Africa: Proceeding with caution

When Private Equity International began working on last year’s annual Africa Special, investor excitement for the region was palpable. In the first six months of the year $2.87 billion had been raised for sub-Saharan Africa funds as investors gradually began to swap their notebooks for their cheque books.

This year, the mood is noticeably chillier.

“The emerging markets have been rocked by negative headlines,” says Brian Lim, a partner at fund of funds investor Pantheon. “Macro-economic statistics in many of these emerging markets, including many African countries, have deteriorated, in some cases significantly, so I think investors are naturally a little more cautious these days. There is a perception of being in the eye of the storm and being extra-cautious in deploying capital there.”

According to the International Monetary Fund, growth across sub-Saharan Africa fell to 3.5 percent in 2015, its lowest level in 15 years, and it is expected to slip further to around 3 percent in 2016.

Although Lim points out that with fewer big-name funds in market in 2016 investor sentiment has not really been tested, he expects fundraising is “probably tougher than it was a few years ago at the peak of demand or interest in African PE”.

Like many investors, PKA AIP, the dedicated alternative investment arm of €35.1 billion Danish pension fund PKA, is not compelled to stick to geographical “buckets” when deploying capital, but looks to invest in buyout funds of between $500 million and $2 billion, regardless of location.

PKA has around DKr42 billion ($6.2 billion; €5.7 billion) invested in private equity and a further DKr5.2 billion in infrastructure funds, according to PEI data. On the private equity side, measured by commitments in its first programme, which ran from 2012 to 2015, 54 percent of PKA’s commitments were to the US and Canada, 19 percent to Europe, 15 percent to global funds, 4 percent to Asia, 4 percent to Australia and 4 percent to Africa.

Its exposure to Africa includes a $75 million commitment to the $990 million Abraaj Africa Fund III and a commitment to agriculture specialist SilverStreet Capital’s Silverlands Fund.

“The first thing is: forget the macro,” says PKA investment director Christian Kvorning. “We don’t necessarily equate high GDP growth rates – which Africa obviously has – or positive demographics, or any sort of macro trends with a positive or a negative PE investment landscape.”

For PKA, investments are not “top-down exercises that are driven by macro events, GDP numbers, birth rates, inflation rates or the emerging middle class”, Kvorning says. “We look at it bottom-up and ask ourselves questions such as: who are the good managers? Do they put money in their own funds? Are they experienced? Do they have good investment strategies? Are they differentiated? Can they explain to us what they’re doing? Are the fees reasonable? If we find affirmative answers to these questions, then we are less concerned about whether the investment is in a developed or emerging market. Our investment mandate is global.”

One thing remains clear: investors are still expecting a risk premium from African funds.

“We understand that we’re taking more risk than we would be in the US, [so] we do expect a stronger return than you would from a typical US private equity fund,” says Brian Hughes, head of private equity at New York State Common Retirement Fund.

“In developed markets – for instance Europe, China, developed Asia generally – our experience has been there’s less of a risk premium, so you’re going to emerging markets in search of that premium.”

Kvorning agrees that due to issues such as currency volatility, political instability and liquidity issues, the pension fund would be expecting a risk premium.

“At a very high level, a PE fund in Northern Europe or the US would have to, at a very minimum, do a 2x gross over the life of the fund,” he says. “Depending on the industry, the size of the fund, the country and the investment strategy and what kind of companies [it targets], I would say an African manager would have to [target] at least a 3x during the investment period.”

Macro stories aside – be they positive or negative – a key issue for investors considering making their first commitments to the continent remains the lack of verifiable track record which, Lim says, is “merely a function of the capital that’s gone into the ground”.

“More [capital] needs to come out for more investors to get more confidence that this is a sustainable, institutional market that is ready to support more capital coming in and support more GPs being funded,” he says.

“That has to be the main determinant of whether the market has been successful or not. Whether African PE has delivered or not, is ultimately [down to] the returns.”

Anne Fossemalle, director of the equity funds team at development finance institution European Bank for Reconstruction and Development, which invests across North Africa, agrees that track record is a stumbling block.

“It’s an underserved region, so these portfolios should do well,” she says. “The difficulty is you don’t have a proven track-record you can look at, but I would say every single one of these GPs that will be coming back to market has a nice story that they can tell, so hopefully they will be able to attract money.”