Footprint to Africa Engages a Finance Scholar and Financial Market Researcher on Investment in Africa

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Ferdinand Othieno is a practicing scholar in Finance and the Research Director at the School of Finance and Applied Economics (SFAE) at Strathmore University Kenya. He holds a Bachelor’s degree in Finance (First Class Honours) from Maseno University and Masters in Banking and Finance from Moi University.

Othieno-2.jpg-innerMr. Othieno also heads the Transaction Services Division of Centerprise Africa Limited where he offers transaction advisory services from mergers and acquisitions; company valuations and capital raising to due diligence and financial reporting assistance to clients across different sectors in East Africa.

He is currently pursuing a PhD in Finance from the Graduate School of Business, University of Cape Town and carrying out research on the estimation and forecasting of the Equity Risk Premium in Africa.

Mr. Othieno gave his views on investment on the continent to Footprint to Africa:

 

  1. The concept of ‘investment’ is often misunderstood. Can you tell us what the word ‘investment’ means to you?

Investment is the commitment of funds (capital) over a time period with an aim to derive future payments/value which is usually higher than the committed capital. The gain, referred to as investment return, acts as compensation to the investor for the time the funds are committed, the expected rate of inflation and the uncertainty of the future payments. An investor can be an individual, government or institutions e.g. pension funds and companies. The return from investment is ‘expected’ because usually it is not known with certainty upfront, so it is referred to as expected return.

It is the identifying of an opportunity where you commit money or capital to place or lend money in a vehicle, instrument or asset, such as property, commodity, stockbond, financial derivatives such as  futures or options, or the foreign asset , that has certain level of risk and provides the possibility of generating returns over a period of time.

 

  1. What criteria should investors look at before pumping their money into industries or markets?

One has to make a financial plan or technically an Investor Policy Statement. This plan aids in identifying and specifying the investor’s objectives and constraints. Investment objectives are desired investment outcomes. In investments, objectives chiefly pertain to return targets and risk tolerances.

Assessing risk tolerance of an individual investor requires balancing between willingness and their ability to take risk.Constraints are limitations on the investor’s ability to take full or partial advantage of particular investments. For example, an investor may face constraints related to the concentration of holdings as a result of government regulation, or restrictions in a governing legal document.Constraints are either internal: client’s specific liquidity needs, time horizon and unique circumstances. Some of the external issues are tax issues and legal and regulatory requirements.

The issues are discussed in detail as below:

  • Investment Risk

The investors should be aware of the level of risk in the particular industries and the return offered for risk taken. This would ensure the investor takes on a level of risk acceptable to them for a particular expected return.

  • Liquidity needs

Investors should consider their liquidity needs in their investment decisions. Growth industries would be a target for investors looking for capital appreciation. However investors with high liquidity requirements may well consider industries that reward in form of frequent liquid hand outs such as dividends.

  • Time Horizons

Time horizon has a close relationship between an investor’s liquidity needs and ability to handle risk. Investors with long time horizons require less liquidity and can tolerate greater industry risk because the funds would not be needed for many years and short falls or losses can be overcome by returns in subsequent periods. Investors with shorter time horizons favour more liquid and less risky investments because losses would be harder to overcome over a short time period. Time horizon should advise an investor’s decision as there are industries are high risk such as the tech industry. Ultimately the investor’s preference in time, liquidity needs and risk should play out in the choice of industry or market he/she chooses to pump money into.

  • Tax Concerns

The tax code existing in the particular industry is a factor to consider for an effective and smart investment planning by the investor. This is because taxes may complicate situations especially if international industries or markets are involved. For example, differences in capital gains and dividends taxes applicable in a particular jurisdiction may influence the decision of a stock market investor

  • Legal and regulatory factors

Investments and markets are regulated and subject to a number of laws. The legal and regulatory factors prevailing on an industry should be carefully considered by an investor before venturing into it. An example of a financial markets regulator is the Capital Markets Authority of Kenya (CMA).

  • Unique needs and preferences

These covers the individual and distinctive concerns of each investor. The choice to pump money to an industry would be advised by the investor’s personal preference or for social consciousness reasons and time and expertise a person has for managing their portfolio in the industry.

 

  1. It is often believed that investors outside Africa are mostly interested in portfolio investment? Why do you think only few want to invest directly in long-term projects?

