Finance-WheretoInvestinAfrica

Impact investment — beyond the traditional

In past editions, we focused on the traditional means by which to access funding mechanisms to mitigate risk and maximise returns, such as loan structures or venture capital funding. But financial innovation in Africa has brought with it changes to financial systems that have led to the provision of diversified services in the banking sector and the assimilation of instruments into capital markets that assist in reducing investment risk.

That isn’t to say that the development of traditional finance has been uniform. In terms of the level of progress measured by the annual Global Competitiveness Report, which evaluates financial systems across a broad spectrum of countries, 26 of the 34 African countries surveyed fell in the overall rankings between 2017 and 2018, with the most distinct being South Africa (four places), Botswana (12 places), Kenya (six places) and Egypt (11 places) (Figure 4.1).

Figure 4.1: Africa’s standing in global financial systems (rank out of 140 countries)

Source: WEF

The decline in rankings reflects a slower pace of reform rather than an outright deterioration: Egypt is closing its credit-to-GDP gap and Kenya is cutting its percentage of non-performing bank loans. Aside from Botswana, the other three countries are still perceived to have relatively deep financial markets when comparing 2018 private-credit-to-GDP stats to the long-term average for Africa (Figure 4.2). According to the World Bank, the latter serves as a reliable proxy for financial development as it has a strong statistical link to long-term economic growth and is closely related to poverty reduction.

Figure 4.2: Private credit to GDP as a measure of financial depth

Note:
The 2018 figure for South Africa was not captured by the World Bank at the time of publication

Source: World Bank

The 2018 Absa Africa Financial Markets Index produced by OMFIF ranks South Africa, Botswana and Kenya among the top three countries to display progress and potential across six critical areas: depth; access to foreign exchange; market transparency; tax and regulatory environment; macroeconomic opportunity; and the legality and enforceability of standard financial markets master agreements (Table 4.1). Egypt, despite making strides in improving its foreign-exchange environment, languishes at number 16, due to challenges in enforcing contracts, which is also reflected in its low global ranking (87) in the Financial Systems Pillar of the Global Competitiveness Index.

Table 4.1: Absa Africa Financial Markets Index

Note:

1. Score across all pillars, max = 100
2. Three more countries (Angola, Cameroon and Senegal) appear in the second edition of the index. The scope for direct comparison of countries’ positions in the index between 2017 and 2018 is therefore limited.

Source: OMFIF

While progress in terms of both depth and sophistication varies across markets has been made, there is a distinct move away from traditional forms of finance to enable access to capital. In this edition, we focus on an emerging stream of finance that is complementary to the realisation of the Common African Position of the AfDB — impact investment.

Making a difference one project at a time

Alternative funding is assuming a more fundamental role in enhancing economic growth across the continent through impact investment, defined by the Global Impact Investing Network (GIIN) as investments that are made to generate a measurable social and environmental impact, alongside financial returns.

The impact investing industry has grown in prominence since the early 2000s, owing to both impact and financial factors. Investors globally have developed a substantial interest in SSA, as evidenced by the GIIN 2019 Annual Investor Survey, which showed that 44% of respondents apportion 14% of their assets under management (AUM) to the region — greater than any other emerging market — while 88% plan to maintain or increase their allocation to the region in 2019 (Figures 4.3 and 4.4)

Figure 4.3: Geographic allocations by AUM and number of respondents

Note:
ercentage of AUM, excluding three outliers (sample of 259 resondents with combined assets totalling US$131bn); percentage of respondents with any allocation to each geography (sample of 266 respondents); respondents may allocate to multiple geographies

Source: Global Impact Investing Network

Figure 4.4: Planned geographic allocation changes for 2019 (% of respondents)

Source: Global Impact Investing Network

Prospects for African investment are ripe, considering that a vast number of countries are well below the long-term global-average score for human development which is 0.8 (Figure 4.5). Moreover, declining levels of official development assistance, which has been a popular means by which to complement low domestic savings, increase the relevance of impact investing to address development priorities.

