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16 March 2021

Why institutional investors in Africa must increase their investment in private markets

This article was originally published by the East African on 16 March 2021.

Despite a total of US$ 22.6 bn in private equity and early stage venture capital having been raised for Africa between 2014 and 2019, investments in private equity today account for less than 1 percent of total pension assets for most countries in sub-Saharan Africa.

In contrast, globally, allocations to private assets such as private equity (PE), private debt (PD), real estate and infrastructure now make up around 26% of global pension fund assets, up from 19% in 2008. In the US for example, the number of publicly listed companies has dropped by about half, over the past two decades from 8,090 in 1996 to 4,397 in 2018.¹ The increasing ability of entrepreneurs to access private capital has encouraged a shift from public market capital-raising. Firms are also staying private for longer. If the trend witnessed globally where listings in public markets is anything to go by, then private capital markets are yet to reach their full potential in Africa.

In Africa, private equity and private debt markets have hitherto been dominated by development finance institutions with very limited participation by domestic institutional investors. Although this may be sustainable in the short to medium term, it is imperative for long term sustainability to mobilize domestic institutional capital into the space. On aggregate pension funds remain the single largest institutional investors in Africa, the assets under management by pension funds currently stands at approximately USD 420 billion with total institutional investor assets standing at approximately USD 1 trillion.² A large chunk of these pension assets is however invested in traditional asset classes.

In 2019, FSD Africa in partnership with The East African Venture Capital Association (EAVCA) and the International Finance Corporation (IFC) commissioned a market study to investigate the low uptake of PE investment by pension schemes in East Africa. The market study report cited knowledge gap on both pension fund and regulatory side and absence of regulatory oversight on the PE Fund Managers by local regulators as some of the key impediments for pensions seeking to invest in PE Funds. Although the scope of the study was limited to East Africa, these challenges are cross cutting across Africa.

In addition to these challenges noted by the study, the lack of appropriately designed structures or avenues for investment that address certain issues that may be unattractive for institutional investors such as the J-Curve effect, is also a key impediment to investment by institutional investors.

Despite the existence of provisions allowing pension funds to invest in private equity, the appetite by pension funds to invest in private equity has remained low and there is a case to be made for African institutional investors to gradually increase allocation to private markets. By making capital for ownership in or as credit to unlisted, privately owned companies, these markets can complement public markets in providing long-term financing for the transformation of African economies and the attainment of sustainable development goals.

African institutional investors and the continent stand to benefit greatly from increasing their investment in private capital markets. The benefits of investment in private capital markets are diverse, ranging from diversification benefits to participation in the social and real sectors. Such investments may provide investors (specifically institutional investors) with exposure to markets and investment strategies that cannot be accessed through traditional asset classes.

In addition to potential attractive risk-adjusted returns, private market investments allow clients to diversify their portfolios by investment strategy, portfolio manager, industry sector, geography and liquidity needs. Furthermore, private market investments facilitate active participation in the growth sectors of the real economy by investors thereby generating returns while contributing to broader economic development goals such as creation of jobs and improving access to basic services. This is because the link between private markets and social impact can be much more direct, more so because in most cases these are direct investments in companies that operate in the real sector.

Furthermore, the COVID-19 pandemic has presented a fresh set of challenges especially for MSMEs. MSMEs have been exposed to significant stress leading not only to job losses but also balance sheet stress due to lack of long-term capital. In normal times, access to long-term finance for MSME sector is typically constrained, this has now been exacerbated by the pandemic. Expected volatility in public markets over the next few years will potentially impede the tapping of these markets by companies to raise money. This coupled with expected increased risk averseness by banks and other lending institutions is likely to create a greater challenge for MSMEs to access long-term finance. The private equity and debt markets are therefore expected to play an even greater role in financing COVID-19 recovery in support of these companies. In particular, private debt markets may provide greater flexibility in structuring solutions that meet the needs of both investors (institutional) and borrowers.

One of FSD Africa’s strategic imperative is to mobilize long term finance in local currency to fund Africa’s developmental priorities. As part of this imperative, FSD Africa is launching a multi-year, multi-country programme to support the development of private capital markets in Africa. The 4-year technical assistance programme will be implemented across Africa in partnership with regulators, policy makers, industry associations and other market operators. The objective of the programme is to support the development of private capital markets as a complement to the public capital markets in Africa.

Table: Low investment by African institutional investors in private equity

Country Pension AUM (USD Bn) Current % investment in PE Maximum allowable investment (%).
South Africa 302.09 0.30 10%
Nigeria 30.17 0.30 10% for higher risk sub-funds
Kenya 12.19 0.09 10%
Ghana 4.61 0.34 10%
Uganda 4.27 2.40 15%

Source: Various regulatory agencies.

 


¹ Willis Towers Watson
² FSD Africa