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AFK Is Even More Underrated Now (NYSEARCA:AFK)

Emerging markets are coming out of a lost decade. Africa’s lost decade was even more extreme. This chart, rebased to facilitate easy comparison, shows how drastically the VanEck Vectors Africa Index ETF (AFK) has lagged the emerging market universe, as represented by the iShares MSCI Emerging Markets ETF (EEM) :

Source: Thomson Reuters Eikon

Yet Africa’s rapidly growing middle class and improving infrastructure indicate that African stocks are one of the best values for the 2020s. In a previous article, I provided more detail on the long run opportunity in Africa. In this article, I’ll focus on how Africa is likely to come out of the COVID-19 pandemic a lot better than most people are expecting.

Africa and COVID-19

As the COVID-19 pandemic started spreading, most people were anticipating humanitarian disasters in the developing world. To some extent, this was a reasonable prediction. Many developing countries did not have anywhere close to the medical system capacity necessary to deal with a pandemic. Expectations for pandemic response and recovery were especially low for Africa.

Yet overall, Africa has done much better than expected, leaving scientists baffled. Africa has approximately 17% of the world’s population, but only 3.5% of the world’s COVID-19 cases. Even assuming undercounting of cases, that is remarkable.

Why has Africa managed to exceed expectations? First of all, Africa has an extremely young population. The median age in Africa is under 20, and only 3% of the population is over 65. This not only helps drive long-term growth, but has also helped mitigate the impact of COVID-19. Part of the reason the death toll was so bad in places like New York and Italy was their densely populated elderly population. Additionally, some analysts have speculated that exposure to other microbes also helps Africa in dealing with COVID-19. At the very least, Africa has extensive experience dealing with outbreaks of Ebola and other diseases that are far more severe than COVID-19. There are certainly institutional weaknesses in Africa, but when it comes to pandemic response, they have done well considering their economic resources. For example, South Africa and Rwanda carefully screened incoming travelers and imposed full lockdowns. Across Africa, countries had strict lockdowns, and they appear to have worked.

It’s possible that Africa was actually too strict. The lockdowns have had many unintended consequences. Treatment of malaria and HIV, along with routine vaccinations, has fallen by the wayside and will take a long time to get back to normal. The economic consequences were also severe, especially considering a large portion of the population survives in the informal economy. The unemployment rate shot as high as 50 percent in some countries.

Now Africa is starting to open up again. South Africa will reopen its borders in October. Nigeria has reopened schools. Bars and restaurants have been returning to normal in Ghana.

Africa’s economy is likely to perform better than expected as the country opens up . Africa’s economy is taking a hit, but it might be less bad than the rest of the world. This creates an intriguing opportunity for investors.

Africa Economy

Many Sub-Saharan African countries are going to outperform the global economy, according to Charles Robertson at Renaissance Capital.

As this chart shows, Africa is facing a recession, but it is likely to be milder than what we experienced in the West.

Source: Financial Times

There is wide variation in the performance of individual countries. Although South Africa and oil dependent countries such as Nigeria, Angola and Gabon are likely to contract, Ghana, Kenya, Rwanda, and several others are expected to grow this year. This contrasts sharply with many western economies.

The Africa ETF Portfolio

It’s relatively difficult for US based investors to get broad African exposure. The only ETF option is AFK. The ETF structure is convenient, but limits exposure to some of the less liquid markets. The management fee of 0.50% and net expense ratio of 0.79% seem reasonable given the operational difficulties investing in Africa.

AFK’s largest portfolio allocation is in South Africa with 31% of the portfolio. South Africa probably had the worst COVID-19 outbreak and recession, although its stock market includes many strong companies with global operations. Other major country exposures include Morocco (17%), Nigeria (10%), and Kenya (9%). AFK also has 9% of its portfolio in mining companies listed in Canada. As Africa develops its capital markets and asset management industry, the portfolio will likely become less dominated by South Africa. The move towards more integrated capital markets in Africa will likely lead to deeper and more liquid markets that can attract a greater range of foreign investors.

AFK’s portfolio includes large exposure to the basic material sector, mainly consisting of miners. This allocation will provide a lot of upside if commodities come back into favor. The financial sector exposure will also benefit as Africa improves its financial and physical infrastructure, although there is the risk of problem loans. The telecommunications and technology sectors are likely to be growth areas in coming years, although they are small portions of the portfolio at this point.

This chart shows the industry allocations in AFK’s portfolio:

Source: Thomson Reuters Eikon

AFK Valuation

As this table shows, African stocks are a lot cheaper than emerging markets, and very close to frontier markets. This seems unreasonable given Africa’s surprising resilience during the pandemic.

Average P/E

Average P/B

VanEck Vectors Africa Index ETF (AFK)

11.70

1.53

iShares MSCI Emerging Markets ETF(EEM)

15.50

1.72

iShares MSCI Frontier 100 ETF (FM)

10.44

1.50

Source: Fund websites

Note that FM has 49% of its portfolio in financials (compared to 30% for AFK). Banks typically trade at low valuations, especially in emerging markets. This drags down its overall valuation. AFK is a comparative value in the other sectors of its portfolio.

Conclusion

After a lost decade and a pandemic, most investors underestimate or simply ignore Africa. Yet, as the world wakes up to Africa’s demographic strength and comparative resilience, more investors are likely to look more closely. Long-term investors should seriously consider investing in Africa before the crowd. AFK is the easiest ETF option in the US.

Disclosure: I am/we are long AFK, FM, EEM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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