Author: Joseph Mate, Head of Advisory & Africa – Qbera Capital LLP.
For the past 20 years, capital markets development has been identified as an important tenet to economic development on the African continent, with several efforts made with varying degrees of success.
Combined efforts of African Governments, Development Agencies and the Private Sector have sought to deepen capital markets via the establishment of stock exchanges to facilitate access to alternative sources of capital to bank lending.
Initially, these initiatives were supported by privatisation programs and regulatory incentives such as tax breaks, that led to formerly state-owned business and multi-nationals securing local listings. However, the growth and development of these markets has stalled in recent years; negative emerging market sentiment, especially with the slow-down in the Chinese economy, an African population that still has a poor savings culture, illiquid markets and lack of confidence in the regulatory framework, amongst the reasons cited.
I am of the view that these initial capital market development efforts did not quite address the social economic structures prevalent in many African countries. There is a large gap between those companies initially listed on exchanges and those which many believed would develop over time and be listed.
Many of the private sector companies that people believe would be listed are still far from being ready to list. These mid-market and large corporates must undergo an additional phase of development – increase their track record with banks as well as opening up to private debt investment.
From a macro perspective, Africa signals many attractive indicators for both investment and investors:
- Real output growth is estimated to accelerate to 4.1 percent in 2019. Overall, the recovery of growth has been faster than envisaged, especially among non-resource–intensive economies
- Growing population and increased urbanisation – increasing the need for world class infrastructure, good and services.
- Nascent African capital markets resulting in a financing gap for growth and working capital to fund SMEs and infrastructure.
- The assets managed by African institutional investors are expected to rise to USD 1.8 trillion by 2020 from USD 670 billion in 2012. African pension funds have expanded in several countries, offering a viable option for both long and short-term financing opportunities.
As touched upon earlier, for African companies and economies to achieve their potential, private debt will play a critical role.
Private debt has become an asset class simply too big and too important to ignore. Given that it is predominantly floating-rate in nature, in an environment of rising rates its appeal can only grow from an investors perspective.
For investors, the market can be somewhat confusing as not only are there many ways of defining private debt, it also forms a sub-set of a larger class of alternative debt strategies. These have grown in size since the global financial crisis as banks have withdrawn or refocused their lending activities.
Active investors in the private debt market range from ultra-high net worth’s & family offices to institutional investors (e.g. pension funds and insurance funds). In the US, institutional investors have been lending directly to the corporate sector for decades and Europe is seeing a more recent transition from the banking sector to non-bank lenders.
Private debt offers both a complimentary (to bank financing) and alternative sustainable financing solutions for SMEs and more established companies, both for long term growth capital as well as short term working capital.
As an asset class, it offers an attractive opportunity to investors, particularly pension funds as it offers a much-needed alternative which has diversification benefits as well as being somewhat uncorrelated to other asset classes and macro-economic conditions (e.g. Trade Finance).
Pension funds can play a catalytic role in economic development; for instance, the 1979 Employment Retire Income Security Act reform in the United States resulted in an explosion in the Private Equity and Venture capital industry. The reforms explicitly allowed pension funds to invest in Venture Capital funds by amending the “prudent man” rule. The Emerging Market Private Equity Association estimates that Africa has an unutilised pool of pension fund capital of approximately USD 29 billion – suggesting significant potential to replicate this impact for the continent.
Pension funds can also play a critical role in finance through the mobilisation and allocation of stable long-term savings to support infrastructure and corporate finance. In Sub-Saharan Africa, the infrastructure funding gap across information and communications technology (ICT), power, water, roads and others are circa USD 100 billion per annum. Targeted investments by pension funds can go a long way to help fill this gap and boost growth. Further, there is increasing literature on the role pension funds play in capital market development:
- by broadening the depth of the market, for example, the Public Investment Corporation (“PIC”) is South Africa’s largest asset manager representing almost half of the non-banking financial assets
- specifically, by improving the efficiency of loan and primary markets by acting as a financial intermediary and lowering the cost of capital
Furthermore, a growing middle class is placing greater emphasis on savings. This growth in Africa’s middle class and the subsequent rise in savings will boost the demand for pension products. This is further aided by increased adoption of technology by pension funds—making it easier to reach wider populations and reducing the cost of distribution. PWC estimates that pension fund assets under management (AUM) in 12 African markets will rise to around USD 1.1 trillion by 2020, from USD 293 billion in 2008.
As AUM grows to significant proportions of GDP, there will be fewer domestic opportunities available to provide the capital protection and diversification necessary for pension funds to meet their obligations and portfolio limits. This will create further pressure for both pension funds and regulators to explore the private credit space.
The immediate benefit of pension funds playing a larger role in the private investment market is the deepening of liquidity sources. The increased liquidity, coupled with pension fund’s increased understanding of the private debt asset classes, will lead to the development of the private credit markets in Africa. Effective mobilisation of capital will deepen the financial sector in Africa resulting in an increase in capital investing in Africa as well as playing a key role in enabling the continent to achieve its potential.
1. AfDB 2018 Economic outlook
2. Pension and Investments – 13 October 2013
3. Gompers, 1994 “The Rise and Fall of Venture Capital”
5. Boston Consulting Group and African Finance Corporation, 2017 “Infrastructure Financing in Sub Saharan Africa”
6. Moleko & Ikhide, 2016 “Pension fund evolution. Reforms and Trends in South Africa, Pensions Institute
7. Meng & Pfau, 2010 “The Role of Pension Funds in Capital Market Development”
8. Africa Asset Management - Report by PwC examining the asset management industry across 12 African countries (Algeria, Angola, Botswana, Egypt, Ghana, Kenya, Mauritius, Morocco, Namibia, Nigeria, South Africa, Tunisia)