Africa appears to have coped with covid-19 better than most parts of the world. Even so, the past year has not been without turmoil for the continent’s nascent private equity industry. Fundraising figures, unsurprisingly, fell drastically. Final closes slumped to $1.2 billion in 2020, barely a quarter of the $3.9 billion recorded the year before, according to African Private Equity and Venture Capital Association data.
While the pandemic posed questions as to whether Africa’s growth trajectory can continue, LPs appear generally optimistic about the post-covid outlook. In AVCA’s annual survey, some 65 percent of LPs reported that they expect to increase their private equity allocation in Africa over the next three years – markedly up from the 58 percent saying the same in 2020.
But GPs are acutely conscious of the headaches involved in raising funds on the continent. Attracting international capital to African investment opportunities is “uniquely difficult”, warns Franklin Olakunle Amoo, managing partner at Baylis Emerging Markets. Two-thirds of managers surveyed by AVCA expect the fundraising environment to be their biggest challenge over the next three years.
The capital raised by Africa-focused funds is little more than small change in the global economy – the $18.1 billion raised by Africa-focused funds in total since 2015 would barely be enough to purchase even a 1 percent stake in a leading global firm like Apple or Microsoft.
“There is no doubt that an Africa-focused strategy is one of the more difficult strategies for which to raise capital globally,” notes Mackenzie Schow, deputy head of Africa equity and funds at DEG, the German development finance institution. “Investors seeking to gain access to the pockets of real growth in Africa that do exist must be willing to accept significant risks (some perceived and some real) that can dampen performance.” Fund managers have a “difficult time convincing investors without a specific mandate to invest in Africa to accept the risks”.
Recovery gathers pace
At least in the short term, covid seems to have heightened this risk aversion. Mike Preston, partner at law firm Cleary Gottlieb, says the pandemic prompted a “flight to safety”, which “had a disproportionate impact on emerging economies”. Almost all GPs that were engaged in fundraising in Africa at the onset of the pandemic saw their plans thrown into turmoil, with 96 percent being forced to extend their fundraising cycle, according to AVCA’s survey. A further 38 percent reduced their fundraising target.
Yolande Tabo, investor relations principal at Convergence Partners, tells Private Equity International that her firm’s planned fundraise in 2020 was postponed by several months due to covid and then had to be conducted virtually. While Tabo notes the process mostly worked well, she says virtual fundraising “certainly has drawbacks”, particularly in making it harder to form relationships with new LPs.
Schow adds that some LPs “have taken active decisions to put a pause on new business relationships until travel resumes”. This is despite Africa’s relative success in escaping the worst of the pandemic – a situation that reflects the continent’s youthful population, as well as its experience in dealing with infectious disease outbreaks. Though South Africa did take a major economic hit, sub-Saharan Africa as a whole saw GDP decline by less than 2 percent in 2020 – a far milder contraction than in developed markets.
But Africa’s recovery has lagged behind, perhaps partly because of its slow progress in administering vaccines. The International Monetary Fund expects growth of 3.4 percent in 2021, weaker than in any other region. This seems to be having an impact on LPs’ expectations for short-term returns; AVCA’s survey found that 74 percent of LPs expect African returns to underperform developed markets over the next three years and 58 percent expect Africa to underperform relative to other emerging and frontier markets.
Green shoots are appearing, however. Schow points out that “we are seeing fundraising efforts resume and slowly receiving more requests for road-show visits”. The AVCA survey found that 74 percent of GPs are focusing on raising new funds, compared with only 54 percent in 2020. And 82 percent of firms planning to fundraise say they plan to raise a fund larger than their last.
Amoo agrees that there are signs of a modest growth in the pool of investors prepared to consider Africa. “Somewhat counterintuitively, surging global markets – and the tight spreads and increased correlation that coincide – have increased the willingness of some LPs to consider non-traditional markets in the pursuit of yield and diversification.
“We’ve noticed some uptick in frontier market curiosity from longer horizon investors, such as family offices and endowments, who have been significant participants in the recently buoyant venture capital and public equity markets.”