Figure 4.5: Human Development Index scores 2017 (0-1, where 1 is best)

Source: Human Development Index

There are ample opportunities to support initiatives offering both financial and social/environmental returns. According to the Bertha Centre for Social Innovation and Entrepreneurship, the key is to partner with entrepreneurs who understand the underlying issues in communities and have found innovative business models to meet the demand for quality services and products. The International Finance Corporation (IFC) and Bertha Institute offer examples of exceptional impact investment across a multitude of sectors:

Healthcare, water and sanitation — Living Goods was established in 2007 to sell essential healthcare products through a door-to-door operating approach. Today there are more than 1,000 Living Goods community health promoters working in Uganda and Kenya through a micro-franchise model. Living Goods initially received grant capital from foundations, which was followed by investment capital from investors including the Omidyar Network, and the company reached breakeven in 2011.

Education — Bridge International Academies (BIA) is re-engineering the business model of delivering basic education by operating an ultra-low-cost private school (US$6.5/month) in East Africa. Launched in 2009, it has become the world’s largest chain of primary and pre-primary schools, with 359 academies and over 100,000 students. BIA received early investment from impact investors including the Bill & Melinda Gates Foundation and the UK Department for International Development and then secured growth capital from larger financial institutions, such as the IFC.

Agriculture and food security — Sekaf is a Ghanaian sustainable social enterprise that processes shea nuts and improves farmers’ likelihood of getting a fair price. Through an investment from Injaro Fund, Sekaf now employs over 250 women and buys shea nuts and shea butter from approximately 2,500 women. By helping these women with loans, training and quality control expertise, it has directly increased the productivity and quality of products for which producers receive a fair price. In turn, this provides employment security and economic empowerment for cooperative members.

Housing — International Housing Solutions is an institutional real-estate manager investing in the acquisition and development of residential and supporting commercial real estate in South Africa. Through its South Africa Workforce Housing Fund, 35 investments involving approximately 30,000 units of affordable for-sale and rental housing have been built since 2008. The fund is fully invested, having raised US$154m of limited partner capital from five different investors, with an additional participating debt commitment of US$80m from the Overseas Private Investment Corporation (OPIC).

Renewable energy and clean technology — M-KOPA offers a low-cost alternative that provides clean, reliable energy for lighting and powering homes. To date, M-KOPA has raised US$45m in total equity funding and debt financing. Lenders included the Bill & Melinda Gates Foundation, LGT Ventrue Philanthropy, Imprint Capital and the Netri Foundation.

Players, purpose and profit

Appetite for investing in SSA is almost evenly split between private equity and debt (with a propensity toward senior and subordinated debt). Collectively, these two subsets of investors allotted US$20bn in capital to the region in 2018. The most common players in Africa in terms of proportion of capital allocated are development finance institutions (DFIs).

Table 4.2: Types of impact investors

Source: UNDP

Honing in on Southern Africa, which is a hotbed for impact investment given South Africa’s market size, socioeconomic needs and rising interest by local financiers, we find that by 2016, DFI and non-DFI activity had accelerated quite significantly, with a large proportion of deals conducted across the region’s financial and agricultural sectors (Figures 4.6 and 4.7). The average sizes of deals have and continue to vary between US$1m and US$10m in the case of non-DFIs, and US$5m to more than US$50m for DFIs.

