Beyond the carry trade: In search of structural alpha

For at least two decades, foreign and institutional investors with capital flowing into West African capital markets have followed one dominant playbook—buy high-yielding government securities, wait to capture the interest rate differential and exit before currency depreciation erodes the interest rate gain. That is known as the carry trade. It worked, and slowly, it stopped working.

West Africa has recently experienced sweeping macroeconomic reforms, including Nigeria’s central bank unifying the exchange rate, Ghana’s fiscal consolidation led by the IMF, and the monetary tightening across Francophone West Africa. Analysts and economists alike believe that these were necessary corrections, but they have also fundamentally changed the terms of engagement for fixed-income arbitrageurs, especially since 2022. Real yields were once attractive but are now being compressed by the twin pressures of sticky inflation and structurally weaker currencies. The “hot money” cycle that characterised the 2010s, with foreign capital rushing into Nigeria and Ghana for the interest rate and quickly exiting at the first sign of naira or cedi distress, is not just less profitable, but it is also a liability to the same economies that it depends on.

But government securities still retain a tactical role in any diversified allocation. However, government securities serve as a tool rather than a comprehensive strategy. The conflation of the two has not only cost the economies they are in and the opportunities for development but also the institutional investors the returns that are sitting in plain sight in the structural core of the West African economy.

The alpha macroeconomics cannot deliver

Sophisticated allocators in other frontier and emerging markets have internalised a concept within their investment thesis that has been missing in the West African investment narrative: structural alpha.

Structural Alpha is the returns generated by strategic investment in the sectors compelled to grow by structural necessity and not sentiment or guesswork. It is a replacement of the returns obtained from bets made on exchange rate movements or the anticipation of fiscal or monetary policy pivots. The alpha is the outperformance available to investors that are able to identify companies and assets that will directly solve the regions’ most profound and irreversible deficits.

The West African region has a widely known macro story: an exploding population exceeding 400 million people across the region, a median age below 20 and rapid opportunities for urbanisation. But these are the headlines, and headlines do not generate returns; execution does. Structural alpha is found in identifying the specific assets and the right position in the value chain that will monetise the growth with discipline and durability and not in knowing that the population of West Africa is growing—every investor, institutional or otherwise, knows this.

The distinction between macro and micro is important. By ‘macro’, we mean the top-to-bottom economic and demographic conditions that shape West Africa’s investment backdrop and rationale, while by ‘micro’ we mean the deal-specific structuring, operational execution and the local market dynamics that determine the deliverability of specific investment decisions. Consequently, investors that buy broad-based West African funds on the strength of demographics are making a different bet compared to investors backing specific facilities or technologies. The first investors are often making a worse bet through a thesis than the second investors, funding businesses that are solving specific infrastructural problems for the region, such as agri-processing in Kaduna or solar-powered cold storage solving post-harvest loss in rural Ghana.

Three pillars of structural necessity

The first pillar is rooted in West Africa’s infrastructure deficit that is estimated at hundreds of billions of dollars and the energy transition. These are not necessarily problems waiting for resolution, but they present an opportunity awaiting the right capital. Novel systems like decentralised energy systems, off-grid renewables and multimodal logistics assets go beyond being inflation-resistant; they also generate recurring and contracted cash flow in currencies that are indexed to hard commodity prices or are dollar-linked. For patient institutional investors, these are the promises of government securities but have faltered to deliver in real terms.

The second pillar is tied to purpose-built real estate and urban development. West Africa’s real estate story is still told through the lens of luxury residential property in Lagos Island or Accra’s Airport residential area. But that is a rather immature story, and the next chapter will be in student housing, industrial warehousing and data centres that will be servicing the expanding global digital economy. These are the assets that have structural demand drivers, and while they do not require an optimistic economic forecast, they demand an accurate reading of how people live and work.

The third pillar is in agri-processing and import substitution. In a region that, according to the African Development Bank (AfDB), sees its annual food import bill surging toward $110 billion, and this bill is predominantly driven by commodities like wheat, rice, refined sugar, and vegetable oils that we are climatically positioned to produce, domestic manufacturing and agribusinesses are not just commercial opportunities. They are national security imperatives that must attract regulatory support and concessionary financing. The alpha here is in the middle of the value chain, in storage, processing and distribution infrastructure, where there’s a fragmentation that creates persistent pricing inefficiencies that a well-capitalised and operationally rigorous investor can systematically build on.

The policy risk that must be named

Any candid assessment of Structural Alpha will demand intellectual honesty on one material risk: policy execution. There is no investment thesis that exists in a vacuum. Structural Alpha is not an exception. Its framework depends on a working assumption that is far from guaranteed, which is that the macroeconomic and regulatory reforms sweeping through the West African region will continue to deepen and, most importantly, hold.

But they may not. West Africa’s reform trajectory has never been linear. Experienced allocators know better than to mistake a promising cycle for a permanent condition. Nigeria alone is a strong indicator of this reality. We have seen with uncomfortable regularity that policy reversals don’t need catastrophe to materialise. Political pressure, an election cycle or even a slight commodity shock that makes fiscal discipline inconvenient can lead to policy reversal. The unification of the naira in 2023 was a bold stand, but it was also, to many observers, overdue by a decade. That lag itself is a datapoint worth sitting with.

Regulatory uncertainty, land tenure ambiguities and the perennial spectre of fiscal populism are features of the landscape and not just tail risks in West Africa. The cautious institutional reader would be right to press on this point. But the appropriate response is not to dismiss or attempt to diminish the risk. Instead, it is to price it correctly and invest in a manner that does not depend on lofty assumptions of flawless reform execution. Assets with hard collateral, contracted revenues and exposure to sectors with political support, such as food, security, power and housing, tend to carry an implicit hedge against policy volatility. Consequently, it’s important to include in the framework that structure is as important as sector allocation.

The moat of local intelligence

Structural Alpha in West Africa has remained uncaptured by global capital mostly because it has qualitative data points unavailable in a Bloomberg terminal. Institutional memory like deep regulatory relationships, an understanding of government procurement and the ability to conduct rigorous on-the-ground due diligence in markets with unreliable and scarce public information are not tangible for “data-backed” decision-making in the investment process. This is where the distinction between volatility and risk is operationally significant. Volatility is a pricing phenomenon; it is the mark-to-market fluctuations that cause anxiety in portfolios. Risk is the potential for the permanent loss of capital. Consequently, a logistics asset in Lagos may reprice in a difficult quarter, but when fundamentals are solid, that reprice is just noise. Patient capital that understands this distinction will consistently outperform capital that does not.

The decade ahead

The carry trade was a rational response to the market conditions of its time. Those conditions are changing, and the next decade of wealth creation in West Africa will belong to those who will build the cold chains, the data centres, the processing plants and the power grids that West Africa’s young and urbanising population will require and not those that just lend money to governments at high interest rates.

The investors who will align their capital with the structural solutions West Africa desperately needs will not only generate superior returns but will also architect the region’s economic future, and that is ultimately the definition of patient and productive capital.

Mounir Bouba, executive director, ARM Investment Managers, Lagos, Nigeria.