In an environment with comparatively small stock markets, private equity investments are not only a potentially attractive asset class, but also help to nurture businesses and entrepreneurs. How can pension funds be convinced to take a closer look?
The global financial crisis may have led to a temporary dent, but private equity’s interest in emerging markets is rising steadily. However, Brazil, China and India still continue to overshadow sub-Saharan Africa, where much of the funding for private equity funds comes from development finance institutions (DFIs) rather than commercial investors.
This needn’t be the case, argue industry representatives: High GDP growth rates in many African countries, a growing middle class and booming sectors like telecommunications, banking and finance, and agribusiness represent interesting opportunities. There is a shift away from the traditional targets like commodities and natural resources.
When the African Development Bank (AfDB), the Commonwealth and the Africa Venture Capital Association (AVCA) hosted the first East Africa Private Equity Roundtable together in Nairobi in May 2010, the intention was to engage African pension funds and other institutional investors: They are a potentially sizeable source of local funds for private equity investments and, the organizers argued, have not paid enough attention to the opportunities that this asset class presents.
Pension Fund Champion
Michael Addo from Ghana’s SSNIT, for one, is a convert, and provided an enthusiastic narrative of how SSNIT began to look at private equity investments as a strategy to become more competitive after Ghana’s pension fund sector had been liberalized. At the moment, SSNIT set aside 3% of its entire portfolio for private equity investments, and currently has four PE funds that it works with: one local and three pan-African, one of which is focused on infrastructure investments.
It is an interesting asset class, he said, that has several advantages:
- It helps SSNIT diversify the assets in its portfolio;
- It hedges against Ghana’s traditionally high inflation as transactions are done in hard currency;
- It provides regional diversification: SSNIT will only consider funds that will invest in Ghanaian companies – but they do not have to do so exclusively.
And there are other advantages that are not immediately reflected on SSNIT’s books, he argues: Private equity investments create knowledge transfers and will help local companies grow. In the medium and longer term, this creates more employment, and so more contributions to pension funds.
Reluctance
But convincing the trustees was not easy, Addo found: Long period of no returns, putting money into a blind pool with no access to investment committee, and capital calls within 15 days made them uneasy. This is reflected across the industry: Overly conservative trustees were a repeat concern. But some of the factors that worry them can be managed, and some can be addressed with more investor education:
- Limited liquidity: typically, PE funds show a J curve as they lose net asset value in the beginning. However, several participants questioned whether liquidity really represents such a major concern: Pension funds typically have other, more liquid assets to compensate for this, and the dip in the J curve is typically found in the beginning. Secondary funds can provide additional liquidity.
- Funders worry about exit strategies, as IPOs are difficult and costly compared to countries with much larger and often competing stock markets such as China and India – but there are alternatives in trade sales, strategic tie ups, and management buy outs.
- That pension funds have no representation on the investment committee makes trustees nervous, but Ugo Ikemba of Vectis Capital points out that it shouldn’t. Aside from liability issues, they are typically no experts in private equity investments, so the value they can add to the process is limited. Vetting the fund they invest in carefully is far more important.
Both Japheth Katto from Uganda’s Capital Market Authority and Stella Kilonzo from Kenya’s Capital Market Authority asked what the regulators could do to support pension fund investments in private equity, or private equity funds in general, but the feedback from the audience was that apart from some tax optimization issues, the key obstacles were not, in fact, regulatory.
Perspectives
South Suez, a fund of funds backed by South African pension funds, came to the roundtable to engage other African pension funds to broaden their investor base. But for the foreseeable future, DFIs will continue to play a very important role. Actis’ Michael Turner expects that the market will continue to be divided between large caps that attract international commercial money, and SME funds often backed by soft money that offer more scope for local participation.
And if the organizers of the round table took home the need for sustained investor education, sometimes other issues than the intricacies of private equity assets occupy pension funds: Uganda’s National Social Security Fund (NSSF) lurches from scandal to scandal, stumbling most recently over the allegedly overpriced purchase of land from a cabinet minister. Kenya’s NSSF, in contrast, had problems locating the share certificates for rather substantial stock market investments transacted through a broker later put under statutory management. In these cases, far more fundamental governance issues probably need to be addressed first.
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