Ideas & Debate

Africa PE markets face tough times in tight money policies

avca

Delegates follow proceedings during the 16th annual African Private Equity and Venture Capital Association conference in Nairobi on April 2, 2019. FILE PHOTO | NMG

Thanks to ultra-low interest rates, world stocks (according to the MSCI World Index) have more than doubled (2.5 times) and emerging markets have equally appreciated.

One place that has benefitted from this excessive flush of capital is Africa's Private Equity (PE) space. According to Africa Private Equity and Venture Capital Association’s (AVCA) PE Industry Survey, the percentage of Limited Partners (LPs or investors in PE firms) planning to increase their African PE allocation over the next three years increased to 65 percent.

This is a massive jump from 58 percent last year, 53 percent in 2018 and 54 percent in 2017. But after a decade of record breaking cash injections, with the world’s big central banks indicating easing off the stimulus pedal, will these markets learn to practice walking on their own again?

It is important to consider that since these rate adjustments are between one to two years cheap cash will still remain plentiful in the short-term. In other words, liquidity— the catchphrase for all that money pumped in by central banks, private lenders and governments— will continue to drive up both private and public markets.

In fact, notable findings of the PE report show that the status quo is likely to remain; almost half (48 percent) of LPs, most of whom are international investors with offices outside of Africa, believe that international capital flows will continue to catalyse the PE industry in Africa.

Moreover, in the past five years, almost three quarters of LPs (71 percent) have co-invested alongside an African General Partner (GPs or managers of PE firms). Of these, 23 percent plan to accelerate the pace of their capital deployment in African PE in the next one to two years, and a further 73 percent will increase their PE allocation in Africa within the next three years.

In short, the excessive liquidity unleashed mainly by the US and European central banks is forcing large LPs to increase their allocation towards higher yielding generating and growing emerging/frontier markets, of which Africa is a major beneficiary.

Institutions— particularly pension funds struggling with sizeable asset/liability gaps— have seen their private equity allocations go up.

In a sense, the global macro has thrust the Africa investment opportunity in a favourable position and most PE investors are inclined towards increased amounts in larger deals. For as long as rates remain low, PE firms have a reason to make more affordable capital investments that will pay off in the future.

As of April 2021, fund managers were sitting on a record Sh160 trillion in dry powder, putting increasing pressure on investors to identify investment opportunities quickly, according to alternative assets market data provider Preqin.

That said, this scenario can only last until the next phase where excess liquidity contracts as a result of inevitable tightening.

Rates adjusting upwards means the outlook for the sector could be slightly more precarious than it seems. When rates go higher, portfolio companies spend more of their revenues on financing costs, which hurt profit margins. Moreover, as equity values decline, more fundraising becomes less compelling. All this means more headwinds for the sector.

Mr Mwanyasi is the managing director at Canaan Capital