Africa-focused private equity funds appear to have enjoyed a boom year in 2021. Figures from the African Private Equity and Venture Capital Association (AVCA) show that private capital fund managers in the region raised $4.4 billion in final closes and another $2.3 billion in interim closes last year. This is a drop in the global financial ocean, but it does mark a fourfold increase on the capital raised during the depths of the pandemic in 2020.

The 2021 fundraising totals were boosted by some of the continent’s largest ever fund closes. Most notably, Development Partners International’s third fund closed in October on $900 million, with another $250 million in co-investment capital.

Scratch beneath the surface, however, and the picture looks less rosy. Much of the capital raised in 2021 simply represents “deferred investment” from 2020, says Clarisa De Franco, head of private equity funds at UK development finance institution British International Investment, formerly known as CDC Group. “It was extremely difficult to fundraise across the board during covid,” she says.

“I think it’s exceptionally difficult for first-time teams to raise capital right now” 

Clarisa De Franco
British International Investment

The total volumes raised by funds holding a final close in 2020 or 2021 – $5.5 billion – were considerably less than the $6.7 billion raised in the two years before the pandemic. Hope that the recovery would accelerate has been dented by the worsening global macroeconomic conditions in the first half of 2022. Today, Africa-focused fund managers face a major test in persuading capital allocators that now is the time to put their money to work on the continent.

Currency crisis

Just a few months ago, it seemed that Africa was poised to continue the modest but real progress achieved in 2021. “In Q1 and Q2 of this year, we saw the same if not a higher pace of fundraising taking place, mostly in the VC space,” says Victor Wambua, head of East Africa equity operations at DEG, the German DFI. 

Yet, with rising inflation in advanced economies prompting central bankers to raise interest rates, emerging markets have become less attractive as investment destinations. Higher returns available in the US and Europe mean investors are less likely to take on the real and perceived risks of allocating to Africa-focused vehicles. 

“With increasing interest rates, we expect the slowdown to start in late 2022, which means that investors will be a lot pickier when it comes to fund selection,” says Wambua. 

This will particularly disadvantage managers unable to demonstrate a track record. “I think it’s exceptionally difficult for first-time teams to raise capital right now,” says De Franco. “That will probably continue to be the case for a little bit longer.”

Currency volatility – a longstanding thorn in the side of efforts to boost investment in Africa – is likely to become more severe in the coming months, given that the Fed’s hawkish policies are strengthening the dollar. Several of Africa’s largest markets have seen their currencies depreciate against the dollar already this year. The Ghanaian cedi, for instance, depreciated by almost 20 percent against the dollar between
January and July, according to the Bank of Ghana.

An AVCA survey published in March found that 23 percent of GPs “frequently” experience delays in raising capital in Africa because of currency risks. Another 41 percent view currency fluctuations as having a “significant negative impact” on returns.

Start-ups stand out 

AVCA’s chief executive, Abi Mustapha-Maduakor, insists that it is possible to take positives from the current environment. She predicts that rising interest from venture capital investors in African start-ups will remain undiminished. “The fundamentals are still strong,” she says. “There will be a sub-set of investors, even at this time, that will probably want to go in harder in Africa.”

Walid Cherif, founder and managing director of Tunis-based fund manager BluePeak Private Capital, agrees that VC firms may be better placed to attract capital in the current environment than traditional private equity players that invest in brick-and-mortar businesses. Fintechs and other tech start-ups have “attracted a lot of international private money, because those businesses are looked at as international businesses”, he says. “They started in Africa, but they can scale up globally.”

On the other hand, Cherif bemoans the enduring wariness among institutional investors of committing to Africa-focused PE funds. “The perception of risk, in general, for Africa is higher than the reality,” he says. “Private investors tend to draw a negative image of Africa; they put Africans in one basket.”

Marc-André Blanchard, executive vice-president at Canadian pension manager CDPQ, agrees with that assessment. Speaking at the Africa Debate, an event arranged by investment promotion organisation Invest Africa in July, Blanchard noted that CDPQ has “very little information” on Africa. It does not invest on the continent, other than through government bonds.

“Don’t overestimate the knowledge of our institutions,” Blanchard said. “When we have very little information about markets, we tend to overestimate risks [and] underestimate the opportunities.”

