With only 85 days left until the next opportunity for Congress to unleash apocalypse on Wall Street in the form of a debt default, it’s a great moment to think about reducing risk in your investment portfolio. Because bourses worldwide have globalized, a U.S. debt default would almost certainly roil markets from New York to New Delhi. Luckily for the risk-averse, there’s still one set of markets out there that may stay bubo-free when the NYSE catches the plague. If you want to preserve at least a part of your retirement nest egg from Washington-induced calamity, start buying up stocks in Africa.
One of the first rules for successful investment is “diversify your portfolio.” If you want a higher return at lower risk, buy stocks and bonds that don’t rise and fall together. Think builders and debt collectors—builders do well when the economy is growing, debt collectors do better in lean times. An investment portfolio split between construction and debt collection should be considerably more stable than one invested in one or the other.
Globalization gave investors a whole new way to diversify, by putting their money in foreign markets. As barriers to overseas investment fell, savvy investors in the West started putting some of their portfolios in Asian, Latin American, and European exchanges. In theory, this should have reduced risk, since economies don’t all perform the same way at the same time (think China and the U.S. over the past 10 years)—so the stocks and bonds of firms based in different markets shouldn’t, either.
Research by Todd Moss and Ross Thuotte of the Center for Global Development suggests that first movers did gain considerably from that diversity. The monthly correlation between Asian markets and the Standard & Poor’s 500-stock index was roughly zero in 1992; between Latin America and the S&P 500, the correlation was 0.15 (where 1 reflects lock-step movement in price indexes and zero suggests absolutely no relationship between price movements in two different markets). Back in the 1990s, European markets were correlated with the S&P at 0.54. U.S. investors willing to put their money in emerging markets enjoyed a considerably larger diversification advantage by doing so.
But investors put a lot of money into emerging markets. In 1980, 2 percent of all global portfolio investment flows headed to markets outside the Organisation for Economic Co-operation and Development. Now 5 percent of flows go to Latin America, with Asia accounting for another 10 percent. Looking at equity alone, about 0.4 percent of net equity flows went to developing countries between 1980 and 1983. Over the last four years the proportion was 13 percent.
As investors piled into global stock markets—and as other markets from bonds to bank loans to commodities became more integrated—correlations increased. When the New York Stock Exchange sneezed, not only London markets caught a cold, so did exchanges in Bangkok and Buenos Aires. The correlation coefficient for Europe increased to 0.817 from 2009 to 2011. But Latin America overtook that, to reach a correlation of 0.823. Asia wasn’t far behind, with a correlation of 0.71.
That leaves only one place left to go to get the diversification that risk-averse investors crave. It might come as a surprise to aficionados of sovereign credit rating agencies, but nowadays Africa is the low-risk option of choice. While South Africa’s exchange falls and rises with the S&P like most of the rest of the developing world, the markets farther north in the sub-Saharan region saw a correlation with New York’s exchange of just 0.36 from 2009 to 2011. Similarly, the Middle East and North Africa saw a correlation of 0.41.
Moss and Thuotte note that investing in African exchanges is hardly straightforward: The entire market capitalization of sub-Saharan stock exchanges outside of South Africa was a little less than $100 billion in 2011—compared with about $16 trillion for the NYSE. Most markets in the region have a total capitalization smaller than the average value of a U.S.-listed firm, and the majority of exchanges have less than 40 listed companies. Developed-country stock exchanges typically see annual turnover on a scale about equal to capitalization. In African markets, turnover is often below 10 percent. In 2011, the total value of shares traded on the Kenyan exchange was around $1 billion, for example. That value is traded on the NYSE about every 15 minutes. The small size of share sales and lack of liquidity increase the costs and complexity of investing.
Nonetheless, African exchanges look to be a good move for global investors who want a diversification play. The region has posted its strongest growth performance in decades, and fundamentals from inflation to debt ratios look healthy. But don’t wait too long: Sooner rather than later, the region will likely follow in the footsteps of Latin America and Asia. African exchanges will become similarly integrated with the rest of the world. All of which means that should Washington keep stumbling into debt crises, the only good diversification strategy left may involve extraterrestrial investment.