African private equity: compelling opportunities while many foreign investors remain on the sidelines

As a former head of investment research and emerging markets (EM) fund manager with 25 years of public and private markets experience, I continue to find it anomalous that the majority of the world’s largest institutional investors have yet to commit materially higher proportions of their assets under management (AUM) to African alternative investment strategies and, more specifically, to African PE.

In this note I assess why such lack of investment exists and comment on why I believe the investment outlook for African PE is now much more favourable given a myriad of positive macro-economic factors and a raft of compelling opportunities which have surfaced in the wake of the Covid-19 pandemic.

Explanations cited by major institutional investors as to their continuing reluctance to invest in African PE essentially boil down to three factors:

1) Poor historic US$ returns from existing PE firms,
2) a relative lack of choice of sizeable funds with strong track records, and
3) elevated perceptions of business and/or financial risk.

Notwithstanding such factors, and whilst fraud and corruption are often cited as key reasons to ‘stay away’ from African PE, one has to question the effectiveness of existing players’ investment processes including the nature and timing of exit strategies. The failure of The Abraaj Group is a case study in itself. It is up to you, the reader, in the face of compelling long-term investment opportunities across Africa, to judge whether such factors are legitimate reasons for poor performance or simply ‘excuses’ trotted out to disguise relative failure.

By definition, the lack of investors’ historic commitment to Africa has led to many of the biggest institutions lacking in-depth experience – a thorny problem exacerbated by the relatively shallow talent pool across Africa and the understandable desire of local portfolio managers to chase better career prospects abroad. Equally, many of the world’s largest asset managers are now measured in terms of their performance on a shorter-term basis than ever before which, in turn, tends to drive risk aversion and a tendency to continue to participate in ‘momentum trades’.

Africa comprises almost 1.3 billion people today. By the year 2100 the UN predicts that an additional 2.4 billion consumers will live on the continent. Consumption as a driver of economic growth, driven by long term positive demographic trends, are generally well understood. Yet custodians of the world’s largest pension funds which, conceptually, should have a long-term view have not yet stepped-up. On the other hand, the development finance institutions have continued to dominate the inward allocation of foreign capital to Africa, principally because of their longer-term focus and a political imperative which promotes initiatives to address poverty, education, climate change, food security, energy and infrastructure to name a just few investment themes.

At some point, the ‘J’ curve of inward investment into Africa has to reach a point of inflexion and attract a bigger proportion of asset allocation. However, for this to occur, key questions surround market timing and risk perception. Interestingly, the US tech giants including Amazon, Microsoft, Google and Meta seem to be waking up to the demographic opportunity. Their collective investments in Africa over the past two years, whist still comparatively small, have dwarfed their commitments over the past decade. A positive sign. Equally, and from a macro perspective, EM assets typically underperform heading into an interest rate hike cycle but outperform thereafter. Over the past six months, markets have shifted from pricing in three Fed hikes this year to between six and seven, amid rising inflation. This suggests the near-term outlook for EM assets may be turning net positive.