Diversification across the strongest stocks in the best-placed economies is one of the cornerstones of successful global investing and as such, no portfolio would be complete without partial exposure to fast-growing emerging and frontier markets. In the fourth of our eight-part series, we examine the investment credentials of Africa and the Middle East.

In line with the FTSE All-World geographic weightings outlined in the opening instalment of our eight-part series (see Cover, Shares, 10 Jan), our 18-strong global portfolio features one pick from the combined Africa & Middle East region. Our selection is Qatar Investment Fund (QIF), the London-listed investment trust offering a prime play on one of the world’s fastest growing economies, Qatar, a politically-stable, hydrocarbon-rich powerhouse whose equity market looks cheap compared to peers.

Regional overview

Africa will hold attractions to growth-oriented investors fretting about sluggish GDP growth in the debt-laden West and China’s ability to continue to set the economic pace. Home to one billion people and growing and speaking for 20% of the globe’s land mass, Africa is the richest continent in the world in terms of natural resources with an abundance of precious metals such as gold and platinum to industrial commodities including copper and iron ore, not to mention vast reserves of oil and natural gas. In tandem with these riches, Africa is set to benefit from a so-called ‘demographic dividend’, with its young and increasingly well-educated workforce set to become the biggest in the world by 2035, surpassing even that of India and China.

Africa’s consumer boom, driven by rapid migration into cities, is an investment theme which is exciting many professional money managers. Rates of urbanisation are dramatic, with 40% of the African populace living in cities today, up from just 28% in 1980. This figure is forecast to hit 50% by 2030, a development that will give Africa’s leading 18 cities a combined annual spending power of $1.3 trillion at a time when the emerging middle classes within these frontier markets are increasingly affluent and aspirational. A technological revolution is also underway across the continent, with Africa’s 500 million mobile phones forecast to hit 850 million by 2015.

While these consumer and natural resource narratives are compelling and democracy is generally taking root, Africa remains plagued by political instability. France has intervened in war-torn Mali with the aim of halting the southwards advance of Islamic militants. North Africa appears to be a magnet for terror with dozens of foreign hostages killed earlier this month by Islamist militants during a four-day siege at an Algerian gas complex, amid claims the attackers entered the country from northern Mali. Elsewhere, suspected Islamists have also been blamed for deadly attacks in Africa’s most populous nation Nigeria, where militant group Boko Haram continues to stage atrocities as it fights to create an Islamic state.

Political instability weighs on sentiment towards the Middle East too, where the seismic effects of the 2011 Arab Spring continue to reverberate. In large part, the causes of the widespread protests have their origins in longstanding socio-political and economic issues which still need to be addressed through structural reform. Millions of discontented young people require gainful employment across the Middle East, a region where ossified regimes dominate and crimp the potential for social and economic advancement among the broader population. Conflict continues to characterise the Middle East region too. Tens of thousands of Syrians have lost their lives in the escalating battle between forces loyal to President Bashar al-Assad and those opposed to his rule.

Despite demands from the West for his resignation, Assad shows no signs of leaving power and there appears to be no end to the conflict in sight since Iran, the Middle East’s pariah state in the eyes of the West, is thought to be propping up the Syrian ruler. Elsewhere in Egypt, President Morsi’s decree to strip the judiciary of the right to challenge his decisions was cancelled following angry protests by the secular and liberal opposition. Meanwhile, tensions between Iran and Israel continue to mount following the recent conflict between Israel and Hamas in Gaza.

Out of Africa

Frontier markets may not be everyone’s tastes, as the risks are elevated, but long-term investors need to keep an eye on Africa. It is home to seven of the world’s ten fastest growing economies and is forecast to generate an annual GDP growth rate of 6% for the next decade. Inflation in Sub-Saharan Africa, home to 856 million inhabitants at last count, also appears to be under control while increases in the Middle East/North Africa (MENA) region seem to be ameliorating. Both Sub Saharan Africa and the MENA economies also have scope to take on more debt to fund infrastructure and other growth projects if need be.

According to recent World Bank estimates, the region’s $1.25-a-day poverty rate has fallen from 58.1% of the continent’s population in 1999 to 47.5% in 2008. Meanwhile, foreign direct investment (FDI) flows jumped 25% to an estimated $35.6 billion in 2011, following sharp declines in 2009 and 2010. With the business climate improving, Africa’s favourable economic prospects are beginning to attract investment across sectors ranging from retail and real estate to telecommunications.

