Into Africa?

Both LPs and GPs alike seem increasingly convinced by the attractiveness of Africa as an investment destination. Some will inevitably be disappointed. But that shouldn't put investors off. 

Every LP we talk to at the moment seems to tell us that they're looking at an Africa fund. And a number of big GPs have also been saying recently that they’re starting to look actively for deals in the region.

All very anecdotal, of course. But there are more concrete signs that interest in Africa funds is picking up.

A recent survey of 48 investors by the African Private Equity and Venture Capital Association (admittedly not the biggest sample, or the most disinterested source) found that 85 percent were expecting to increase their allocations to African private equity in the next two years, while 70 percent said returns from Africa would outperform other emerging markets.

The fundraising stats paint a similar picture: Africa-focused funds raised nearly $2 billion in total last year, according to PEI's Research & Analytics division, about twice as much as the previous year.

And there should be plenty of opportunities for eager LPs to follow suit in 2014: Jonathan Blake of King & Wood Mallesons SJ Berwin told us recently that his firm alone was currently working on no fewer than 15 Africa funds. We've already seen one high-profile close, of course: The Carlyle Group's Sub-Saharan Africa Fund, which after a slow-ish start in 2012 ended up smashing through its $500 million target to close on $698 million last week.

So why do LPs like Africa?

There's a notion in some quarters that African economies are not quite as correlated to the rest of the world economy as other emerging markets, according to Mark Richards, who leads the financial services team at emerging markets specialist Actis (Richards has been focused on Africa for more than 20 years, and the $1.7 billion fund his firm closed last year includes a $160 million Africa 'side pool'). “If you look across all the different currencies, there's less volatility; you don't see the same correlation with what the Fed's doing.”

And then there's the growth story. “Politically, Africa is a lot more stable and democratic than it has ever been. Countries also have a better understanding that a sensible business environment is good for the country, so they're more welcoming to international investors. That means we're starting to see GDP growth and the emergence of middle income markets.”

So: less volatility, less risk, more growth. That's the good news.

The bad news is that the pool of opportunities is probably still too shallow to sustain all this extra interest. “What's beginning to happen now that there are more funds around is that some of them are struggling for dealflow,” says Richards. “Africa's different in that most of the best deals are still proprietary. If you have the sector expertise and the local knowledge, there's still plenty to do. But if you're sitting around waiting for deals to show up in a nicely-packaged investment memorandum, you probably won't see many. You have to make deals happen the old-fashioned way.”

He points out that most of the investment banks that set up Africa M&A units a few years ago have now pulled back, because the deaflow just wasn't there; there just aren’t enough businesses to sell at the larger buyout end of the spectrum (Actis is trying to get around this by buying smaller businesses and using them as a platform for a buy-and-build play, as it previously did with EMPH, a payment processing services group, and is now hoping to do with Credit Services Holdings, which it announced yesterday).

Nonetheless, that growth story is hard to ignore, particularly in a world where other emerging markets have lost some of their lustre. Last year, consultancy McKinsey predicted this African consumer economy could be worth $30 trillion by 2025. That sort of explosive growth has to represent an opportunity, not least in areas like consumer and financial services – sectors where there are, as Richards puts it, still “some big white spaces” to fill.

Increased competition might yet drive pricing up and returns down in the short term – but LPs shouldn’t lose sight of that long-term opportunity.