By Francisco Machado, Investment Director
Until recently, Ghana was considered a macroeconomic and political model in sub-Saharan Africa; in 2019, the World Bank described it as ‘a rising growth star’[1]. However, in May 2023, the IMF signed a new bailout agreement worth $3 billion over three years. It’s a program that’s widely seen as a band-aid for a host of long-term economic challenges facing the country – a net importer – including a balance of payments deficit. The nation’s public debt is nearly as large as its annual economic output, inflation has been running at over 40% in 2023[2] and Ghana’s currency, the Cedi, has fallen by more than 45% against the dollar since January 2022[3]. The bailout will do little to address poverty, create new jobs, boost salaries or address the rising cost of living facing Ghanaians.
Ghana is not alone in facing economic headwinds and other countries on the continent face a similar fate driven by a range of factors, including the Russia-Ukraine conflict, the rising cost of food imports, a reduction in foreign direct investment and rising interest rates globally that are increasing cost of debt servicing. Kenya, East Africa’s largest economy, has recently agreed new funding amounting to around $1 billion to help relieve pressure caused by rising debt servicing and effects of drought.
One solution to help advance economies in Africa and provide some insulation from global economics might lie in the growth of local institutional investors. They are uniquely positioned to help boost industry, agriculture and overall economic development, while reducing reliance on international investment, the international currency markets and interest rate fluctuations at the same time. Research conducted by the IFC in 2022[4] highlights that “a well-functioning local institutional investor base may play a role in bolstering the economy” and “financing the ambitious development agenda ahead calls for an enhanced role for the region’s institutional investors.” Africa’s institutional investor base has become an increasingly important source of capital over the past few decades, having grown strongly and steadily accumulated assets under management. The IFC analysis found that pension fund AUM grew by an average of 65% between 2016-2020 across the seven African economies they looked at.
These investors have typically been very conservative in their investments, investing primarily in government bonds in their territory. The IFC research found that pension fund investment in “alternative assets” accounts for a very small share of assets; across five markets they found it accounted for between 0 and 2.7% of AUM. A lack of familiarity with and capacity to evaluate the associated risks, along with uncertainty over policy approaches to these assets, may be holding back allocations. But as seen with Ghana, excessive investment concentration in government bonds can carry its own risks. As a result, these investors are missing out on the opportunity to diversify and manage risk, as well as the opportunity to generate alternative sources of returns and create sustainable impact in their communities.
By diversifying their portfolios into other asset classes, including alternatives such as private equity and infrastructure, investors will mitigate against the risks associated with concentrated portfolios. Furthermore, private equity firms can be nimble and uncover opportunities that might not be immediately apparent. They can also target very specific social and environmental goals, mitigating risks for entire communities and contributing to their development, as well as creating financial returns for their underlying beneficiaries.
At Vital Capital, through our investments totaling around $300 million, we have provided 22.6 million individuals with solutions to meet their essential needs, diverted 1.04 million tons of CO2e through the use of renewable energy sources and supported 64,850 jobs and livelihoods. There is also a multiplier effect and contribution to development by stimulating further growth through the knock-on effect of investing locally directly and indirectly by creating jobs or generating local purchases. For each dollar Vital has invested in building capacity locally to stimulate local economic activity, it’s led to $2.50 of direct local purchases.
With little in the way of experience of investing in alternatives for many institutional investors in the region, the prospect may seem daunting. Some considerations to make when considering such investments include assessing alignment with investment objectives and target outcomes. This could be a return profile, types of investment, sector focus or an impact objective such as building and maintaining critical infrastructure, mitigating climate change or providing more affordable housing. When investing in impact funds, investors should look for alignment with international best practices and their impact measurement and management processes. Of course, track record is also important, both in terms of financial returns and the creation of meaningful, measurable impact.
An understanding of, and experience in, the local investment landscape is also essential. At Vital Capital, we focus on the sectors and countries we know and understand, and where we know we can make a difference – as well as returns – for investors. We also understand that a different approach might be required to the usual private equity model. For example, the normal three- to five-year investment period may not be the right time horizon for value to be created and realized.
Finally, investors should look for fund managers that are operationally minded and quick to adapt. During Covid, support for businesses in many parts of Africa was slow to materialize. As a result, otherwise viable businesses were left to fend for themselves, with many failing as a result. In contrast, we were able to step in quickly and, within 30 days, had put business continuity plans in place at all our portfolio companies. Furthermore, we put in place a $10 million direct loan facility, the Vital Impact Relief Facility, to help fundamentally sound SMEs through the immediate economic fallout from Covid.
By embracing alternative assets, local institutional asset managers across Africa can better manage risk, diversify their portfolios, and contribute to positive social, environmental and economic development within their communities. With substantial assets at their disposal, this has the potential to be transformational for countries across Africa, making them more self-reliant and insulated from the swings of macroeconomic and geopolitical events, creating more stable – and more sustainable – economies.
Institutional investors need to embrace alternatives, and alternative asset managers need to do a better job of explaining the benefits and providing relevant investment solutions that meet the needs of this investor base.
Efforts to encourage more institutional capital to be invested locally are underway. For example, the Kenya Pension Funds Investment Consortium (KEPFIC), an initiative supported by the World Bank and US Aid, has brought together the country’s leading pension funds to encourage them to increase in their allocation to alternative investments. Such initiatives help with professionalization and resourcing to support allocation to alternatives, but it’s only one part of the puzzle. This needs to be followed elsewhere and accompanied by supportive legal and regulatory frameworks.
For example, regulators might consider introducing – and enforcing, where applicable – minimum allocations to alternative assets within their portfolios to encourage diversification. Furthermore, they might follow practices in Europe and elsewhere to limit personal responsibility for trustees of pension schemes for investment decisions. Here, it is common for pension scheme rules to include exoneration and indemnity rules for trustees where losses result from properly taken actions to ensure they aren’t held personally responsible – with liability insurance also available. This could and should be replicated for trustees of pension funds across Africa.
As the amount of assets managed by institutional investors in Africa continues to grow and the market matures, the role for alternative assets within portfolio construction is becoming more important, both as a means of diversification and risk, but also to the development of economies across the continent.
A version of this article was originally published in Africa Global Funds.
[1] https://thedocs.worldbank.org/en/doc/61714f214ed04bcd6e9623ad0e215897-0400012021/related/Ghana-Rising-Accelerating-Economic-Transformation-and-Creating-Jobs.pdf