For Portfolio investment, Investors tend to take a shorter-term approach which allows them to sell their shares whenever they want because foreign securities are traded regularly. An investor looking to liquidate a foreign portfolio can sell off assets like stocks or bonds with relative ease. Foreign direct investment are more intricately tied to a specific business which makes it harder to exit their positionsThis is a way to curb risks that come with foreign investment for example currency risk, political risk, concentration risk liquidity risk.

Investing in long term projects may be limited by several constraints.Liquidity constraint, this is where by the investor has short term obligations for example payments to beneficiaries. Investors or institutions that have such obligations will go for short term projects. It also depends on the investors investment beliefs whether long term investments can produce higher returns.Investing in long-term comes with a high risk for example market risk, country risk and political risk among others which could affect the return of the asset, one would take long term project depending on the risk appetite of the investor.Lastly it depends with the ability of the investment team and trustees to execute a long term investment strategy.

 

  1. Do you consider return on invest in Kenya and the whole of Africa good enough for investors?

Africa is the second largest continent in the world in terms of population size (over a billion people and her growing middle class is an interesting subject of study. No wonder companies like Coca-Cola have a billion reasons to believe in the continent’s ability to give business. Kenya indeed offers a good return for investors her middle class are good spenders. The country’s capital has attracted renowned retail giants such as Choppies from Botswana and France’s Carrefour to mention a few. In addition, international fast food joints and cosmetics manufacturers that are looking to take advantage of the convenience and spending appetite of the Kenya middle class have also been reported to set up in the region. Education is also fast being embraced in the region with countries like Kenya introducing IT and skills based learning to impact her youth. Africans have been known to massively acquire international scholarships to study abroad. They are thus able to forge relationships outside which they use back home to enable success in local and international investments. The African and Kenyan population and massive undertaking in education of the youth of the continent provide a conducive investment ground for delivering good enough return for investors.

 

  1. Most African countries think of FDI more than investments coming from indigenous players. Do you consider this approach appropriate?

Although there has been much debate about the potential benefits and risks of international investment, there is no systematic evidence on the actual impacts on the host country. The impacts vary significantly across countries and also across locations within a given country. They depend on many factors, including the contents of the investment contract, the type of business model implemented and the institutional framework in place in the host country. The main benefits that can be expected for the host country are economic benefits such as employment creation, higher productivity, improved access to finance and markets for smallholders, technology transfer and enforcement of production standards. In order to maximize the positive impacts of international investment while minimizing the risks, governments should verify that the existing policies, regulations and institutions are adequate, as well as undertake preliminary studies and consultations with all stakeholders.

African countries have experienced a significant increase in FDI flows over the past decade but there are concerns that the developmental impact has been limited due in part to weak linkages between foreign and local businesses. The lack of adequate infrastructure and skilled labour, low absorptive capacity, policy incoherence and the lack of a vibrant domestic private sector are some factors responsible for the weak linkages between local and foreign enterprises. It is recommended that African governments create and strengthen linkages by developing and improving workforce skills as well as raising the absorptive capacity of local firms, for example, through the imposition of technology transfer requirements on FDI. There is a need to promote joint ventures between local and foreign enterprises and make FDI policy consistent with the promotion of domestic entrepreneurship. In this regard, it would be advisable that African Governments promote FDI in a manner that does not discriminate against local investors. Furthermore, if incentives are to be used to promote FDI, they should be used mainly for attracting new investments in activities where a country cannot attract investors without such incentives. For example, in most cases, incentives are not necessary to attract FDI in the extractive industry because such investments will take place regardless, given the high demand for resources and investor interest in the sector.

 

  1. FDI in Africa fell by $38 billion in 2015, according to UNCTAD. Will you attribute this to dwindling spend on the continent by China?

Yes and No

It was largely due to the decline of FDI in Sub-Saharan Africa due to the slow economic growth in China and a drop in commodity prices. A few other things contributed such as the Ebola crisis, political risks spawned by an ever-busy election cyclesecurity threats from the rampant escalation of violence by organizations such as Boko Haram in Nigeria

FDI to Nigeria Africa’s largest economy in Africa reduced by 27% after it was affected by the drop in oil prices while South Africa FDI went down dramatically by 74%.

