February 24, 2014

Oliver Bell Oliver Bell, manager of the T. Rowe Price Africa & Middle East Fund.

Structural reforms and strong economic growth are fueling equity outperformance and attracting increasing investor interest in the Africa and Middle East region.

Although the region's average performance lagged frontier markets in 2013, mainly due to weakness in South Africa, it outperformed in each of the prior four years. (See chart below.) T. Rowe Price managers expect that trend to continue.

Africa and Middle East (AME) Region Outperformed Global Frontier Markets

Note: Indices used are the MSCI Frontier Markets Index and the S&P Emerging/Frontier ME & Africa ex IL Index, which includes all of the daily priced, free-float market cap covered by S&P across the Middle East and Africa, excluding Israel. Sources: T. Rowe Price and MSCI.

Africa has been one of the world's fastest-growing regions in the last decade, and the International Monetary Fund predicts it will account for seven of the world's 10 fastest-growing economies from 2011 to 2015.

Oliver Bell, manager of the Africa & Middle East Fund, says that Africa is at a stage of growth and development similar to Asia and Latin America in the mid-1990s.

"Africa is transforming faster than anyone realizes," he says. "I think the single biggest upside for Africa is that there is a huge gap between most investors' perception and the reality. Companies are growing rapidly, and the political situation on the ground is vastly better. As that gap closes, people will look at these companies in a very different light."

With a reduction in armed conflicts across Africa, democracy is taking hold, he notes. Fifty of 54 African countries have held elections in the past three years. The improving stability, along with progress in rooting out corruption, is attracting more foreign investment and boosting economies.

"Overall, the region offers better governance, attractive demographics with the world's youngest population, rising urbanization, infrastructure investment, and a strong asset base in natural resources," Bell says.

Indeed, new oil and gas discoveries in East Africa are an added bonus. Mozambique, one of the world's poorest countries, has discovered more commercial gas than exists in Australia. Tanzania also is sitting on large gas reserves. And Kenya's oil reserves are about the same size as those in the North Sea, Bell says.

Another misperception concerns the quality of management, which Bell says has improved as educated Africans are beginning to return from abroad for opportunities at home.

One of the most important structural reforms, he says, has been the privatization of electricity generation in Nigeria: "The single biggest hurdle to all the sub-Saharan African countries is energy. So just having an energy grid that's on 24 hours a day without interruption is going to have a massive impact."

Bell also is optimistic about long-term prospects for the Middle East but has medium-term concerns over a feverish pace of building in Saudi Arabia, United Arab Emirates, and Qatar that could lead to overheated markets in the next few years.

Such nascent economies and undeveloped markets, of course, can be more volatile and pose relatively higher risks for investors. Political risks remain a big concern, as transitions of power can stir violence, Bell says. Also, leaders tend to overspend and overinvest leading up to elections, causing such "economic hiccups" as inflation and currency weakness, he says.

Nevertheless, Bell says, "I think there is a strong chance that the Africa and Middle East region will continue to outperform because its economic growth could be higher than emerging markets generally. Africa could continue to surprise everyone because of the structural changes taking place."

Investing in frontier markets entails a range of risks, including those associated with volatility, liquidity, regulation, corporate governance, currency rates, and politics.