Amoo adds that “the growing desire for impact and sustainability related investments… has also expanded the universe of potential allocators to Africa-focused managers”.
Dependence on DFIs
A reality of the Africa investor landscape is that DFIs remain by far the most important source of capital for private equity funds. This dependence has deepened further due to covid. “GPs have looked more intensively to their existing LP base for support during the pandemic,” says Schow. “Given the fact that DFIs have most of the existing relationships in Africa, it has been much easier for us to continue investing and supporting our GPs throughout 2020 and 2021.”
A good example is provided through Convergence Partners’ digital infrastructure fund, which announced its first close in July. All of the initial investors in the fund are DFIs. “Due to the challenges in running a classic raising process, including travel, we focused on this smaller group of LPs for the first close,” says Tabo. The firm’s targeting of DFIs was “based on our strategy for an accelerated first close from parties who were familiar with Convergence Partners, and who are continuing to make commitments to African PE throughout the pandemic period”.
Preston agrees DFIs have become “more important following covid-19”, adding that “DFIs can play an important role anchoring fundraising efforts, and their presence in turn helps to mobilise capital from other sources”.
Tabo tells PEI that Convergence Partners is in discussions with several commercial investors on the back of its fruitful fundraising efforts with DFIs.
But when it comes to mobilising capital, fund managers have had little success in persuading African investors to put their money at work in private equity. Schow says: “For the industry to thrive, policy makers need to make efforts to mobilise local institutional capital, which can become one of the driving forces behind Africa’s private equity industry.”
Several sources tell PEI there are signs that institutional investors in countries such as Nigeria, Kenya and Ghana are becoming more willing to consider increasing their allocations towards private equity. Meanwhile, Tabo notes that proposed regulatory changes in South Africa that will unbundle private equity as a separate asset class could lead to more capital being unlocked.
Yet Amoo emphasises that Africa’s “de facto strategy of wholly financing its development externally” needs to change. “African governments and banks, perhaps via public pension plans and insurers… are a far more natural source of first loss capital than total return-oriented investors from developed markets far afield,” he says.
“The real nut left to crack is the African private wealth community. Significant private wealth exists but is largely externalised by Africa’s wealthy to the US, Europe and select investment markets in the Middle East,” Amoo explains. “I’m confident that north of 75 percent of locally-generated funds available for investment find their way offshore to opportunities outside of Africa. Absent that most logical pool of funds, there may never be sufficient risk capital for African investments.”
First time lucky?
While the fundraising environment in Africa certainly looks rosier than at the height of the pandemic, many investors remain guarded in their approach.
Speaking to PEI in July, Angela Miller-May, then chief investment officer at the Chicago Teachers’ Pension Fund, which has invested in several Africa-focused funds, emphasised the importance of selecting an experienced manager. She said GPs that are “knowledgeable about the regions, culture, regulations, politics, opportunities and threats – and have a strong risk management process – are critical for long-term positive performance”.
Miller-May, who took on the role of CIO at the Illinois Municipal Retirement Fund in August, told PEI that the CTPF was “cautious about allocating to first-time managers overall”. In markets such as Africa, where the pension fund has less experience, she explained that the CTPF had “not invested in first-time funds and will turn to [its] fund-of-fund managers for increased oversight or will only commit to proven strategies with proven general partners in Fund II or later series funds”.
Some 71 percent of LPs surveyed by AVCA selected a track record of investment through to exit as an important factor in evaluating fund managers. But the survey also gives first-time managers reasons for hope – 53 percent of LPs say they would at least consider investing with a first timer.
Although Baylis Emerging Markets’ Franklin Olakunle Amoo acknowledges that travel restrictions and the associated hurdles in conducting diligence have added to the difficulties faced by first-time managers, he notes that, on the plus side, “the pandemic certainly reduced costs incurred by aspiring fund managers. Superfluous travel expenses for conferences and other networking events being replaced by virtual connectivity has probably extended funding runways for budget-conscious start-ups.
“Almost everyone I know who is raising a maiden fund is busier than ever, but also much more productive, as efforts have been streamlined to mission-critical work streams such as trying to close early deals to build track records.”