Investing in Africa Beyond Natural Resources: Interview with Robert Scharar of Commonwealth Funds

It would appear as though investors just haven’t been able to look at emerging markets with the same kind of fondness and longing since the Federal Reserve began floating trial balloons about reducing Treasury spending last year.

And since the Fed actually began implementing cuts to the Quantitative Easing program, the situation hasn’t much improved, as the substantial outflows of investor cash from exchange-traded funds since late 2013 should attested. But it must be said that timing has also played a role in further compounding the situation for emerging market ETFs.

Indeed, the announcement of the dreaded “taper” of fiscal stimulus was followed by growing uneasiness over the future trajectory of the Chinese economy, and then more recently by the as-yet unforeseeable outcome of wildly fluctuating tensions just west of the Russia-Ukraine border.

All of this has made for a rough time for emerging market investors, even those endowed with the stomach for bigger risk-taking. That said, it should be remembered that much of the fundamentals that have turned the BRICS into a fulcrum of the world economy are largely still in place and their regularization should be welcomed and encouraged, even (and perhaps especially) if this comes at the expense of speculative bonanzas.

It is in this context that the work of Robert Scharar should be of special interest to Equities.com readers. With a long experience in international investing, Mr. Scharar is obviously a veteran in his field. But with the November 2011 launch of his Commonwealth Africa Fund, he might also be described as something of an innovator as well.

Commonwealth Africa is the outcome of over two decades of boots-on-the-ground experience in facilitating private investments throughout the sub-Saharan portion of the continent. For all of the preoccupation with the developing world, markets have remained stubbornly oblivious both to opportunities outside of the ETF space as well as to Africa’s considerable and growing potential, especially with regard to the many opportunities that exist there outside of the natural resources space.

Equities.com: You have at least a couple decades of involvement in African business to your credit, and I imagine you’ve been aware of the continent’s potential for some time now. But the Commonwealth Africa Fund is relatively young. I was hoping you could tell our readers, why Africa? and why now?

Robert Scharar: Well, it’s a huge continent, made up of a lot of different cultures, political systems, geographies, and languages. “Africa” is used as an all-embracing term, and one that I think really oversimplifies this. In fact, I always get a kick whenever I’m giving a talk somewhere with other speakers and they refer to Africa as a country, and not a continent.

EQ: You really do see that quite a lot. It’s somewhat similar to what you hear when people talk about the “Middle East,” or even “Asia” in monolithic terms. It’s much easier to use a broad term than to take account of the many particularities of each situation, especially when these particularities are so intricately layered.

RS:Those who stakeout Africa do it for different reasons. You have people of African heritage, African-Americans for example, largely of West African heritage. And they have their own particular views and emotions about the continent. You have the politicians, who try to do it in the US for all kinds of reasons. You have the humanitarians who will have you believe that everyone in Africa is homeless and starving.

And then, you have the financial markets and Wall Street, who largely ignore it.

The America Fund is a good example. In one of their reports, there was a chart listing the dividends for all the different parts of the world, except for Africa. They basically ignore the whole continent because they assume that there couldn’t possibly be any opportunities there. Meanwhile, the South African stock exchange has been around for 150 years, so it’s really almost an expression of arrogance.

So we started facilitating investments in Africa on a private basis over 20 years ago and, through a series of events, we ended up not in a mutual fund but in a private undertaking, becoming a controlling shareholder of an insurance group listed on the Malawi Stock Exchange. Now we’re now in five countries. So I’ve been going and actually participating on the board and chairing the audit committee, among other things, since the 1990’s.

In that time, I’ve observed a lot of very positive developments. I witnessed the middle-class boom first hand. I saw young professionals staying in their countries, trying to do things. The education was improving and so was the infrastructure. I noticed there were stock exchanges springing up all over, and civil societies were demanding more transparency and peaceful transitions of some of the governments.

