Africa special: currency risk is the biggest concern for LPs

CDC, South Suez and 57 Stars discuss the risks – and returns – of investing in Africa.

Our investor panel
Charles Groom
, Africa portfolio director, CDC Group
Matthew Hunt, director, South Suez Capital
Stephen O’Neill, managing director, 57 Stars

What’s your advice for first-time investors in Africa?
Charles Groom:
“Expect to commit resources or spend substantial time on the ground to develop local relationships, best practices and to help your investees drive their growth. Consider how to mitigate against currency risks and to manage political risks, but think and act micro.”

Matthew Hunt: “The key ingredients to a successful African private equity recipe are local presence and execution. A first-time investor should ensure that its GP has an investment strategy and team that is well suited to its markets. Most important of all, it is crucial to choose a GP that has boots on the ground so that it can follow through on its plans with hands-on execution.

Stephen O’Neill: “Africa is no different from any other region – you need to do your homework before committing capital. It is important to construct a detailed map of the investment opportunities and to analyse the capabilities of the GPs. Africa is a unique blend of 54 countries with profound heterogeneity and risks that are different from other places we operate. Our top-down process assesses around 40 factors which we incorporate into algorithms that help us to quantify and mitigate these risks.”

What’s been your most successful investment in Africa?
CG:
“From a commercial perspective African Development Partners I (vintage 2008), managed by Development Partners International has performed very strongly. In early 2017, DPI concluded their fourth exit from the fund, from CAL Bank, one of Ghana’s leading independent banks. CAL Bank reported profit after tax growth of 77 per cent per annum from 2011 to 2015.”

MH: “In 2010, we invested in Vivo Energy, alongside one of our GPs. At that time, we concluded that the company offered multiple value enhancement options and was linked to attractive macro growth drivers. Earlier this year, Vivo Energy was listed through an IPO in London, making it the first UK listed entity with operations wholly within Africa and was the largest African IPO on the LSE since 2005.”

SO’N: “The most successful transactions have been in the mobile sector. More broadly, we have successfully committed to regional funds, and work with those GPs to deploy capital to the mid-market. In addition, our market position has provided a compelling pipeline of co-investments and we are optimistic that these may ultimately be our most successful transactions.”

What are the most interesting trends in the African market?
CG:
“For generalists, to capture the opportunities arising from building regional businesses across fragmented markets. For the emerging set of venture capital fund managers, the ability to identify and grow high calibre and motivated talent in African cities.”

MH: “I think that digitisation will play a catalytic role in Africa in the coming years and allow the continent to leapfrog other regions in certain sectors through the use of mobilising technologies. Digitisation has already revolutionised the financial services space, in particular retail payments system and the payments infrastructure. Online retail is still nascent in Africa, but there are already unique and attractive applications across the consumer goods spectrum including in healthcare and education.”

SO’N: “The region is evolving in terms of the range of PE strategies that GPs are credibly pursuing and increasingly includes sector strategies (eg, financial services, consumer and healthcare), credit-related strategies, infrastructure-related strategies, and even an emerging venture capital community. As in a number of other regions, we have been most focused on some of the sectoral funds.”

How does Africa fit into a global portfolio?
CG:
“Aside from the obvious benefit of diversification, investing in Africa has the potential to deliver strong returns through careful selection of management teams and partners to invest alongside. Successful investments will also often deliver significant development impact.”

MH: “African PE is predominantly a growth opportunity and is unlevered, in contrast to more developed markets which tend to have higher leverage levels. In addition, Africa offers a unique geographical diversification to a portfolio of developed and emerging market exposures. African listed markets have less of a correlation with developed markets than emerging markets do. This is partly due to growth being domestically led, low debt levels and the relatively low levels of foreign ownership.”

SO’N: “Our approach is more as an opportunistic investor than as an allocator. As such, we have no bucket for Africa. We evaluate opportunities on a risk-adjusted basis against those elsewhere. We have had consistent and increasing exposure to Africa over the last few years. It yields compelling and differentiated opportunities, but has complexity and a range of unique risks.”

How do returns in Africa compare with those in the rest of the world?
CG:
“Whilst individual transactions have exhibited strong returns, there is a large dispersion of returns in the market as a whole and financial performance has been hurt by significant currency depreciation more recently. Furthermore, returns in Africa suffer from a lack of leverage during a period of all-time low costs of debt.”

MH: “Realised returns have not yet lived up to the expectations, driven in part by the recent macroeconomic challenges in Africa, in particular currency depreciation and lower commodity prices. However, the last 12 months have seen rising commodity prices, a changing political climate and more stable currency regimes which should all serve to create a more positive environment for exits.”

SO’N: “Top quartile private equity returns in Africa compare well with those for many other regions and can contribute usefully to a global strategy designed to optimise both diversification and positioning relative to the efficient frontier of optimised risk and reward.”

What’s the key risk of investing in Africa?
CG: “Currency. Then execution risk.”

MH: “Currency depreciation remains a significant risk in Africa, as has been witnessed with the recent devaluations of the Nigerian naira and Egyptian pound. We have seen GPs partially protect their investment through deal structuring as well as through thoughtful portfolio construction techniques. This is a welcome development, but ultimately the best defence is diversification.”

SO’N: “Similar to other regions, in Africa it is important to assess the legal, regulatory, and political framework, as well as macroeconomic and currency conditions. These factors are not homogeneous across the region but vary widely from market to market.”