Just a decade ago it was considered daring to allocate any portion of your assets to China or even South America. Today most investors have devoted a slice of their portfolio to the emerging markets. But not all developing regions have been investor darlings. Africa, widely perceived as a continent wracked by poverty and political instability, has failed to attract the investing public’s attention. That should change soon, according to Larry Seruma, manager of Nile Pan Africa (NAFAX). African nations have transitioned to free market economies over the past 15 years, enjoy growing political stability and are likely the last bastions of true growth in the emerging markets. 

Why should people consider investing in Africa?

There are several compelling reasons why investors should include African exposure in their portfolios. The No. 1 reason is that there are extremely compelling valuations to be found in Africa. The average price-to-earnings multiple in the universe is about 8, compared to 16 for the S&P 500. This ratio is also extremely favorable when compared to other frontier and emerging markets.

The other reason is historical performance and return. Over the last decade, the African market produced an annualized return of about 14 percent compared to 7 percent for the MSCI Emerging Markets Index. On top of that, Africa experienced much lower volatility compared to the broader emerging markets

Africa will continue to supply the rest of the world with a broad range of resources, from iron ore to oil. That quality is more important now than ever because the global supply of natural resources is becoming more limited. As emerging markets such as India and China continue to grow and mature, they will need the natural resources that fuel economic growth. That new supply of natural resources will come from Africa. As a result, African countries will continue to receive foreign direct investment, which will be used to develop their economies.

My last argument for investing in Africa relies on demographics. There are 1 billion people in Africa and more cell phone users on the continent than in the entire US market—but cell phone penetration is only 37 percent. There’s tremendous growth potential, and that’s true across most industries. About 40 percent of the population is younger than 15 years old. But the most important demographic shift is a swelling middle class that demands more services. By contrast, the industrialized world has a much older population that demands more health care. Africa’s productivity and the growth of the consumer class is an extremely compelling story.

A good example of a company that has recognized these trends is General Electric(NYSE: GE). The firm reorganized its business on the continent and created GE Africa in order to take advantage of the growing consumer culture.

What other factors beyond Africa’s mineral wealth are driving the growth of the middle class?

The biggest fundamental change in African countries can be found in their fiscal policies. Most African countries over the last 20 y ears have greatly reduced debt and liberalized their economies. You’re not going to find many PIIGS [the fiscally troubled European nations of Portugal, Ireland, Italy, Greece and Spain] in Africa, because these economies have been well managed for some time. In addition, an improving legal and taxation framework have fostered a strong investment climate, allowing African economies to compete with other emerging markets.

What risk does political instability pose for investors?

Political instability is a significant challenge, and African markets should be evaluated on a country-by-country basis. Politically unstable areas such as Zimbabwe and Somalia should be avoided. But it’s a mistake to see these troubled areas as representing the whole continent. In historical terms, the continent’s political situation has improved dramatically. Nigeria is an excellent example of this trend. Until 1990, the country’s government changed primarily through a series of military coups. Since the 1990s, we’ve seen peaceful transitions of power. In face, the most recent election in April is considered the fairest election ever to be held in Nigeria. With a population of 160 million, Nigeria accounts for about a quarter of the continent’s population and is a prime example of the changes underway in Africa.

Northern Africa—Egypt, Tunisia, Sudan, Libya, Morocco and Algeria—is largely populated by Arabs and is experiencing unrest. Africa’s Arab regions have long operated under different economic and political structures than non-Arab regions of the continent. These structures are being challenged, which may lead to some positive results.

I believe Libya will eventually split into two countries. The turmoil in Egypt, however, will be resolved. Egypt has a far more homogenous society than is found in Libya. Egypt also benefits from two powerful forces. The first is historical: Prior to the recent revolution, Egypt had been a very stable country with strong institutions. If you invested in Egypt, you would have suffered heavy losses, but you’ve never experienced outright expropriation by the government.

The other positive sign for Egypt is its transition toward greater democracy, though this is a very painful process. At present, there is significant uncertainty over how the country’s political situation will be resolved. Egypt will hold parliamentary elections in September and presidential election in November.

Most investors are waiting to see how these events unfold, which means there’s a high-risk premium for investing in Egypt relative to other emerging markets.

Additionally, the market was closed for eight weeks due to the political turmoil. As a result, gross domestic product (GDP) growth for this year will be much lower than originally forecast. That means the Egyptian pound is extremely weak and there’s’ the potential for more inflation.

But for investors with a long-term focus, there are tremendous opportunities in Egypt as the country democratizes and wages rise.

What investment opportunities have you found in Africa?

Guaranty Trust Bank (Nigeria: GUARANTY) is a mid-sized lender with about USD3 billion in market cap. It’s a well-managed bank that pays a dividend of about 5 percent. An investment in Guaranty Trust Bank provides exposure to Nigeria’s economic growth; the country’s GDP is expected to grow about 8 percent annually over the next 10 years.

Nigeria has a growing middle class, a huge portion of which lacks access to banking services—that’s enormous growth potential. More important, Nigerian banks have undergone a huge restructuring in the wake of the financial meltdown. The industry has been cleaned out, and the surviving banks will grow at a much faster rate than before.

The consumer story drives growth for MTN (South Africa: MTN). With a market cap of USD34 billion, MTN provides telecommunications services and operates in 21 countries. The company holds a 40 percent share of the Nigerian market. In 2001 there were about 500,000 active phone lines in the country; by 2010 that number grew to 65 million—almost half of Nigerians now have access to telephone services. Last year MTN paid out a dividend yield of about 9 percent. The stock also trades at 20 percent discount to other mobile network operators. The company has no debt and has tremendous growth opportunities as a provider of data services. Data is a high-growth business in Africa because the industry is essentially starting from scratch.

Africa’s urbanization has led to a boom in new infrastructure building. Regardless of whether these projects are located in Cairo or South Africa, the main ingredient is cement.

Orascom Construction (Egypt: OCIC) has two business lines—construction and fertilizer—that  each generate about half of total revenue. The fertilizer segment addresses booming demand for agricultural products and rising food prices. The construction business benefits from tremendous growth in residential and commercial construction and road construction. The demand for these types of services is enormous and will only increase over the next 20 years.

What’s your best advice for investors who are considering adding African exposure to their portfolios?