After doing this for almost 20 years I decided to create a pure Africa Mutual Fund. Not a private investment but a pure fund, and now here we are. We’re a well-kept secret because we’re very small, but we have a wealth of knowledge because of our activities on the continent. What we’re trying to do is basically build a portfolio for people in the US who want to invest in publicly traded companies that, essentially, are based in Africa or are generating their business from the African continent. And we’re trying to get into as many markets as we can. Some of the stock markets are very small, so as the fund grows it will give us more scope to be able to do that and over a pretty broad cross-section of sectors.

Africa is obviously replete with resources, but not just mineral resources. In fact, the mineral companies: you can actually buy those, you don’t have to go buy an African mutual fund if that’s what you are looking for. So, we decided from the start that we wouldn’t over-emphasize the mining sectors in the African market. That wasn’t going to be our goal, because the continent has so many other resources, in particular this labor pool that has been growing. There are a lot of opportunities for tourism, and the financial markets are rapidly changing. I mean, I watch people in Africa do banking over the internet, buy insurance over their cell phones – these are huge leaps, and there’s a lot involved in that. So we said we’re going to try to build portfolios, and at least in some respect, look to the consumer in the marketplace, as well as to the companies, often Africa-based, even some based in South Africa who are looking at expanding all over the continent.

So, for instance, you have supermarket chains that are in many countries today – you know, one chain in multiple countries. You’re seeing insurance groups going Pan-Africa, you’re seeing banking groups going Pan-Africa. Telecommunications companies, transport companies, even distribution companies to get the goods and services around; all of those are Pan-Africa stories. And within that context, we’re seeing companies providing consumer goods, whether it be retail services or manufactured goods and food products for consumers. We’re not so much looking at the primary producers, the agriculture, but more the distributed product. And so that’s sort of our story.

Here’s a continent with great growth and consumption that is leading to demands for better housing, and for better access to material goods. We had a really interesting experience about ten years ago, when we were participating in building a new shopping center. And everyone told us at the time, our insurance group being one of them, that it was never going to work, that there wasn’t enough money to support this center, being that it was in one of the smaller countries in Africa. But the final results were unbelievable. The volume was huge, we got a major South African supermarket chain to come in there, and I think it’s probably one of their better stores.

Furthermore, once quality goods became available, people started coming out of the woodwork. And when you go in there, one of the things I like to do when I take people there, is take them to the back of the store. There’s a line anywhere from 10 to 25 people waiting for slices of bread. They’re making fresh bread, slicing it, and you see people coming in there and buying a loaf of bread and two or three other things using the express line, and at the same time you find people shopping just like they do in the US. So, once the services were there and the quality of the goods were there, it impacted the local marketplace, because what happened was that the competition all of a sudden had to get the out-of-date cans off the shelf and clean up their stores, and it really changed the whole dynamic. And there’s just a lot of money in Africa to buy consumer goods if they have something worthwhile to spend it on.

EQ: You certainly paint a very hopeful picture here, one that is in stark contrast to what is often reported about the African continent. But for all of the negative press, and even though there’s not maybe the sense of urgency that one might want to see from US investors vis-a-vis African growth, the conflicts that have rekindled rather viciously over the last six months, like in the Central African Republic, or between Sudan and South Sudan right now, which are pretty huge, intractable conflicts, they don’t seem to be diminishing people’s interest, all the same.

RS:Now I know there’s some areas of Africa I could find, maybe if you go to the Sudan, or some of the northern countries, where there are terrible things happening. But that masks all of the positive things that are happening. I have never, in my life, in all the times, over 50 times I’ve been there, ever seen anybody dying on the street corner. Like, you know, how you see and hear about in India and other places. I’ve never seen that.

And in those areas actually, you know, there’s no stock markets in the Sudan. Those are areas that really are subsistent, which you also find when you venture further south into the continent. You find it where you have high-levels of political unrest, like you mentioned the Congo, or the Central African Republic, as well as in the the northern portion of the continent, it’s a whole different environment there. There are a lot of have-nots. A huge amount of have-nots, with no capitalist structure and no place for a change, there are few alternatives to the nomadic lifestyle.

EQ: Indeed. Saharan existence is notoriously severe, for instance.