Perhaps more surprisingly, given the opportunity to contribute to the Sustainable Development Goals by investing in Africa, even asset owners that have an impact mandate are often hesitant about the continent. A report published by the International Finance Corporation in July 2021 found that 31 percent of impact capital is invested in emerging markets funds, of which only a small proportion is dedicated to Africa.

“The perception of risk, in general, for Africa is higher than the reality”  

Walid Cherif

Mustapha-Maduakor says more work needs to be done to educate impact-focused LPs, such as foundations and family offices, on the merits of backing African funds. “For every dollar you invest on the continent, the social effect of that dollar is way more than if you invest a dollar into developed markets,” she says. “Whether it’s on job creation, whether it’s on gender parity, whether it’s on poverty alleviation, we need to demonstrate that impact more.”

Mobilising local capital

Institutional investors from outside the continent may be less likely to commit to Africa-focused funds until currency and other macroeconomic headwinds have eased. But what about pools of capital from within Africa itself?

African pension funds hold assets amounting to at least $350 billion, a figure that has grown substantially in recent years. But these funds overwhelmingly allocate to government securities or, in markets such as South Africa, listed equities. While Mustapha-Maduakor believes private equity and pension funds should be an ideal fit, she warns that there is a “lack of understanding of the asset class in general” among African pension funds. 

Progress is being made in reforming regulations to allow institutional investors to allocate more to alternative funds. The South African government confirmed in July that the country’s pension funds will be able to increase their allocation to private equity to 15 percent of their assets from January 2023. At present, allocations are limited to 10 percent. 

It is worth noting, however, that South African pension funds are not in danger of breaching the current limit. In fact, South African institutional investors allocate just 0.3 percent of their AUM to private equity, according to research published last year by development agency FSD Africa.

DFIs are commonly cited as playing a critical role in convincing institutional investors to back Africa-focused funds. Recounting British International Investment’s discussions with local pension funds, De Franco notes that “some of them say we absolutely need a DFI to be part of a fund, because it gives comfort around the level of due diligence and ESG processes”.

There is little doubt that DFIs will remain indispensable to private equity in Africa. “At the start of the covid-19 pandemic, many commercial investors paused their investments in African private equity funds as their risk perception increased,” says Kevin Njiraini, the IFC’s regional director for southern Africa and Nigeria. “As a result, development finance institutions have become an even more important source of capital for Africa-focused private equity funds, and in some instances, the sole source of capital.”

DEG’s Wambua offers a similar perspective. “The international investors have withdrawn significantly,” he says, “leading to most closings now [being] led by DFIs. This has been visible in both PE funds and even in the VC space where initially DFIs had a [less significant] role. 

“We do not view this as an unusual case given DFIs have a mandate to support markets during a crisis. We view this… as a ‘feature rather than a bug’ of investing in Africa.”

Data dilemmas

LP demand for ESG data is on the up, but this could cause headaches for portfolios where the requested metrics are less relevant, or where companies are not yet in a position to provide data.

It might be assumed that the growing global interest in sustainable investing would provide a boost for African private equity, given the clear potential for investments on the continent to boost livelihoods and drive development. Indeed, LPs are virtually unanimous in agreeing that ESG should be an important consideration for portfolio companies, according to AVCA’s 2021 African Private Equity Industry Survey.

But Brondwyn Douglas, senior ESG officer at Spear Capital – a southern Africa-focused PE firm – argues that an inflexible approach to reporting ESG data may bring about unintended consequences, and
could ultimately drive capital away from Africa. “What the LPs are asking for is a lot of reporting back to them on a set number of metrics, which these companies aren’t in a position to report to us on from the get-go. They require a lot of handholding, a lot of help, to actually have the systems in place.”

Douglas credits DFIs and other LPs in providing help to fund managers looking for best practice in managing and measuring ESG issues, but she believes that the industry needs a new mindset for approaching ESG. “If you really want to have sound ESG management as an organisation, you have to understand what the material risks are to the organisation,” she says. This means that investors need to take care in selecting relevant metrics. “Sometimes you get a list of metrics that aren’t even material to the businesses that we’re investing in.”