How can Africa’s pension funds unlock growth?

With Hamdiya Ismaila, Founder & CEO, Savannah Impact Advisory

The pension industry in Africa has been developing since the introduction of private pension schemes across many countries, including Ghana, Nigeria, and Kenya. These private pension funds have led to the ballooning of local pension assets across the continent, prompting practitioners to explore ways to leverage this capital for good. Mobilizing domestic capital for African development offers numerous advantages.

First, when leveraged properly, domestic capital could provide a significant boost to the development of the VC/PE ecosystem. It could attract smaller funds within the continent and offer a local context to how investments are viewed more generally. For instance, Africa still has many small and medium enterprises that require smaller ticket-size investments, much lower than what most larger PE funds are currently offering in the market.

Second, domestic capital could enable local currency investments, which would significantly support investments in the real sector of African economies. This, in turn, could foster the growth of small and medium businesses, innovations, and ultimately lead to job creation, new technologies, and economic growth.

Third, domestic capital could also encourage local fund domiciliation, as most domestic institutional investors, such as pension funds, have limitations on how much of their assets they can invest outside their jurisdictions. This means VC/PE practitioners need to be creative in designing structures that can unlock pension funds to invest in sectors that make sense for Africa.

Fourth, domestic capital could help determine the actual performance of fund managers, as currency fluctuations tend to erode the gains made by managers in Africa. Typically, funds are raised in hard currency, invested in local currency, and then converted back to hard currency for returns. This process has negatively impacted the return profiles of most managers, not because they underperformed, but because currency fluctuations significantly reduced their gains.

Likewise, investments in "hard currencies" have not been very beneficial for small and medium enterprises, including start-ups, in the continent, as they bear the forex risk. If the business is not export-oriented and thus cannot generate hard currency, it is unlikely to grow or could even collapse.

While the benefits are clear, there are significant challenges in mobilizing domestic capital, particularly from pension funds, due to the following reasons:

First, pension funds are regulated in ways that stifle innovation in investment decision-making. For instance, pension funds have restrictions on how much they can invest outside their jurisdictions, with some countries allowing as little as 5% in "external" investments. To address this, there is a need to explore local domiciliation of different structures that work within the local context.

Additionally, there is a general lack of understanding of the VC/PE asset class. Education is therefore crucial, but instead of a generic training approach, localized and targeted training is essential. It’s also important to note that many trustees have limited tenures, and some schemes experience high turnover rates in trusteeship. Continuous training will be more effective than one-off sessions. Trustees should also be educated on the importance of investing in the real sector for the broader economy.

Furthermore, there is a strong fear of losing money, as pension funds are very risk-averse. This is where catalytic capital can be a game-changer in many forms. Whether through guarantees or first-loss structures, catalytic capital can help unlock pension fund investments into the domestic economy.

In conclusion, Africa’s pension assets will continue to grow, driven by its youthful population. It is essential to find ways to leverage these assets to invest in the real sectors of African economies. Risk aversion and a lack of understanding of the asset class are key barriers to pension investments in the VC/PE ecosystem. Therefore, more capacity building and the use of catalytic capital are needed to unlock this potential. However, training must be tailored to the local context, and promoting local currency funds should be the starting point.