Investors should follow Africa’s diaspora in search of profits

Over the past two years, Africa has been in the news for all the wrong reasons sadly, not an unusual situation for the continent.The ongoing fight against the terrorist group Boko Haram continues in Nigeria (and more than 200 girls remain missing). Last year's Ebola outbreak claimed more than 11,000 lives before it was brought under control and there are still reports of ongoing mini-outbreaks in Liberia. What's more, economic logic suggests that the collapse we've seen in both energy prices and commodities in general this year and last will devastate economies dominated by mining and oil production.

Yet despite the gloom, Africa remains one of the most exciting regions in the world today one that you should be invested in. The continent's rapid growth, both in terms of the economy and the population, is one attraction over the past 15 years the economy has grown by around 5% a year, meaning that total GDP has roughly doubled, and with an ever-growing, youthful population, that's likely to continue.

But more importantly, life in the continent at large is improving rapidly. New drugs have helped bring the Aids epidemic under control and the number of wars has fallen, so that life expectancy has risen steadily from 50 years in 2000 to nearly 60 today. Indeed, in Botswana, it has shot up by 17 years in just over a decade.

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Lifting the commodity curse

Traditionally, Africa has been associated with commodities. The continent is endowed with substantial natural resources. Half of the world's diamonds come from Africa. There are large reserves of coal, iron, bauxite and other metals. As for oil, Nigeria and Angola produce around 5% of the global supply between them more than Iran.

These natural resources should have made the continent rich. Instead,they've held development back. The biggest problem is that corrupt leaders in many African nations sold access to natural resources to mining and oil companies at well below their market cost, in return for bribes, which were spent on building up large militaries to secure their grip on power, rather than funding infrastructure development.

Meanwhile, insurgent groups and local warlords used their control of various resources to fund economically devastating conflicts. The most obvious example is the diamond industry, which has seen a high-profile crackdown on "blood diamonds" (or conflict diamonds) in recent years. But many other minerals have played a similar role.

Natural resources crowded out development in more conventional ways too. During the commodity boom of the 1970s and early 1980s, Africa (and Latin America) borrowed huge sums of money from banks against future revenues that failed to materialise, as commodity prices crashed during the mid-1980s and 1990s. The debts quickly became unsustainable and Africa was forced to go through a long debt restructuring process that involved austerity programmes and cuts to investment in vital infrastructure. Countries also suffered from "Dutch Disease" whereby demand for commodities pushed up domestic currencies, making it hard for exporters of other goods and services to compete.

Getting its house in order

However, in the past decade Africa has begun to get its house in order. Thanks to international and domestic pressure, there has been a major crackdown on corruption and efforts to increase financial transparency. The US and other countries have helped matters by stepping up prosecutions of their own firms for corrupt practices abroad. This has led to better deals being negotiated, meaning a greater proportion of resources revenue remains in Africa. Mining and energy companies have also been persuaded to invest in processing and refining facilities close to the mines and oil wells, increasing the amount of value added.

At the same time, there has been a conscious effort to diversify Africa's development away from energy and minerals. With wages rising fast in many Asian countries, several companies are looking to shift the production of low-cost, labour-intensive goods to Africa. China has been at the forefront of this process Africa is now the destination for 15% of Chinese-led foreign direct investment. South Africa, with its relatively skilled workforce, has received a large chunk of this, but Ethiopiaand Rwanda have also benefited.Indian and Turkish firms are also big investors in Africa.

Domestic investment, fuelled by African entrepreneurs, is improving too. Kenya is even developing its own fledgling technology sector. An estimated $650m has been raised by Kenyan start-ups looking to exploit the rapid rise in the use of the internet and mobile phones.

The best-known technological innovation is the branchless banking service M-Pesa, which we've covered a number of times in MoneyWeek. Launched in 2007 by Kenyan mobile-phone operator Safaricom (which is part-owned by Vodafone), it now has more than 15 million users and operates in ten countries, including Romania. In a sign of Kenya's increasing technological sophistication, several rival services are now up and running.

As a result of all this, the decline in the commodities sector has been offset by a surge in the development of services, construction and manufacturing sectors the "commodities curse" is starting to lift, and there has been rapid growth in the size of Africa's middle class. A now famous 2010 estimate by the African Development Bank (ADB) suggested that around a third of Africans (nearly 350 million people) now earn between $2 and $20 a day. Deloitte estimates that this should rise to 500 million by 2030.

This claim has been criticised for defining the middle class too widely, and even the ADB acknowledges that most of the people it defined as middle-income were "barely out of the poor category". There's no doubt that the majority of Africans live lives that are nowhere close to being middle class in the Western sense, and as news website Quartz points out, in several countries "virtually the entire population is poor or low-income". Food giant Nestl recently decided to cut back its workforce in sub-Saharan Africa, although it's also insisted that its long-term commitment to Africa remains solid.

However, many other studies suggest that the direction of travel remains positive. A study last year by Simon Freemantle of Standard Bank looked at 11 key countries (Angola, Ethiopia, Ghana, Kenya, Mozambique, Nigeria, South Sudan, Sudan, Tanzania, Uganda and Zambia) and found that the number of people earning at least $15 a day ($5,500 a year) had tripled from around 4.5 million in 2000 to 15 million in 2014. Around half of these earned at least $8,500 a year. Freemantle also predicts that the wider middle class in those countries will keep expanding, hitting 40 million by 2030, with 20 million of these earning more than $8,500.

The ranks of the middle class are also being swelled by the return of the diaspora. More and more skilled workers who had emigrated are now returning, attracted by lower living costs and economies that can now offer well-paid jobs and opportunities. Reverse-emigration has become such a phenomena that there is even a hit Ghanaian TV show, An African City, about the lives of five fictional returnees.

