Specialisation of private asset classes in Africa – a growing theme?
During 2021 only eight Vintage I funds in Africa reached first close in the year. Looking at Vintage I funds is an interesting reference point for the direction of change in the market overall.
It is consistent with a theme we have seen in the market over the last few years – the growth in the number of specialist fund managers – while certain of the traditional large cap generalist pan-African players have battled raising capital for their new vintages, or in one or two cases have left the market altogether.
We have seen demand from limited partners, for more specialisation in the private asset class as a whole. This includes the development finance institutions who consider specialisation as a means to have a greater control over the developmental impact of their capital commitments. Also, specialist teams, with specific track-records and technical skills can provide a compelling answer to the question, why invest through a fund rather than through direct investing operations?
Most of the sector specialist funds in Africa are focused on sectors which offer high developmental potential, for example, financial inclusion, renewable energy and agri-business (food security). We believe this can also be said for tech and “fintech”.
One question we were frequently asked during our fund raising for our first close by prospective LPs was: why be a sector specialist and diversified across the region rather than be a country specialist and sector diversified”? In most markets in Africa we see limited advantage or risk mitigation in sector diversification in a single country: in the event of a sharp downturn in the economy of one country, most sectors are negatively impacted. This is one difference to investing in mature markets, where arguably there is more alpha in sector selection. We see the fundamental drivers for this distinction as including: (i) the enlarged role of the government in many African economies, (ii) in many countries the dependence on one or a small number of commodities in terms of export earnings and tax receipts, and (iii) unstable politics and weak institutions. As an aside, while South Africa is undoubted a more mature and diversified economy than its neighbours, it arguably has more similarities than differences to most other countries in the region. Equally, country specialist funds in theory can invest in a broad range of industries and must have the breadth of expertise in their team to match, while having access to much narrower sector expertise than a global fund with a much much larger AuM.
The converse is funds which are sector specialist and diversified across the region. Examples of which from the Vintage I funds which reached first close last year include, the Verdant Capital Hybrid Fund which is specialising in inclusive financial institutions, and Fortis Green, which is specialising in renewable energy. Sector specialist funds benefit from deep expertise and understanding of their chosen sector, knowledge of comparators and typically an extensive network of relationships with potential investees, their management and shareholders and other roll-players. Sector focus also allows for effective fund management at a smaller fund size. This is a valuable fact as average fund sizes are smaller now than the boom years of the last decade. As per GPCA data, during the last five years the private equity in Africa has raised on average USD 1.6 billion per year, compared to the prior five years which saw have average of USD 2.3 billion. The average number of funds closing each year was 21 and 22 in the two time periods respectively, i.e., almost exactly the same, implying average fund sizes 30% smaller. Exposure to multiple jurisdictions provides a valuable risk mitigation. For example, the performance of an asset finance investment in Southern Africa is likely to have limited correlation with the performance of a similar business in East Africa.
There has also been a significant growth in Africa of specialist “sister” asset types in such as mezzanine, infrastructure and venture. This part of a global trend, for example EMPEA, which stood for the Emerging Markets Private Equity Association, rebranded to the much less catchy acronym the GPCA or Global Private Capital Association. The best example of this in Africa is the growth of venture, driven in part by the strong demand for the fintech theme. As per GPCA data, venture funds deployed in Africa an aggregate of USD 3.0 billion in 2021 out of the total of USD 6.3 billion deployed in Africa in total across all private asset classes.
Arguably the growth of other specialist private asset types and specialisation within the private equity asset class itself has arisen in response to fundamental challenges in the performance of private equity in Africa, as such can be expected to be a continuing theme. As discussed above specialisation of teams and funds can help in portfolio construction, given the challenges running generalist teams with the broad expertise required to build generalist portfolios notwithstanding smaller fund sizes in Africa. In terms of other specialist asset types, mezzanine or hybrid capital funds, by being senior to the holders of common equity, usually in Africa “insiders”, benefit from an important mitigant to the principal-agent risks which have impacted many minority equity investments in Africa. Another example: venture funds are seeking businesses with growth prospects disconnected to the lower than previously forecast growth of dollar GDP in the markets in which they operate. This might have appeared unnecessary a decade ago in the Continent of the “Fastest Billion”!