An embarrassment of commodity riches represents one of the continent’s key economic strengths. Immense agricultural assets further reinforce the top-down case for the continent. A mere 1% of Africa’s 1,160,000 million hectares of agricultural land is currently irrigated so output is a fraction of what it could be. As Sven Richter, head of Africa and frontier markets at Renaissance Asset Managers (RAM) and manager of the $102.56 million Renaissance Sub-Saharan fund, puts it: ‘Eighty per cent of Africa is well fertilised, good farmland and there is potential for large amounts of water under Africa’. Put simply, while the world has been used to feeding Africa, future generations may see Africa taking its turn in feeding the world.

Need for speed

Published in October and updated in January, the latest World Economic Outlook from the International Monetary Fund (IMF) describes the MENA region as a two-speed one, differentiated by oil exporters and oil importers. While political and economic upheaval is weakening activity in parts of the MENA region, growth in most of the oil exporting nations is benefiting from higher government spending.

Despite the risk progress could be hindered by drought or civil conflict, the IMF identifies a favourable outlook for Sub-Saharan Africa, where it still forecasts growth above 5% this year. The Democratic Republic of Congo, Gabon, Equatorial Guinea, Angola and Nigeria are seen increasing output by closer to 6%. Continental superpower South Africa is forecast to generate a mere 2.8% GDP increase this year despite of its abundance of mineral riches. Besides deep-rooted structural challenges ranging from the issue of land redistribution to poverty and high unemployment, South Africa’s exports could suffer if the developed world economies of the US and Western Europe continue to struggle.

For the Middle East, the key economic driver remains the energy market and crude oil in particular. The MENA nations can be broadly split into three groups. The first are those resource-rich, labour-abundant countries which produce and export oil and gas and have large native populations, a list that includes the likes of Iraq, Syria, Algeria and Yemen. The second set of nations are resource-rich, labour-importing countries which produce and export oil and gas and where expatriate residents represent a significant percentage or even the majority of the total population. This grouping encompasses the Gulf Co-operation Council members Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, Libya and the United Arab Emirates. The final batch includes resource-poor nations with limited oil and gas production or who are net importers of hydrocarbons, such as Egypt, Jordan, Lebanon, Mauritania, Morocco, Tunisia and the Palestinian Authority.

For those states blessed with hydrocarbon wealth the challenge is to use it to keep discontented populations sweet and at the same time develop more diversified economies which are less reliant on a volatile energy market. The net importers of oil and gas need to manage the risk of inflation and keep budget deficits under control as they aim to meet social demands during a period of slow global growth.

Ways to play

Africa has 29 stock exchanges which represent the capital markets of some 38 nations and the general theme across the continent’s equity markets is one of improving liquidity. Yet it remains tough for the UK investor to access African equities directly. A better, less time-consuming and safer option may be to buy some of the select band of corporate names with a listing on the London Stock Exchange (LSE) whose earnings are derived from Africa, or else purchase a collective investment scheme offering diversified and cost-effective exposure to the African growth story.

Key resource plays listed on the LSE include Anglo American (AAL), the £26.4 billion cap mining behemoth with huge coal, platinum and iron ore businesses in South Africa, Namibia, Zimbabwe and Botswana. Other notable resource names include Randgold Resources (RRS), a gold miner in Mali and Côte d’Ivoire, as well as Lonmin (LMI), the platinum group metals producer with operations situated in South Africa’s Bushveld Complex. Investors can play Africa’s abundance of oil and gas riches via Afren (AFR) and Tullow Oil (TLW), the FTSE 100 constituent also quoted on the Ghanaian and Irish stock exchanges.

As we highlighted last week (see Cover, Shares 24 Jan) the emergence of an increasingly affluent and aspirational consumer class across Africa now represents a key investment theme. Thankfully, there are a number of ways in which UK-based investors can ride the boom, among them Vodafone (VOD), the world’s largest mobile telecoms company. It has a significant presence in South Africa, Ghana and also Kenya, where it owns a 40% stake in mobile phone company Safaricom (SCOM:NB).

