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Digging for higher returns out of Africa

What can the world's poorest continent offer adventurous private investors? Chiara Cavaglieri reports

Africa is a continent rich in natural resources such as oil and diamonds and has great potential for economic development, but investing in any emerging market is risky and not for the fainthearted.

The global downturn has caused a dramatic fall in demand for commodities which African economies rely on and all eyes are on South Africa, the continent's largest economy, after the re-election of the African National Congress (ANC) and its controversial leader, Jacob Zuma. "As a largely undeveloped continent, rich in resources with a large workforce, Africa has potential to grow, but in the past, African countries have generally not been successful in converting these ingredients into consistent growth," says Marcel Porcheron, a research analyst at advisers Bestinvest.

Africa has highly profitable investment opportunities partly because it has so much room for expansion. The telecommunications industry, for example, is likely to develop substantially because take-up of mobile phones is currently so low. In practical terms, though, taking advantage of those opportunities can be difficult. "Options are limited because of the lack of collective investment vehicles, such as unit or investment trusts, which focus solely on African shares," says Owen Wintersgill, the director of financial advisers Axxis Financial Planning.

It is also difficult to tap into African potential because many markets are small and illiquid, so fund managers are unable to buy and sell shares easily. One of the few Africa-dedicated funds, the "Heart of Africa" from New Star, was recently closed and then sold to Duet after it suffered liquidity problems.

Global Emerging Market (GEM) funds can be a good alternative. However, few of these have any investments in African countries other than South Africa and Egypt. "Sub-Saharan markets and companies are generally considered too small and illiquid, markets are often poorly developed and the quality of the companies is often questionable," says Mr Porcheron.

Of those funds that do invest in Africa, Genesis Emerging Markets Investment Trust has 6.4 per cent in sub-Saharan Africa, a further 11.5 per cent in South Africa and 2.1 per cent in Egypt. Advance Frontier Markets has 23 per cent of its total shareholding invested in African markets.

The high-risk nature of African investments means that most financial advisers recommend they should make up no more than 5 per cent of any portfolio. The potential for political and economic instability is high so assets may need to be invested for a long time to withstand the huge shifts in sentiment towards African markets. The more traditional emerging markets, the so-called "BRIC" countries of Brazil, Russia, India and China, may offer similar potential but fewer risks. "Opportunities in Asia, for example, are probably looking better. The markets are more mature and much easier to invest in," says Mark Dampier, of Independent Financial Advisers Hargreaves Lansdown.

Exchange Traded Funds (ETFs) are a simple way to get into African markets and, as they are not actively managed, they are also a relatively cheap option. ETFs track the performance of an underlying stock market. "Unfortunately, there are no ETFs that track the whole of the African market. But UK investors can track the next best thing – the top 40 shares on the Johannesburg Stock Exchange through the Lyxor South Africa ETF," says David Kuo from financial website fool. co.uk. Another option for those interested in Africa is to invest in UK-based companies that derive their profits from Africa. "Life insurer Old Mutual gets four-fifths of its revenue and 80 per cent of its profit from South Africa. Standard Chartered is another company that has exposure to Africa," says Mr Kuo.