One of the most common complaints heard from the private equity community in Africa centres on the relative lack of availability of quality investment targets capable of delivering the returns expected by their limited partners (LPs), the underlying investors in their funds to whom they have a fiduciary duty to provide an expected rate of return on the capital deployed, notes Charles Buchanan, managing director of fund services for Africa at SGG Group.
While this is by no means a problem unique to Africa, and is in fact a common refrain heard globally, Africa presents a unique challenge in terms of the limited number of investment opportunities available as well as their comparatively smaller scale. This is largely a symptom of gross domestic product (GDP). According to the World Bank, Sub-Saharan Africa’s GDP amounts to $1.649 trillion, which represents just over 2% of global GDP. Africa still comprises a relatively small portion of the global economy, which makes it difficult for more commercially minded private equity funds that are not only tasked with finding quality investment targets but are also competing with other investors for a limited number of potential acquisitions.
However, this also represents a rather unique opportunity for impact investment funds to play a powerful role in meeting Africa’s investment needs. If we consider the definition of impact investing as capital deployed for the purposes of making a positive a social and environmental impact as well as generating financial returns for investors, then we see that this form of investment approach – with its more flexible return parameters – is possibly better suited to a landscape where patient financial capital is not only a virtue but a necessity.
Since the concessionary capital that is typically deployed into impact funds tends to originate from development finance institutions (DFIs), quasi-government or government-linked sources with a specific agenda to effect change in certain sectors or geographies, the financial-return criteria are somewhat more lenient than for their purely commercially driven private equity peers. While it’s true that the LPs of impact funds are often still driven by financial returns, they are often willing to accept a discounted return in exchange for the knowledge that their capital is making a meaningful social or environmental impact.
Whereas commercial capital deployed into a strategic but growing sector like education in Africa may target an internal rate of return (IRR) upwards of 25%, an impact-oriented fund may be satisfied with return in the region of 12% provided it was achieving its social mandate. Impact funding, therefore, not only has the opportunity to be the patient capital that Africa needs, it is also uniquely suited to the continent’s idiosyncratic risks.
Nevertheless, one shouldn’t fall into the trap of thinking that impact investing is not of sufficient scale to meet Africa’s investment requirements. A report by the Global Impact Investing Network showed that the total assets under management (AUM) of impact funds doubled in the last year to $228 billion, up from an estimated $114 billion since mid-2017. Africa accounts for roughly 12% of this total AUM, which suggests that impact investing has significant capacity to effect meaningful economic change on the continent. With the impact investing market expected to be worth around $307 billion by 2020, Africa stands to gain considerably in areas such as education, housing, energy and financial services.
Impact investors are also currently building, testing, and refining a wide range of tools and systems for measuring impact, which should lead to more efficient and effective investment outcomes. It is no exaggeration to say that impact investing is fast reaching a level of critical mass where it is catalysing changes that are reshaping the relationships between people and financial markets.
While the impact investing movement has fundamentally raised the bar for how the investment industry can positively impact society, its next challenge is to accelerate that impact by demonstrating its viability to a wider audience so as to encourage new entrants into the market. With no shortage of capital available, if impact investing can demonstrate its ability to effect change more widely it may go a long way towards proving its particular relevance and suitability for the African investment landscape.