What Does an Allocation to Africa Bring to an Institutional Investor’s Portfolio?
We built a model which uses a traditional mean-variance optimization methodology with long-term historical and adjusted forward-looking expectations for traditional local and global asset classes; and a correction for stale pricing present in African asset classes. For purposes of this article, only listed equities (unconstrained) and private credit were considered for inclusion in an African allocation. The negative and zero correlations exhibited by these African asset classes relative to the traditional assets led to their inclusion and to improvements in the efficiency of overall portfolios (as can be seen in the chart below).
Standard Deviation
The chart above shows a definitive improvement in the risk of every fund that included Africa relative to the same targeted return profile. Notably, the diversifying characteristics of the African asset classes resulted in a maximum 10% allocation in each of the ‘optimal’ portfolios shown above. Furthermore, the bias within the Africa allocation moved entirely towards private credit as the target margin above inflation increased (as reflected in the table below).
Africa
It is worth noting that, in addition to the risk-return benefits outlined above, an investment into private credit has liquidity advantages over its private market peers – the weighted average duration of the portfolio modelled was two years.
There’s more to ‘impact’ than infrastructure investment.
Although investors have traditionally focused on infrastructure when a key driver for their allocation to Africa is the potential impact of that investment, many investors are identifying the critical credit funding gap as an equally noble cause.
It is certainly an honorable endeavor to support the growth of Africa’s capital markets and, equally so, to broaden the financial inclusion of Africa’s citizens. The inability to access debt capital is not limited to corporate entities and local banks, but also micro-SMEs and individuals. Apart from funding institutional borrowers, private credit funds are indirectly able to assist in servicing the individual and micro-SME market by providing debt capital to reputable micro-finance organisations that operate in this sector. Unlike borrowing for private use in more developed markets, such borrowing in Africa is not used by individuals for consumption but rather to fund necessary expenditure related to housing, education, small-scale agriculture and small business.
As an African country, South Africa’s growth is inextricably linked to the continued development of the African economies and the communities with which it engages, and institutional investors in South Africa have a critical part to play. Historically, investors have had few doubts about investing billions of dollars into assets outside the continent. Treasury has now opened the door further for investors to make an impact on the continent, where opportunities abound for earning attractive and consistent risk-adjusted returns.