LONDON Nigeria's recent explosion of violent political unrest is damaging the economy and forcing investors to reassess their optimism over the short-term returns available there and elsewhere in Africa.
Stock and bond investors started looking seriously at sub-Saharan Africa after 2005 when debt forgiveness deals paved the way for growth and reform across the continent. But anyone seeking a killing from the hottest investment pitch of the time will have been disappointed.
Frontier market investors pumped $1.3 billion into African equity funds in 2010 excluding South Africa, EPFR says, up 10-fold from 2005. Such markets are a rung below emerging markets in terms of liquidity, size and transparency, but promise strong returns.
Asset managers Renaissance estimate Nigeria -- two-thirds of MSCI's frontier Africa equity index and almost a tenth of the broader frontier index -- took in half this amount, boosted by deep banking reforms and smooth 2011 elections expected to unleash infrastructure improvements.
The country was also included by Goldman Sachs in a group of eleven most promising emerging economies after the BRICs.
Yet a dollar invested five years ago in MSCI's Africa frontier equity index, comprising Nigeria, Kenya, Mauritius and Tunisia, would have lost 23 cents, Thomson Reuters data shows. In Nigeria, the loss is 36 cents. An investor in mainstream emerging equities would have made a 22 cent profit.
"If you go back to 2006 expectations of frontier markets were very very high, that's the difference between then and now," said Andrew Brudenell, who helps manage $180 million in frontier stocks at HSBC Global Asset Management. "What you have now are very low expectations and very low valuations."
In Nigeria, key reforms to unlock the economy's potential, have been slow, with this month's removal of the $8 billion petrol subsidy the first major step since President Goodluck Jonathan took office last April.
Worse, recent bombings directed at Christians followed by strikes against the ending of fuel subsidies, have shattered a fragile veneer of stability, with the strikes estimated to have cost sub-Saharan Africa's second-largest economy more than $600 million a day.
Nobel laureate Wole Soyinka even predicts the nation is headed for civil war.
After last year's debt default in Ivory Coast, Tunisia's turmoil and currency collapses in Kenya and Uganda, such developments revive Africa's reputation as a high-risk play for only the most adventurous investors.
"In the current risk off environment, frontier markets are not a short-term story," said Maria Gratsova, an analyst at Citi. "They are small and illiquid and that's not a good place to be when markets are extremely volatile as in past years."
Gratsova is worried by Nigeria's increasingly violent sectarianism but remains bullish on it and most frontier markets, saying the woes are reflected in stock valuations some 20 percent below those of emerging markets.
"At this price you are getting access to population growth and GDP growth. It's not a high price to pay," Gratsova said.
RISKS IN THE PRICE
There is no guarantee that faster growth will lead to better equity performance -- stocks in India and China have done poorly in recent years despite rapid growth rates.
But many argue Africa's risks are already in the price. Shares trade at an average price-earnings ratio of 7 times or less, versus over 9 times for emerging markets, says Sven Richter, head of frontier markets at Renaissance Asset Managers.
"That's a significant risk premium," Richter says. "I don't expect Africa to be valued on par with emerging markets but over time this premium will reduce. A PE (ratio) of 10 will still capture some risk premium."
Local African bonds also carry a bigger yield premium to hard currency counterparts than is common elsewhere. Daniel Broby, CIO at Silk Invest, a frontier markets focused fund, says the pickup is 200-300 basis points or more.
Ghana's 10-year dollar bond for instance yields 6.5 percent, while 10-year cedi-denominated debt pays over 15 percent.
"Political risk is part of the scenario in Africa but the risk is mispriced," Broby says, noting that events in one country do not tend to have a fallout elsewhere.
Buyers of African dollar debt haven't fared too badly. Nigeria's sovereign bonds returned 5 percent last year and has barely budged despite the turmoil. Bonds from the Republic of Congo and Seychelles returned 14-16 percent in 2011.
Investors insist long-term returns will be worth the pain. Incomes are rising across Africa, implying poor penetration levels for all goods and services from telecoms to transport, will rise if reforms work.
Up to 40 percent of Nigerian firms' costs come from running power generators to cover for electricity shortages, analysts say, a bottleneck which could be addressed were fuel subsidies redirected into power infrastructure.
And even within poorly performing markets, there are gains to be won. Brudenell of HSBC for instance invested in consumer staples such as Guinness Nigeria which rose 18 percent last year, bucking an index loss of 24 percent.
"That shows there are some very good quality companies in frontier markets that are doing well in balance sheet and cash generation point of view," he said.
(Additional reporting by Carolyn Cohn; editing by Ron Askew)