The lure of sub-saharan Africa, with its geographic proximity and promise of higher returns, is tempting cash-rich Gulf Arab bond investors to look south, a marked departure from the relative comfort and familiarity of the Middle East.
Gulf investment in Africa is not a new trend, with numerous examples of strategic as well as opportunistic forays into the continent in sectors such as telecommunications, agriculture, and healthcare, through mergers and acquisitions, private equity deals and foreign direct investment.
Although timely and complete data on Gulf investment in Africa is not available, analysts say it broadly follows increases in annual trade between the Middle East and Africa, which has grown fivefold to $49 billion over the past decade, according to Standard Chartered Bank.
Deploying cash into the continent's debt markets, though, would signal a new form of investment, supported by increased US dollar-denominated issuance from Africa to help fund massive development and infrastructure needs.
"The increased issuance from African names in hard currency has started to attract regional (Middle Eastern) investors who are looking for new investment opportunities to diversify risk, and invest in higher-yield opportunities," said Dilawer Farazi, portfolio manager at UAE-based asset manager InvestAD.
The company launched a fixed income fund in November to focus on Africa as well as the Middle East. Along with Morocco's Attijariwafabank, it also said it would launch a fund to invest in African-listed equities.
Yields on emerging market bonds have slumped to historic lows this year as global investors have scrambled to put excess liquidity to use. With safe-haven assets such as U.S treasuries offering low single-digit returns, investment into riskier bonds in "frontier markets" has risen.
Last year, African bonds delivered returns of almost 20 percent according to the JP Morgan Emerging Markets Bond Index. Although yields on African bonds have also tightened, they are still higher than other markets.
Farazi said that many African issuers tend to be lower rated than issuers in the Middle East and hence the yield pickup, but if investors are comfortable with the credit story and the risk, Africa throws up some good opportunities.
In April, Rwanda, ravaged by genocide 19 years ago, sold a$400 million bond, its first international debt sale, with a coupon of 6.625 percent, partly to fund infrastructure projects.
Though still a nascent market, new U.S. dollar issuance from sub-Saharan Africa is likely to increase in 2013 from just under $10 billion last year. Kenya, Angola and Cameroon could be among first-time sovereign issuers over the next couple of years, according to the IMF.
"Demand for African fixed income assets is growing, and Middle East investors are becoming more active in buying sub- Saharan Africa bonds," said Rupesh Hindocha, head of credit trading for Middle East and North Africa at Standard Chartered Bank in Dubai.
"For Middle East investors, the historical trade links, for example with East Africa, plus a strong commodities play on many potential African issuers, make sense."
Hindocha said regional accounts, particularly asset managers, have been more "active" in trading African bonds in recent months but did not wish to give any quantitative volume data. Recent new issues out of Africa had attracted interest from the Middle East on the secondary market, he said.
One of the biggest factors that could mobilise Gulf investors into African debt markets is the development of Islamic finance on the continent, and specifically, issuance of Islamic bonds, or sukuk.
New issues of sukuk, including issuance in local currencies, jumped to a record high of about $121bn worldwide in 2012, according to Thomson Reuters data, from around $85bn in 2011. But outstanding global demand for sukuk totals about $300bn, according to an estimate by Ernst & Young.
"While Africa, hungry for investment, has a large Muslim population, the Gulf states contain considerable wealth. Put these two together and one has a compelling argument for the involvement of the Gulf states in African Islamic finance," said John Bates, emerging markets fixed income analyst at PineBridge Investments, in London.
Last year, South Africa, by far the largest and deepest bond market on the continent, announced plans for a sovereign sukuk which would have specifically been marketed to Middle Eastern investors.
It is believed the government had mandated at least two Gulf banks to help arrange the transaction as well, but so far, a deal has proved elusive. Nigeria, Kenya and Tanzania have also expressed a desire to issue global sukuk.
But there are risks.
"The legal systems are largely untested and given the propensity of Islamic finance to be linked to underlying physical assets, the issue of title presents challenges," Bates said.
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