Investment Risk in Africa
Reducing Portfolio Risk through Investments in Africa
It is true: you can reduce your investment risks by allocating funds to Africa.
The reason for this is the application of the portfolio theory created by Harry M. Markowitz. The key finding of this theory is: the unsystematic risk of stock market investments can be significantly reduced by spreading funds to stocks of many different operations. This effect is the greater the less correlated the performance of single stocks are to each other. In contrast, the systematic risk that applies to all listed securities cannot be reduced by diversification.
African capital markets are less intertwined with the Western financial community then all other international stock markets.This is becauseof the low development stage of most African stock markets and due to the fact that they are still grossly neglected by global investors.
The low financial inclusion of this last “big white spot” of the investment landscape within the world financial system leads to a low correlation to stock exchanges in New York, London, Frankfurt, Beijing, Tokyo etc., resulting in a significant reduction of the total risk of a global stock portfolio.
Risk at Direct Investments
If you take a look at a single investment, things are different. The risk of a single investment in African equities is remarkably higher than that of German, European, or American stock corporations. This risk composes of the following parameters:
- Company risk: this is higher in Africa because principles of good governance are slowly becoming common practice, with big differences from country to country. Legal certainty cannot be compared with the situation in Europe since corruption is widespread, and for a number of other reasons.
- Country risk: it includes the political risk, risk related to the code of law, and the fiscal risk, mainly associated with high external debts.
- Currency risk: currencies were weak in the past and have been devalued.
- Risk of transferring foreign exchange: the risk of limited or restricted repatriation of capital invested in foreign currency is evident in countries with acute lack of foreign exchange (currently [Aug 2011] Malawi) as well as in countries with nonconvertible currencies (Ethiopia). There are foreign exchange control systems in various other countries, i.e. South Africa, but they are less relevant in practical terms.
How will these risk factors develop in the future?
- The political risk is decreasing in almost all sub-Saharan countries. Democratization has made big progress. Many governments fight decisively against corruption. Social unrest and some long-lasting civil wars have been ended within the last years, i.e. in Angola, Mozambique, Rwanda, Burundi, Liberia, Sierra Leone, and the Democratic Republic of Congo.The situation in Ivory Coast is improving as well.
- The revolution in the Arabic world has led to bigger uncertainties in the North African countries. There is hope for a successful transformation of formally autocratic governance nations towards more democratic structures. However, this process should last for many years to come and will be accompanied by imponderability.
- The financial risk is also decreasing. Many highly indebted nations have benefited from debt relief by international donor communities. Resource-rich countries have gained aa better ability to retire debt. Many African countries are much better situated than most of the highly indebted developed nations.
- Currency risk: when inflation rates decreased the last few years, some local currencies have been stabilized against the US dollar. In the medium term, currencies of resource-rich countries might rather appreciate against Western currencies.