Look Sharpe: Do the Rewards of African Stock Markets Outweigh Their Risks?

I talk a lot about the rewards of investing in African stocks. And it’s (in my entirely biased opinion) with very good reason.

Most of the African stock markets outperformed the S&P500 quite handily over the past five years and appear bargain-priced for the next five.

But astute investors consider the risks when assessing these potential returns. So, how can we determine whether the reward is worth the risk?

The Sharpe Ratio helps analysts to determine exactly this.

I talk a lot about the rewards of investing in African stocks. And it’s (in my entirely biased opinion) with very good reason.

Most of the African stock markets outperformed the S&P500 quite handily over the past five years and appear bargain-priced for the next five.

But astute investors consider the risks when assessing these potential returns. Currencies can depreciate. Political crises can erupt. Commodities can nose-dive. Stuff like this can make the price charts of some African indexes look like something out of The Perfect Storm.

Take a look at the below chart. The percentages in the “Volatility” column indicate the monthly standard deviation of each index over the past five years. You’ll note that while most African markets outperformed the benchmark S&P500 index, most (with a few interesting exceptions) also traveled a much more bumpy road to get there.

Index Total Return (1/2007 – 1/2012) Volatility of Monthly ReturnsĀ (1/2007 – 1/2012) Annualized Sharpe Ratio
MSCI Botswana Index (4.6%) 5.2% (0.16)
MSCI Kenya Index (30.8%) 11.1% (0.24)
MSCI Mauritius Index 72.3% 9.9% 0.26
FTSE JSE Namibia Local Index 135.5% 5.2% 0.85
MSCI Nigeria Index (44.4%) 12.0% (0.33)
iShares MSCI South Africa Index Fund 36.2% 9.1% 0.13
Tanzania All Share Index 9.7% 3.5% (0.01)
Uganda SE All Share Index (34.3%) 9.3% (0.32)
Lusaka SE (Zambia) All Share Index 65.6% 9.3% 0.25
S&P 500 Index (8.1%) 5.7% (0.19)

So, how can we determine whether those juicy returns were worth an extra queasy stomach?

Photo by MikeBaird

The Sharpe Ratio helps analysts to determine exactly this. It measures risk-adjusted returns by subtracting the risk-free rate from the return and dividing by the standard deviation. The higher the Sharpe Ratio, the more worthy the investment.

As you can see, all the markets above outperformed the S&P500 on a risk-adjusted basis except for Kenya, Nigeria, and Uganda where political instability and currency volatility conspired to create some very unhappy investors. Mauritius, Namibia, South Africa, and Zambia, on the other hand, utterly crushed US stocks.

So, the results are mixed. But I believe this analysis helps demonstrate that African stocks merit a close look from international investors.

Related Reading

Correlation (or Lack Thereof) Between African Stock Markets

One thought on “Look Sharpe: Do the Rewards of African Stock Markets Outweigh Their Risks?”

  1. I totally agree that Africa needs to be looked at for the investment potential, and as a continent has a compelling long term investment story to tell. But Africa as continent is not an investment whole in terms of macro, politics, liquidity, governance, and while the long term is exciting, and as it is said “we will all be dead” it is the short term volatility that can kill you with the wrong timing. It reminds me of sage advice when I started to look at Turkey in the early 1990’s when I was told “you either invest by finding good managements and companies you believe in, buy them, and then close your eyes for a few years, or you trade it madly!” Take a look at Egypt this year where from the top down it seems it is running into a brick wall, and yet you could have got superb returns from a trade there. Nonetheless it seems a sensible approach to first chose the market, then look at the valuations and stories, but the real pricing anomalies come out of inefficiencies, distress, and the very market difficulties that cause the high volatility and cheap valuations. These would pay to study carefully to gain comfort for the correct entry point for what could be a good change for the better. it would be interesting if you look at the more liquid money and debt markets to see what returns you would have made instead of chasing/avoiding the volatility of the equity markets. Nice article so many thanks

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