RS:That’s true, but you know, when I first went to Malawi, I found that Deloitte had already been there for 30 years, and that KPMG had an office there. There’s an accounting society – I once gave a talk at the accounting society as a matter of fact. Most people have no idea that any of that stuff exists. But there is indeed a formal sector, and Malawi has an excellent university, especially the medical school.

The people are doing all these things in small doses with locals that are changing the environment. Of course, you still have significant political issues, but there’s a demand for transparency. People are becoming less and less willing to have their leaders rip them off.

The last year has been really tough. The emerging markets have all gotten hammered. The currency, South Africa’s currency, has reached a new low in recent years. But it’s interesting to me. People think that somehow you’re going to figure out the exact day to go back into the market. That’s not how it works in these markets at all, I don’t think.

So there has to be some recognize that you have to sort of dollar average in. And you hope that you dollar-average in more at the low point than you do at the high point. But if you don’t do that, if you miss those opportunities to be in the market, and I think that it’s a good diversification from the US investor’s point of view, to have some funds in those markets. And the laws work like here. They have a system of laws based on English law in many of the countries. They have regulations, insurance is enforced, and you can access legal services. It works like it does here. People don’t come and take your property in the dead of night or any of that. There’s over 30 stock exchanges. You’ll find they’re dominated by financial companies and mining companies.

The big markets are really Nigeria and South Africa – those are the two really large markets. Then you get to Egypt and Kenya, maybe, and go down the chain from there. You know, to give you an idea, I think the financial sectors of the market are about twelve times the size of the consumer sector. But that doesn’t mean you don’t have consumer companies you can buy in a variety of different areas. You know, whether information technology, or health care services, or telecom, or food services, or consumer staples, there’s plenty of opportunities to invest in companies that do those sorts of things.

EQ:Your fund’s holdings seem to reflect that pretty faithfully.

RS:Absolutely. It’s not always readily apparent on our website, I’ve put links to every stock exchange in Africa, which could be helpful to your readers. And you’ll see most of the major African marketplace entities, the regional exchanges, and other information. What I found is people really know nothing about Africa. So I decided to approach this in a didactic format, in order to give people the source information. If somebody wants to learn something about it – if they want to learn about the South African stock exchange, for instance, they can go directly to the website.

EQ: I was going to suggest that maybe this lack of the sense of urgency I was talking about on the part of investors, I would imagine it’s maybe less to do with the perception of risk, than a simple lack of awareness. That has to be a huge part of it as well.

RS:Yes, there really is a lack of awareness. So I’ve felt like people could be helped if they wanted to see more. But our strategy is to provide a portfolio that a US investor is not likely to get on their own. They’re not likely to get it by buying ADRs, because most of the ADR stocks, for example, many countries don’t have any. And most of those tend to be around mining and a few of the big banks, whereas we bought different size companies, and companies which are listed only on the local exchanges, which brings greater diversity than a portfolio of companies that are simply traded elsewhere. But they act a lot like American companies.

EQ: Well this is all very fascinating, and I look forward to speaking with you again so that our readers can learn more about what you’re doing with the Africa Fund. Is there anything else you would like to add?

RS:There is, actually. The thing about us, as managers, is that though we’re a small mutual fund group, we feel as though we are a little bit different. I’m actually an attorney and CPA. I’ve taught courses on international accounting standards before they were en vogue, and so we have a knowledge of those sorts of things as well as the American market.

Our first fund was our New Zealand fund. I started investing in New Zealand in the 80s, and we’ve run the mutual fund since 1991. You know, we have a lot of on the ground experience in these foreign markets, and our expense factors are larger than I’d like them to be, which is largely due to the size of the funds themselves and not our advisory fees.

We are hopeful that those will adjust downward accordingly. And in fact, because we didn’t waive it forever, we can’t put it on the prospectus, but if you look to the report for last year on the Africa Fund and look through the financial statement, you’ll note that we reimbursed most of the expenses for the funds. So we try to do some things to help. That’s not a guaranteed type of thing, but we’ve tried to show that we understand it’s a small fund – otherwise, the expense factor would have been crazy.

Robert Scharar is Sr. Fund Manager of the Commonwealth Funds and President of FCA Corp.