A consumer revolution

This growing wealth is creating a consumer economy that is increasingly similar to those in developed countries, if a lot smaller. African consumers are becoming much more discriminating and brand aware, for example. A recent survey by Deloitte found that 32% of Kenyans and 23% of Nigerians agree with the statement: "buying well-known brands makesme feel good". A quarter of Kenyans would also "spend a bit extra to keep up with the latest fashion", while around a fifth of Kenyans, Nigerians and South Africans say they "can afford the latest gadgets".

As a result, some of the world's largest consumer brands are focusing their efforts on Africa. Procter & Gamble has been one of the most successful in tailoring its offerings to the African market, although others have also been successful. One strategy that has worked particularly well is to offer goods in smaller quantities than would usually be available in richer countries. This means they can be priced at a level affordable for an African consumer who is keen to buy an international brand, but who has a more modest budget.

The rise of the African consumer is not just being felt in the numbers and type of goods that Africans buy, but also where and how they shop. Until recently, most Africans outside South Africa bought most (if not all) of their food, clothes and goods from informal stalls or small shops.

However, global supermarkets are starting to enter the market, with Carrefour expected to open its first store in Kenya this year. South African chain ShopRite now has 163 stores outside its home market in 16 countries, including Kenya and Angola. The number of goods bought from the formal retail sector in other words, supermarkets and large stores has hit a record 30% in Kenya.

With around 20% of Africans now having accessto the internet, e-commerce is also taking off. One site generating a huge amount of interest is Jumia, which aims to be the African equivalent of Amazon. Jumia sells a wide range of goods online, which it then delivers via its own network of delivery trucks.

Three years after its launch in Nigeria it now operates in ten other countries, including Ghana, Cameroon and Angola. Overall, the e-commerce market is expected to be worth as much as $75bn in the next ten years.

Another industry expected to do well is the airline industry. Until now, air travel has been held back by a lack of infrastructure and regulations that effectively gave small national carriers monopolies. This has allowed them to get away with substandard service and sky-high prices. As a result, Africa only accounts for around 1% of the world's air passengers.

However, the market is being liberalised, allowing new entrants to emerge. Economic growth is also leading the major international carriers to increase their services to the continent. As a result, the Boston Consulting Group reckons passenger numbers will grow by around 6% a year.

The seven investments to buy now

How can you profit from Africa's rapidly changing economies? On the e-commerce side, we first tipped South African payments and transactions firm Net 1 UEPS (Nasdaq: UEPS) just under three years ago. Since then it has more than doubled, going from just under $9 to more than $18.

However, thanks to surging earnings, its valuation remains attractive, trading at just 8.2 times 2016 earnings. At the moment, as well as focusing on e-commerce, the company is targeting Africa's increasingly sophisticated teenage market, and also aims to grab a share of the billions of pounds in international remittances. It has also bought into other financial firms, including Nigerian consumer finance group, One Credit Limited.

One beneficiary of the rise of large-scale retail chains in Africa is Zambian food giant Zambeef (LSE: ZAM). Its main attraction is that it owns all parts of the supply chain, ranging from the farms where it raises its cattle to meat counters in supermarkets, and a fast-food chain. While a drop in the value of Zambia's currency means it is currently loss-making, sales are growing quickly and it is expected to return to profitability later this year. It also trades at a 40% discount to the value of its assets, making it an interesting play for investors willing to take a risk.

Of course, as these two examples suggest, buying individual stocks is generally risky, and that's amplified when you're investing in an unusual market that's still developing, such as Africa's. So getting some diversification via a fund might be a more suitable approach for most potential investors.

As regular readers will realise, we tend to favour a cheap, passive approach, and there are now several exchange-traded funds (ETFs) that allow you to invest in Africa. But make sure you get what you're looking for. Many investors in Africa are really looking for exposure to sub-Saharan Africa, whereas ETFs are more often heavily weighted towards north African nations, such as Egypt and Morocco, or to a more developed market, such as South Africa (even though Nigeria is now Africa's largest economy after the recent rebasing of its GDP).

Market Vectors Africa ETF (NYSE: AFK) has a large chunk devoted to "real Africa". It has a price/earnings (p/e) ratio of 12, and a fairly high total expense ratio (TER) of 0.78%, though this reflects the difficulty of investing in some of the more exotic markets. If you want to invest directly in Nigeria, you might try Global X Nigeria Index ETF (Nasdaq: NGE). Its exposure to energy stocks is less than 10% of the fund, while mining stocks account for around 8%, leaving financials and consumer staples together to account for 80%.

The ETF has reflected the volatility of the Nigerian market, losing 45% of its value in a year. But it's trading on a p/e of nine, with a 3.5% yield. The TER is 0.68%.All of this said, sometimes it's worth paying for active management, and given the complexities of the Africanmarket, this may be one of those areas.

In terms of activelymanaged funds, Templeton Africa was set up in May 2012and is run by the highly respected Mark Mobius. Its relatively large exposure to Egypt and fees of 2% may not be toeveryone's taste, but it has beaten the market since itsinception (although given that its benchmark has fallenvery slightly, that's not reflective of stellar returns). It alsohas significant investments in Nigeria, South Africa, Kenyaand even some firms from Botswana.

Alternatively, an interesting investment trust is the Africa Opportunity Fund (LSE: AOF). The trust has heavy exposure to both Ghana and Senegal (with a large stake in the dominant Senegalese mobile-phone provider, for example). Another option, which adds exposure to frontier markets beyond Africa, is the Advance Frontier Markets Fund (LSE: AFMF), which has just under 40% of its portfolio in Africa (including a stake in AOF), with more than 10% in Nigeria and 6% in Kenya.