prices and the appreciation of its currency. This is true for 2004 and 2005, but not 2006. See "Cons" section below.
  • A good way to diversify: the stock performace in South Africa, for example, is not correlated to other emerging markets, which is attractive in reducing the risk in the overall emerging market portfolio.

Cons

  • Not for average Joe: The stock markets, if available to foreigners, are very illiquid. This usually means the markets are volatile and you may have a hard time getting out of the positions. In fact, for a normal guy, South Africa is the only option.
  • Roller-coaster currency: The South African currency fell 40% against the US dollar in late 2001, then fully recovered within 24 months. It continued its big upswing in 2004 and 2005, only to fall back (closer) to earth in 2006. The swing in currency significantly affects the investment return. For example, South Africa's stock market year-to-date return is 24% in local dollars, but -1.4% in US dollars.
  • Commodity -- old news? The commodity story has been going on for a few years and some people question if the upward trend is going to continue. In fact, YTD returns for Egypt is 0.8%, a significant drop from the 3-digit returns for the last year or so. (You can learn more about Commodities, an important asset class, by reading Jim Roger's Hot Commodies listed under my recommended book list)

Conclusion

  • We can have a small position (pick the most traded, liquid product -- see below) for the sake of diversity. Other than that, I would save the opportunity to those who have deep understanding of the local economy.

Available Products

  • South Africa is basically the only option.
  • ETF: The easiest way to buy into this market is through ETF (exchange traded funds), which is as simple as buying US stocks. Ticker: EZA
  • Mutual funds: I have not looked into the details, but Southern Africa Fund Inc (SOA) and Southern Africa Fund Inc (XSOAX) are two options.
  • Structured coupon: this is mostly available to private banking clients only. If you would like to have exposure to Africa economic growth through the appreciation of their currencies, you can ask your banker if they can structure a US-dollar coupon that captures the appreciation. For example, if the currency goes up within a certain period, you get the USD equivalent coupon at par (which captures the currency appreciation) plus the coupon interest (usually pretty high for emerging markets, e.g. 5-10+% because of the high deposit rate there). Obviously, if the currency goes the other way, you will be given the currency itself and have to wait until it appreciates again. Therefore, confidence in the underlying currency/country is crucial. In any case you still get the interest which acts as a good cushion.

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