Figure 4.6: DFI direct investment by sector

Note:
Average deal sizes may not equal displayed capital disbursed divided by deal sizes. Capital disbursed rounded to nearest million, except where less than US$1m (rounded to nearest 100,000). Average deal sizes rounded to nearest 100,000. Excludes US$83m in capital where sector is unknown. Excludes domestic South African DFIs due to limited data. WASH refers to water, sanitation and hygien

Source: Global Impact Investing Network

Figure 4.7: Non-DFI direct investment by sector

Note:
Average deal sizes may not equal displayed capital disbursed divided by deal sizes. Capital disbursed rounded to nearest million, except where less than US$1m (rounded to nearest 100,000). Average deal sizes rounded to nearest 100,000. Excludes US$4m in capital where sector is unknown. WASH refers to water, sanitation and hygiene

Source: Global Impact Investing Network

Regardless of the investment type, investors are driven by the need to be responsible in their capital spend and show intent through their respective allocations (Figure 4.8).

Figure 4.8: Reasons for tracking performance against the Sustainable Development Goals (% of respondents)

Source: Global Impact Investing Network

Though motivated by the change that their monies can effect, investors still actively target financial returns, with most pursuing risk-adjusted market rates (Figure 4.9). For SSA, the target is slightly different due to the composition of the investor base, with private-debt houses tracking below-market returns that are either close to the prevailing market rate or nearer to a level for capital preservation.

Figure 4.9: Targeted financial returns principally sought

Source: Global Impact Investing Network

Impediments to impact investment

Impact funding, though beneficial, is not without challenges. The Bertha Institute finds that the regional African market for impact investment is relatively immature, with underdeveloped market infrastructure narrowing the opportunity for efficient capital distribution across asset classes. Some of the primary concerns, not unique to Africa, include the mismatch in expectations between investors and entrepreneurs with respect to pricing, the type of capital required and the longevity of investment. Investors also highlight legal and regulatory barriers that pose additional challenges to capital outlays.

Measuring impact investment is crucial to assessing whether capital can, and has been, allocated efficiently. The Sustainable Development Goals provide a benchmark against which a growing number of investors are evaluating their performance: 90% of respondents to the GIIN Survey define it as a means to communicate their impact externally or to integrate into the global development paradigm. However, the challenge for investors is in quantifying and verifying both the social/environmental and financial impacts due to a lack of a universally-accepted measurement standard, resulting in inconsistent tracking across sectors, which affects project viability.

The IFC is more intentional in identifying the challenges. They include:

• Difficulty sourcing viable investments that meet both financial and social/environmental objectives as a result of the limited capacity of sustainable social enterprises;
• Limited innovative fund and deal structures;
• Difficulty exiting investments;
• Poor visibility and credibility of sustainable social enterprises in the absence of a sustainable social enterprise “label”;
• Limited capital supply across the risk/return spectrum;
• Unclear regulatory environment;
• Poor linkages between sustainable social enterprises, entrepreneurs, investors and innovation networks; and
• Poor and inconsistent impact-measurement practice.

Be the change you want to see

As with any development activity, interested parties subscribe to a common vision. In the case of impact investment, the IFC recommends:

• Strengthening the pipeline of viable impact investment prospects that can meet both the financial and social/environmental objectives of impact investors;
• Creating an enabling regulatory and policy environment in which impact investment can thrive;
• Strengthening impact investor capacity and practice;
• Developing and fostering appropriate infrastructure for the impact investment sector; and
• Enhancing and developing impact-measurement practices and standards.

All this is easier said than done considering pipeline development, the existing regulatory and policy environment, industry infrastructure and the lack of standard measurement practices. Therein lies the opportunity, particularly for investors who can optimise social and environmental investments through innovative solutions such as impact bonds — once again raised by the Bertha Institute as an alternative way of paying for outcomes-based contracts.

Investors provide capital to underwrite social projects and reap returns if the predetermined benchmarks that relate economic value added are achieved. A prominent example is the Impact Bond Innovation Fund, a South African outcome-based financing mechanism that seeks to improve early childhood learning and development outcomes in the Western Cape province in South Africa. It is the first of its kind and has piqued interest among prominent local asset managers with social and environmental development funds. If successful, the model will be replicated nationally to other social interventions. This will create a mechanism by which public and private capital can be blended, and crowding-in new funding to underfunded programmes can be achieved.