How to win in South Africa

Are there pots of gold for investors in the Rainbow Nation? Chiara Cavaglieri weighs up risk and reward

(Reuters)

With the World Cup under way, all eyes are on South Africa, but if keen investors take their eye off the ball – just for a second – they will see an emerging country rich in resources, with huge potential for growth.

The Rainbow Nation has seen huge infrastructure development in preparation for the football jamboree, and the big hope is that this will raise the profile of Africa's most successful economy with tourists and international investors alike.

"Africa has generated gross domestic product [GDP] growth above 5 per cent in the past decade," says James Cook, product manager at Fidelity International. "While this isn't the heady heights of China, with GDP at around 10 per cent, Africa remains one of the most underappreciated investment opportunities."

As the continent's richest and most advanced country, South Africa has an abundance of natural resources and is one of the world's largest producers of gold and platinum. Much of South Africa's potential is driven by trade with China and India, and it is benefiting greatly from the urbanisation and industrialisation of those countries. So much so that China is now South Africa's leading trading partner.

With such a wealth of opportunity, the question for investors is, how do you actually tap into all this potential?

Unlike other emerging markets, notably the Bric countries of Brazil, Russia, India and China, there is a notable lack of investment options with a direct focus on African equities. This reflects the considerable risks to investing solely in Africa. Previously, New Star's Heart of Africa fund offered such a focus, but had to be closed after suffering liquidity problems.

"We consider investing in a single country fund on the African continent 11 out of 10 on the risk scale," says Darius McDermott, from independent financial adviser (IFA) Chelsea Financial Services. "South Africa may be Africa's powerhouse, but it can be as brittle as some of its neighbours' economies. There is certainly scope for growth over the next 10 years versus the developed markets, but any investment should be a very small proportion of an overall portfolio."

One option is to invest in South Africa through a managed fund which offers some diversity, such as the Investec Global Gold fund, which has a regional weighting of 8.9 per cent in South Africa and, despite the name, invests in companies involved with the mining of several precious metals and minerals, such as platinum, silver and diamonds, as well as gold.

"In terms of performance, the fund has a strong track record, having returned 75.8 per cent over a three-year cumulative period and 21.1 per cent year-to-date," says Andy Parsons, advice team manager at The Share Centre.

Similarly, Global Emerging Market (GEM) funds diversify across high-risk markets, although most have very little investment in Africa other than South Africa and Egypt.

"The Aberdeen Emerging Markets fund is ideal for more adventurous investors who want broad emerging market exposure, with access to more than just the Bric economies, in a well diversified portfolio. It currently has a regional weighting of 5.10 per cent to South Africa," says Mr Parsons.

Once again, the fund has a strong track record with a return of 182.71 per cent over five years, according to The Share Centre. But the problem is that actively managed funds can be expensive. First, there are fees to operate the fund, and there may also be upfront charges for the initial investment. The Aberdeen Emerging Markets fund, say, has an initial charge of 4.25 per cent, and an annual charge of 1.75 per cent.

If you're looking for a cheaper way in, exchange-traded funds (ETFs) are a good alternative. These work by tracking an underlying index – for example, the top 40 shares on the Johannesburg Stock Exchange through the Lyxor South Africa ETF. These are passively managed funds and so have low fund-management charges, with average annual charges of less than 0.4 per cent.

On the downside, there is no fund manager making decisions as to what to buy or what to avoid within an index. So, while an actively managed fund will usually aim to outperform an index, ETFs will only mirror that performance and there is no way to discriminate between stocks that may be too risky, or overvalued. Also, if you buy an ETF which is concentrated on a small number of countries or large companies, you may find that you have all your eggs in one investment basket.

Finally, for investors who enjoy stock picking, you can get a piece of the action through UK-listed companies that operate in South Africa, such as brewer SABMiller, life insurer Old Mutual and Lonmin, a platinum mining company, all of which derive large amounts of their profits from their activities in this part of the world.

But stock-picking apart, all potential investors must acknowledge the volatile nature of any emerging market, with the threats of political instability and currency fluctuations.

"I would suggest if you want to invest in Africa you buy and then forget about it for 10 years," says Ben Yearsley, from IFA Hargreaves Lansdown. "The one big danger is that South Africa ends up like Zimbabwe – which was, at one time, one of the most prosperous countries in Africa."

Expert View

Ben Yearsley, Hargreaves, Lansdown

"The case for Africa is that, like China and India 20 odd years ago, it is an emerging market in the early stages of developing, but with huge growth potential. South Africa itself has an abundance of natural resources that makes it an exciting economy, albeit with lots of risks. It is clear that huge amounts of money need to be spent developing the existing infrastructure for example, and even though they are holding the World Cup, more needs to be done."