Also because of the Ebola crisis, political risks spawned by an ever-busy election cyclesecurity threats from the rampant escalation of violence by organizations such as Boko Haram in Nigeria

China has been lending billions of dollars to Africa in tied loans that guarantee Chinese companies contractor rights and ensure Chinese goods are used in development projects. The loans tend to be granted when their repayment can be guaranteed by payments from China for African exports. So China is buying African exports, but trying to ensure the African export revenues are spent on Chinese goods and companies, while aiming, over the longer term, to boost African GDP and the African market of 1bn consumers. What Africa gets in return is cheaper, longer-maturity loans, investment in infrastructure, and the ability to afford Chinese-made items to meet consumer demand. Although larger exports to China have helped drive economic growth in the region, they have also led to greater exposure to China. The slowdown in the Chinese Economy contributed to the FDI drop in Africa.

  1. How will you rate risk, cash flow and resale value of investments in Kenya and other parts of Africa?

The resale value of investments in Kenya is significantly high. For instance, a UK Private Equity firm raked in a return of 436% from its divestment in Equity Bank – a local bank. Helios was able to raise up to KES50 billion ($500 million) from the sale and collected KES6.5 billion ($65 million) in dividends from the lender, having made an initial investment of KES11 billion ($110 million) in 2007. There has also been local sales that have had significant gains e.g. Centum’s sale of its stake in UAP Insurance Company. The resale value of investments in Kenya is highly profitable and has been reported to significantly improve the bottom-line of the investors making the sale. The investment however must have been chosen wisely to rake in such values over the investment horizon.

Moreover, we have the ‘rush for Africa’. In 2015 alone, we had about 8 stock markets being classified as frontier markets (a type of developing country which is more developed than the least developing countries, but too small to be generally considered an emerging market) in 2015 alone. In the same year, Kenya was rated as one of the top seven hottest investment destinations globally.

Economic growth in Africa has recently been significantly higher than that in many developed regions, which is often cited as the main reason for investment in Africa. Africa has a lot to offer, particularly the supply of scarce resources into a commodity hungry world. However, there are also a host of factors hindering Africa’s success. These include a huge infrastructural gap, various barriers to trade, low productivity and skills shortages. The significance of economic growth, therefore, should not be focussed on alone. It should also be borne in mind that each African country should be considered according to its individual risks and opportunities. Each region and country is sensitive to unique factors, with each country having its own strengths, opportunities, challenges and cultural differences. Companies considering investing on the African continent should therefore consider the challenges and opportunities in each of the individual countries in which they intend investing.

In a survey conducted by PwC, a couple of key reasons were cited as driving investors’ interest in African companies: African companies have greater growth expectations; the return expectation relative to risk has improved in recent years; investors are seeking to diversify away from low return markets and political stability has improved, reducing country risk.

Nonetheless, the lack of data, both about comparable companies that could provide valuation benchmarks in a valuation analysis, as well as industry data (for example around market demand, competitiveness and growth expectations) that could support cash flow forecasts, are the most common difficulties encountered. However, over recent years macroeconomic research in emerging markets has improved significantly and data are now available for many emerging markets. As emerging markets continue to enjoy more focus, research is likely to improve over time.

 

  1. There are peculiarities associated with investing in Africa. Some investor’s think that analysis done by experts do not always follow through, on the back of several socio-economic factors in the continent. As an expert, how would you advise a prospective investor in Africa?

In my opinion the major problem in Africa is weak Governance hinged on weak institutions and political instability when it comes to election period.

Conduct a thorough due diligence where the funds will be invested.

An important consideration for potential investors are the political landscape and business environment. The political situation incorporates political stability and security factors. The business environment includes factors such as infrastructure, corruption, onerous regulations, taxation regime and the conduciveness of the regulatory environment to the starting and operating of a business in that jurisdiction (KPMG, 2016).

 

  1. With South Africa and Nigeria, two biggest investment environments struggling, how do you see the future of Africa?

According to ( Africa Growth Initiative)Nigeria’s real GDP growth is expected to fall to 4.0 percent in 2015 from 6.3 percent in 2014 and recover to 4.3 percent in 2016. South Africa is expected to barely grow in 2015-2016, with a growth rate hovering around 1.4 percent.

