The good news is that impact investing - at least in its broadest definition - is truly in motion in African PE. “You're not raising capital today without having a framework for approaching impact,” says Stuart MacKenzie, partner and head of Africa for The Rohatyn Group. This is in large part due to the source of that capital, much of which comes from development finance institutions (DFIs) that are more focussed than most on environmental and social outcomes.
Karima Ola, who leads LeapFrog’s African Financial Services investment team, highlights the importance of clear frameworks like the ABC of impact. A is avoiding harm, B is benefiting stakeholders, and C goes further to address wide-scale challenges. “At LeapFrog, we aim to do all three, underpinned by a robust environmental and social action plan,” she says. “Impact is only truly impact if it’s intentional.”
But across the PE landscape, the outsized presence of DFIs is in part a function of historically poor returns. This is not down to any lack of expertise or ability across PE firms, but rather the economic volatility inherent to investing in Africa. A decade of underperformance has kept commercial capital away and left local institutions and DFIs to fill the gap. “We’re at an inflection point in the cycle of private capital in Africa,” says MacKenzie. The question, he adds, is how to deliver the risk-adjusted returns necessary to draw back commercial capital while embedding impact principles in a cost-effective manner.
Firms are eagerly searching for ways to lower the cost of creating impact strategies and performing due diligence, monitoring and reporting. A multitude of different investor frameworks means there should be room for standardisation. Some investors have also shown willingness to accept first-loss or capped return structures as part of ensuring impact.
“The other innovation we’re seeing is managers being prepared to put their own fee structure on the line - tying it to the delivery of impact KPIs,” says MacKenzie “That helps layer costs in a way that incentivises managers to ensure impact.”
Scaling up solutions
All that should help lower the cost of pursuing increasingly ambitious impact metrics. On the returns side, meanwhile, technology is making it possible to dramatically scale -up solutions for huge swathes of underserved consumers. A perennial issue in Africa is the focus on providing services to higher income groups already catered to by the status quo. Some of the most attractive sectors for PE in Africa are health, finance and education - where fintechs are unlocking ways to reach lower-income groups.
Healthcare and finance have featured prominently in LeapFrog’s Africa-focussed funds. “When you map the number of consumers we’ve served over the last 17 years - over half a billion people reached through our investments to date - the growth curve accelerates sharply in the last decade,” says Ola. She attributes that surge to technological innovation and the rise of fintechs able to expand the reach of essential services.
Kayode Akindele, managing partner at Coronation Capital, points to success in renewable energy deals and growing support for investments that aim to improve gender diversity. “The biggest success has been to improve the understanding from local market participants especially on exactly what impact investing is, and that just because non-financial benefits are targeted does not mean a financial return is not required,” he says.
Hedging headaches
The factors that contributed to a decade of underperformance have not gone away, though. A significant proportion of impact investment funding is in dollars, which creates a currency mismatch that remains hard to hedge through traditional means. Currency devaluation, especially of the kind seen in the last three years across many African countries, erodes returns and valuations. “Hedging solutions need to be developed and more local currency funding sourced from LPs to diversify the investor pool currency denomination,” says Akindele.
Other hurdles include accurately measuring the outputs from impact investing. Akindele says teams are building the necessary skills and experience in data collection and analysis. “But there is still a dearth of independent third-party data sources and verifiers that LPs can rely upon to substantiate fund claims.”
Ola emphasises the importance of enabling institutional investors to benchmark and compare impact outcomes. “Unlike financial returns, impact results—such as financial inclusion for low-income consumers, affordable access to electricity, or educating children —are not easily comparable,” she says. “Some solutions include assigning a dollar value to benefits or using metrics like Disability-Adjusted Life Years.”
Competition for returning commercial capital means the key will be in devising frameworks that make it possible to measure, manage and compare diverse impact objectives. Only then can impact investing fulfil its potential.