Globalization and the New Frontier of Emerging Markets

Ask a risk analyst what they thought of emerging markets five years ago and they would have responded with one word: China. Asking the same question today arouses a different response that encompasses a larger geographical perspective. Emerging market investments are on the rise, and while stalwarts such as China and other Asian countries are getting the lion’s share of the investment dollars, places like Africa are beginning to stand out.

In 2006, close to US$22 billion was invested in emerging markets representing a 15% growth over 2003 investment figures. Private equity annual returns in emerging markets show a 23% return since 2003. That is more than double the return S&P 500 index offered during the same time frame. An industry survey by The Emerging Markets Private Equity Association revealed 65% of respondents plan to increase their commitments to emerging markets in the next five years. But the area that continues to draw the largest investment returns remain in Africa and the Middle East.

In the Middle East the private equity investments are dominated primarily in Israel where the stock of private-equity investment as a fraction of GDP amounted to 3.2%, which is only second to North America. In Africa, the most mature market located in South Africa received 1.9% of GDP, putting it in a class on its own. But, what can be one investor’s frontier can be another’s backyard. Why are these markets attractive to so many? What do North American investors see in these markets and how do they take their decisions?

The answer lies predominantly in political and country risk analysis. While the purview of this craft is among the political scientists, economists and spies, it remains an imperfect and subjective science. The analysis of political events and regulatory measures allows investors to better understand the general business atmosphere and allows for a better investment decision.

Citibank recently unveiled plans for a new US$200 million fund dedicated to Africa. Investors for Africa have typically looked at mining resources and unexplored energy fields. But, the new African reality is a budding entrepreneur class in the high-tech fields, pharmaceuticals and consumer goods.

C.K. Prahalad, author of the book “the Wealth at the bottom of the pyramid,” outlined the basic premise to successful selling in emerging markets. Prahalad, believes that large multinational corporations need to sell in emerging market consumer terms. In the North American consumer market, shampoo is usually purchased in one litre bottles, yet in Africa, consumers purchase them is just a one-use format, which brings the price down considerably. Proctor & Gamble has declared their African sales of consumer goods to have grown more aggressively than any other market. In fact, smaller African companies have gotten into this marketplace to offer consumers 5ml packets of soap, shampoo, and other like-products. Demand has outpaced supply.

But these little companies do not only rely on the multinational banks for capital—they also raise funds through their local stock market. Alternative capital markets are also gaining momentum with brokers and hedge fund managers.

In a large office complex in downtown Accra, in Ghana—there is standing room only for locals queuing up with cash to buy shares of a mutual fund that has generated over 60 percent return for the past several years. Databank, the local mutual fund company, has been strategically investing in publicly traded firms all over African stock markets in Ghana, Nigeria, Botswana and Kenya—not only investing in natural resources, but in high-tech start-ups.

So what is turning off some investors? According to the Emerging Markets Private Equity Association, the biggest constraints to further investment are concerns about accounting and corporate governance of managers and portfolio companies, followed by concerns that governments may not pursue sound economic policies.

As a case in point, after Chad agreed to a World Bank administered fund on oil revenues from the Exxon pipeline project, President Déry changed his mind and decided to seize the funds in order to keep buying more arms. Other countries have had similar stories, such as Benin, who endured a long stable dictator for over 30 years, only to have his son succeed to the “throne” after the president’s death. Other examples of unstable policies are those of Zimbabwe —once the rising star of Africa, dictator-for-life Mugabe, implemented a horrible land-reform and lost over 60% of its foreign currency reserves, after evacuating the most lucrative agriculturalists in his country.

International investors are getting smarter, analysis is becoming more pertinent and access to information, in this digital age, ever easier to get. Thus the trick to wise investments in emerging markets lies in the understanding of the underlying themes of most government policies.

Two rising stars of Africa in the next few years are; Democratic Republic of Congo (DMC) and Zimbabwe. The DMC just voted in their first democratic elections since the 1960s, in which foreign observers declared fair. These elections brought back Kabilia junior but with an eye to building peace between its internal enemies and neighbours. What is important of the DMC—is their rich reserves of Tungsten. A little know natural stone that is used in cooling microchip processors. Large companies such as Microsoft have invested heavily in getting their feet on the ground and reserving “their share of the pie” in time for a peace deal.

Zimbabwe is run by an old tyrant, who will eventually extinguish. Until that time, this budding, African nation with a highly-educated work force will become the next international call centre with its cheap labour, good infrastructure and its abundance of languages. Zimbabwe will be brought back into the club of nations as the next generation of leaders stake their positions after Mugabe. This generation are armed with US MBAs and with a list of NY-based investment banking contacts that will change the face of this part of Africa.

A client once told me to “follow the traffic”. Well, if it is any indication, Chinese companies have been buying everything and anything in sight in southern Africa. Maybe it is time to “follow the traffic”.