JOHANNESBURG Nov 7 African debt has increasingly captured the attention of global bond investors lured by the promise of high yields and diversification.
That interest will now be tested as dedicated African bond funds are emerging for the first time to provide exposure to one of the world's few remaining growth engines.
Investec Asset Management launched an Africa Fixed Income Opportunities Fund in July, which will invest in hard and local currency debt markets such as Nigeria, Uganda and South Africa.
Frontier market investment boutiques Silk Invest and Insparo Asset Management are planning to launch African debt funds in 2014. A similar offering by pan-African lender Ecobank, which created an African domestic bond index in 2011, should also be ready early next year.
Africa's appeal to investors lies in its strong growth, improving macroeconomic fundamentals including lower inflation and debt levels, and its low correlation to financial markets in the developed world.
The specialist funds are an important step in the continent's evolution from niche asset class to mainstream investment destination, analysts say. But it still has a long way to go and many markets, particularly in sub-Saharan Africa, need to implement reforms to improve liquidity and transparency and broaden their local investor base.
"It's important for these capital markets to develop so they can attract outside funds. Once frontier market investors are engaged, behind them come institutional investors that start to dip their toe in the water and that's really where the big, real money is," said Angus Downie, head of economic research at Ecobank.
"We've seen that in Asia so we can expect to see that happening in Africa."
Ecobank plans to launch a sub-Saharan African local currency bond fund after some investors had expressed interest in getting similar annual returns of 12-14 percent as shown by its Middle Africa bond index, Downie said.
Nigeria, Ghana and Kenya are among the seven countries included in the index.
The African Development Bank is also producing an index which will be the precursor to an African domestic bond fund.
BORROWING FOR INFRASTRUCTURE
Local and international bond issuance by African sovereigns is expected to accelerate given their need to fund investments in infrastructure, which the AfDB estimates will cost around $90 billion annually.
Africa's stock of outstanding international debt securities more than tripled over the last decade to $72.8 billion at the end of 2012, according to the Bank of International Settlements, but just 14 out of 54 African countries have issued Eurobonds. Debut issuers expected to tap international capital markets in the next few years include Kenya, Ethiopia and Cameroon.
Domestic bond markets in countries such as Ghana, Kenya and Uganda have drawn in foreign investors, while Nigeria's inclusion in JP Morgan's GBI-EM bond index last year has led to significant offshore inflows into its debt market, the continent's second most liquid after South Africa.
Silk Invest's fund will invest in local currency bonds in at least ten countries screened for market access and liquidity, said Stephen Charangwa, a portfolio manager at the firm.
Total outstanding debt in African local currency bond markets is now in excess of $400 billion. In some countries, total outstanding debt grew between 15 and 25 percent on an annualized basis from 2008 to 2012, which means markets are becoming deeper, he said.
"Investors are mainly concerned about liquidity," Charangwa said. "A diversified portfolio is possible because you now have fairly deep local bond markets like Nigeria and Egypt complementing South Africa, with Kenya and Ghana also providing sufficient liquidity."
With the exception of South Africa, foreign participation is still limited so African markets also offer diversification.
"In a world that's increasingly been dominated by events in the U.S., the African universe is very much less correlated to these global events such that the currencies and rates are not as volatile," said Charangwa.
In order to boost liquidity, authorities need to ensure that primary dealers, usually banks, are well-capitalised, which in some countries may mean consolidating the banking system, said Samir Gadio, emerging markets strategist at Standard Bank.
While some markets have healthy local investor participation, others will need to diversify their domestic investor base beyond their state-owned pension funds, he added.
"The more foreign interest you have, the more interaction you're going to have between foreign investors and those policymakers and the more the latter will be under pressure to carry out these reforms," he said. (Reporting by Tosin Sulaiman; Editing by Ron Askew)