Frontier Market ETFs: Guide to the Africa Index ETF (AFK)

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The Africa Index ETF (AFK) is one of the most cited ways for most retail investors to have an exposure to African markets in their portfolios. Trading in AFK began in July 2008, where it was one of the first ETFs to focus on Africa as a region. Requirements were that companies needed to generate the majority of revenues in Africa, or have their headquarters there. Despite great performance in Africa according to our Market Dashboard last year, AFK has traded sideways for the past 3 years, so we took a closer look at it for prospective investors.

1. Since 2013, AFK has replicated a GDP-weighted index

Prior to June 2013, AFK replicated the performance of the Dow Jones Africa Titans 50 Index. They have now switched to their own Market Vectors GDP Africa Index (MVAFKTR), which is a GDP-weighted index. In other words, the bigger the GDP of a target African country, the bigger the weighting it gets in the index. With this methodology, you would expect South Africa, Nigeria, and Egypt to have the biggest weightings, and as of AFK’s last report, these are indeed the top three countries represented, not including companies domiciled outside of Africa.

Given almost all of Africa ex-South Africa is considered a frontier market, this bodes well for retail investors looking for African frontier market exposure. However, for those looking to participate in the growth of smaller countries (eg. Botswana and Rwanda) or countries that are starting from a very low base of GDP, AFK would not be the best investment.

2. Expenses could begin rising after May 2014

One of the key factors when investing in ETFs is ensuring that expense ratios are under control. AFK has had it’s expenses capped at 0.78% a year as per an agreement with its Board of Trustees, an agreement that is set to expire in May 2014. While slightly on the high side, the expense ratio is not unexpected given the difficulty of investing in emerging and frontier markets, especially Africa. However, it is concerning that this ratio could begin rising in the near future; the gross and net expense ratios as of Feb 2014 were already 0.91% and 0.80% respectively.

3. Almost 69% of holdings are domiciled in Africa

One concern when buying frontier or emerging ETFs is that the majority of holdings are US or UK listed companies that just happen to conduct business in a certain market. While this is obviously helps with liquidity concerns, this also increases the correlation between frontier market ETFs and developed markets, nullifying one of the basic benefits of investing in frontier markets.

In this regard AFK does reasonably well, with a clear majority of its holdings domiciled in African countries:AFK Country Breakdown4

Companies headquartered in eight different countries in Africa are represented in AFK, most notably Sierra Leone with a token 0.3%. AFK also holds a wide range of securities, with 108 different stocks total and zero bonds. While at first glance Angola seems to be a large omission, many of the offshore entities are for oil companies that do a lot of business in Africa. All in all, investors can be assured that they are getting a more “African” ETF rather than companies that just do business there.

4. AFK is a smaller-sized ETF

With just over $110m USD in net assets, AFK is a smaller-sized ETF with average volumes of just over 20,000 shares over the past three months. For retail investors, liquidity should not be a major concern. But with the ETF performance almost flat over the past 3 years, net assets are not growing and expenses could be rising as a result. AFK does have the benefit of being one of the few ETFs aspiring to represent Africa though.

Conclusion

We were pleasantly surprised by the high composition of African domiciled companies held by AFK. For investors looking for broad exposure to the African continent, with a focus on South Africa, Egypt, and Nigeria, AFK is a decent choice. However, as with all passive investments we would keep a close eye on expense ratios after May 2014, and returns have been subpar in this ETF despite strong years from Africa overall.

 

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