Research states that some nations are going to benefit from the slump of both Nigeria and South Africa for example Kenya. According analysts at CfC-Stanbic Bank, owned by South Africa’s Standard Bank, South Africa may witness sovereign credit downgrade yet is seen by global financial players as the barometer that is used to measure the continent’s liquidity ability. Also Nigeria has been considering to devalue their currency therefore rating agencies are expected to rank Kenya better.

The Fortune Magazine has recently ranked Kenya among the seven most promising global investment destinations in 2015.  The favourable ranking which places the country alongside Economic giants such as India, Malaysia, Indonesia, Mexico, Poland and Colombia cites good and improving governance structures that guarantee sustainable growth as a key catalyst for investment attraction. The United Nations World Investment Report 2014 places the country ahead of Nigeria and Ethiopia as the most attractive investments destinations for foreign capital on the continent. Amongst the trends highlighted by the report, Kenya is set to develop as a regional hub over the next decade not only for oil and gas exploration but also for manufacturing and transport(United Nations, 2014)

Recent oil, gas and mineral discoveries in Tanzania, Uganda, and Kenya are expected to anchor an even much stronger economic performance of the EAC region into the medium to long-term outlook

  1. Apart from infrastructure deficiency, what other challenges cripple investments on the continent?

Armed conflict and terrorism, policy uncertainty, macroeconomic instability and inadequate and corrupt legal systems in specific African countries, and regions, have historically tainted foreign investors’ perceptions of Africa as an investment destination (KPMG, 2016).

Macroeconomic instability such as  the effect of the low economic growth in China to Africa’s economy and also how the African currencies were affected by the increase in interest rates of USA

The past few years has seen Africa being the ground to a lot of terrorism acts for example Boko Haram and Alshabab. This has made Africa really insecure leading to a decrease in tourism which discourages investors from investing in that sector.

Corruption, real and perceived, remains a key hindrance to doing business. It is difficult to run business smoothly with clean hands without having to pay something somewhere. This poses a huge challenge to investors who have regard for integrity and negatively affects attracting investment, both domestic and foreign. Nonetheless, many economies are showing commitment to improved governance as a means of curbing corruption. I would also want to applaud effort by financial market regulators e.g. the Central Bank of Kenya who are showing commitment to deter and punish industry malpractices that may discourage investors.

Bureaucracy: –A significant number of economies are known to have very bureaucratic processes which are exhausting and hinder ease of doing business. These inefficiencies are encountered in business registration processes, quality control and safety mechanisms, transfer of property and quality of land administration system, resolving commercial disputes and judicial processes. However, there have been deliberate efforts to improve processes and make the business climate investment-friendly. For example, in 2015, Kenya improved 28 positions in the World Bank’s Ease of Doing Business Index being ranked at position 108 out of 189 countries globally compared to 136 in 2014, making it the third most improved economy globally owing to reforms that improved the business climate.

Market depth – There is no derivatives market yet, which can help one hedge against risk

  1. What is your assessment of the investment climate in Africa at the moment given the current economic realities and the almost compelling argument that the ‘Africa Rising’ narrative is no longer tenable?

I think the global economy is currently going through a tough time and Africa has had greater share of these challenges. This notwithstanding I expect increasing investor participation on the African continent. There is increasing awareness of the investment terrain by foreign investors, reducing investment rigidities and bureaucracies and increasing transparency; all of which are expected to spur investment interest in Africa.

  1. We often hear that capital is not shy of risk so long as there is guaranteed return on investment. How true is this about Africa in the context of recent security challenges?

I am believer in the risk-return paradigm. However, the challenge posed by security challenges, and indeed high uncertainty in the business environment,is the increasing inability to correctly price risk and therefore inability to allocate capital commensurate to the risk profile of the intended investments.

 

  1. Africa is in dire need of investments, especially Foreign Direct Investments, to lift its economies and create jobs. What, in your view, should African governments do now to attract these badly-needed investments?

Governance (both public and private) is of ultimate importance. African governments are required to make every effort to ensure political and economic stability, promote private-sector development and engage in greater dialogue with private enterprises.

The government could increase their promotional efforts, by highlighting the opportunities in particular industries or projects.

  1. What would be your advice to a foreign investor coming into the African market for the first time?

Fear not. Africa is a great investment destination. Just invest some time in understanding the environment.

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