Food and beverages giants offer an additional way to tap into this trend. FTSE 100 brewing giant SABMiller’s (SAB) beer brands are popular across the continent. This was demonstrated by last week’s (22 Jan) third-quarter update, which highlighted 4% organic growth in lager volumes as the £47 billion cap benefited from strong growth in most African markets. Meanwhile premium alcoholic drinks giant Diageo’s (DGE) beer and spirits brands are harnessing the region’s growth potential too. Guided by chief executive officer (CEO) Paul Walsh, the £45.8 billion cap continues to invest in marketing Guinness and Johnnie Walker to capture the rising purchasing power and taste for brands across Africa.

Investors seeking to tap into the long-term potential of African agriculture might examine prospects at Zambeef Products (ZAM:AIM), the Zambia, Ghana and Nigeria-focused producer and seller of beef, pork, chicken and even edible oils. Those looking for a continental option could plug into prospects at Swiss multinational Nestle (NESN:VX), which has the stated aim of tripling its business in Africa by 2020 through organic growth alone.

Collective opportunities

Given the difficulties in accessing African and Middle Eastern markets directly and in selecting stocks in companies whose operations are so far away, a regional exposure through a well-diversified collective looks a sensible strategy. In the open-ended investment company (Oeic) universe, the £101 million Fidelity Emerging Europe Middle East and Africa fund run by Nick Price offers portfolio exposure to nations such as South Africa and Nigeria through interests in the likes of communications giant MTN (MTN:JSE), media group Naspers (NPNJ:JSE) and Nigerian Breweries (NB:LG).

Another canny way for investors to access the African growth story is via the Investec Africa Opportunities fund. This $104 million book aims to deliver long-term total returns through companies either domiciled in Africa or established elsewhere but generating a growing proportion of their business within the continent. Run by South African-born money manager Malcolm Gray, the portfolio’s interests range from Nigeria’s Zenith Bank (ZENTIHBA:LG) to Telecom Egypt (ETEL:CA) and resources play Impala Platinum (IMP:JSE).

Shares also has faith in the expertise of David Mcilroy, manager of the Alquity Africa Fund, a long-only portfolio aiming to deliver double-digit annual returns through investments in African-listed equities or companies listed outside of Africa yet generating the bulk of their sales and profits from the continent. Another option is the Templeton Africa fund run by star manager Mark Mobius, a $16 million book launched last May whose holdings include MTN, Kenya Commercial Bank (KCB:NR) and Anglo American. Emerging and frontier markets specialist Mobius is also the investment brains behind the Templeton Emerging Markets Investment Trust (TEM), a closed-ended long-term capital appreciation focused book that invests in companies operating in or listed on the stock markets of emerging markets including Africa.

It is difficult, nearing impossible for retail investors to participate directly in the Middle East equity markets due to restrictions on foreign ownership and a lack of liquidity and transparency. In fact, with no mainstream UK-based brokers allowing you to trade any of the Arab bourses, collective funds offer the best way for UK-based investors to play the region. According to fund information provider Morningstar, around 60 open-ended funds offer exposure Africa and Middle Eastern equities. Investment trusts are thin on the ground in this area, although we are fans of the solitary name thrown up by a screen of the site for Africa and Middle East equity vehicles. This is our key pick, the Qatar Investment Fund, currently trading at a 5.3% discount to its net asset value (NAV).

Qatar Investment Fund (QIF) $0.95 buy

London-listed Qatar Investment Fund (QIF) offers a play on one of the world’s fastest growing economies, Qatar, and the wider Gulf Cooperation Council (GCC) region. Politically-stable and hydrocarbon-rich Qatar is readying itself to host the 2022 FIFA World Cup as it invests aggressively in infrastructure and growth.

The £125 million cap fund seeks to tap these trends via investments in Qatari equities listed on the Qatar Exchange. It can hold up to 15% in companies listed elsewhere in the GCC region.

At the time of writing, the portfolio has 20 positions of which 17 are in Qatar, two in Oman and one in Dubai. Dominating the top ten list are financial services firms including Qatar National Bank, the country’s largest bank by assets, Commercial Bank of Qatar and Doha Bank, although the portfolio also offers exposure to the likes of Barwa Real Estate and Qatar Telecom.

A trading update notes the Qatar market trades on a 2013 price/earnings (PE) ratio of 8.8, cheap versus peers including Saudi Arabia on 9.7 times and Kuwait on 9.6, while the Qatari market is also well-supported by significant dividend payouts with a 2012 estimated dividend yield of 5.2%. A 5.3% share price discount to a net asset value of $1.0026 a share suggests a buying opportunity.