Welcome to the fourth edition of Africa Focus. This issue explores various ways in which African nations are becoming more hospitable to business and investment interests, depicting a fast-changing continent where—despite undeniable challenges—there is much cause for optimism.
Promising developments in Africa extend beyond the business sphere. This spring, White & Case is hosting and sponsoring a private opening preview of Sotheby's auction of Modern and Contemporary African Art in London. This client event celebrates the work of artists across the continent, with a strong focus on the independence and colonial eras. Modern and Contemporary African Art, Sotheby's newest department, was formed in 2016 to address growing market demand. Sales in this category have broken more than 50 artist records and attracted collectors from 40 countries across six continents.
We hope you enjoy this edition of Africa Focus. Please let us know if there are topics or issues you would like us to cover in the future.
Doing well by doing good
Impact investing offers great potential for Africa
Most leading, modern investors have clearly defined values, mission statements and governance policies. In recent years, they have placed more emphasis on ensuring that investments reflect those values. Ethical investing, more accurately known as socially responsible investing (SRI), first manifested itself in taking greater care to avoid investments that did not meet acceptable environmental, social and governance (ESG) standards. Investment funds emerged that overtly excluded investments in companies that engaged in practices that they (and their stakeholders) found unacceptable, such as:
Enthusiasm for responsible, sustainable investments shows no sign of abating.
Excessive pollution
Climate change aggravation/ global warming
Deforestation or wildlife destruction
Child labor
Corruption
Workforce exploitation
While these funds had philanthropic goals, return on investment (ROI) remained important. As standards evolved for assessing and verifying ESG performance, so did new approaches to investment, with funds investing only in businesses that tracked and reported their performance against those standards.
Figure 1 shows the full investing continuum, from pure philanthropy focused only on the charitable impact, to traditional investment driven wholly by financial returns. This article focuses on impact investment, which aims to find a balance between the two.
43%
of those surveyed under the age of 40 reported having made an impact investment
“Investor Motivations for Impact”, Barclays
Impact investing strives not only to avoid investments that support harmful practices, but also to actively seek out opportunities that positively change the communities and ecosystems impacted by the target business, while delivering acceptable ROI. It represents a shift from merely avoiding negatives to proactively embracing positives—to do well by doing good.
Although "impact investment" can describe a wide variety of investment types and asset classes, the Global Impact Investing Network (GIIN) definition summarizes the general concept: "An investment made with the intention to generate positive, measurable social and environmental impact alongside a financial return."1
A July 2018 impact investing report published by Barclays included a survey of 2,000 UK investors.2 It showed that the number of investors making sustainable investments increased by two-thirds from 2015 to 2017. The millennial demographic is largely credited with driving this change. In the Barclays study, 43 percent of those under the age of 40 reported having made an impact investment, compared to only 9 percent of those aged between 50 to 59. In a similar report published in 2017, Morgan Stanley's Institute for Sustainable Investing found that 86 percent of millennials surveyed identified as being "interested in sustainable investing" and highlighted that millennials were twice as likely as the overall population to invest in companies targeting social or environmental goals.3
36%
of respondents listing sub-Saharan Africa
as one of their top-three geographies for capital deployment
GIIN 2018 Impact Investor Survey
Historically, African governments have supplemented their budgets with official development assistance (ODA) to meet the needs of their populations.4 The 2008 financial crisis made inflows of ODA more volatile. As a result, over the last decade, private inflows of capital into Africa have been rising to replace funding previously provided by ODAs. African governments are therefore well positioned to capitalize on this increase in private investment and find market-based solutions to address their nations' socioeconomic challenges, particularly those highlighted in the African Union Commission's Agenda 2063.
The need for market-based solutions in Africa, combined with an increased investor appetite for responsible and sustainable financing, illustrates that impact investment has the potential to become an important source of funding for African governments. It can serve as a tool to deploy private capital that effectively bridges existing funding gaps in several emerging-market economies across Africa.
Sustainable development goals
Approximately US$428.29 billion of investment assets in sub-Saharan Africa were dedicated to impact investment strategies.
In addition to a number of specific impact investment strategies commonly used in Africa and further discussed below, several overarching principles underpin the impact investment market. These include initiatives such as the Sustainable Development Goals (SDGs). In 2015, as part of the 2030 Agenda for Sustainable Development, all United Nations member states adopted a shared blueprint for a better and more sustainable future for all. This blueprint includes 17 SDGs, each developed to address specific global challenges including poverty, inequality, climate, environmental degradation, peace, prosperity and justice.5 In addition to providing a useful framework for member states to use when developing their agendas and policy initiatives through 2030, the SDGs have given the impact investment industry a helpful set of quantifiable development objectives for investors to use when selecting suitable projects, funds or asset classes in which to invest. By distilling global challenges into a set of common goals, the SDGs united the global players—public and private sectors, NGOs and corporations, investors and startups—with a common vocabulary that naturally aligns with impact investing.
In practice, the SDGs have provided an effective common framework. The GIIN 2018 Impact Investor Survey found that in the two years since their adoption, 55 percent of impact investors tracked their investment performance to the SDGs and another 21 percent said they planned to do so in the future.6 When questioned, the impact investors surveyed cited a number of reasons for doing so, including the ability to attract investors and investees, the ability to communicate impact externally against a widely recognized framework, integration into the global development paradigm and the ability to set appropriate targets and aims.
As described above, with decreasing amounts of ODA available to African economies, governments will have no choice but to mobilize private funding to meet the SDGs by 2030, and the synergies between the SDGs and the aims of impact investment will help facilitate this.
Common impact investment strategies
Enthusiasm for responsible, sustainable investments shows no sign of abating. This is promising given the significant need for private funding to address socioeconomic challenges in African economies to satisfy the SDGs. However, an important aspect of impact investment is the investors' ability and willingness to monitor the progress of their investments to ensure accountability and transparency and to inform future investment decisions. While there is no universally accepted definition or accreditation to determine which investments are classed as "impact investments," many market participants seek to implement certain impact investment strategies to ensure that their investments fulfill the required criteria to be deemed responsible investments.
The African Investing for Impact Barometer 2017 (AII Barometer) 7, published by the Bertha Centre, outlines the key investment strategies implemented on the African continent:
46%
of sub-Saharan Africa–focused investors identified “country and currency risks”
as severe when it comes to making and evaluating investments
GIIN 2018 Impact Investor Survey
ESG integration: This involves integrating ESG factors into investment analysis, valuation and decision-making based on metrics and appropriate research resources. There are numerous ways to do this. For example, one can integrate ESG-related key performance indicators into staff objectives or consider ESG data when structuring a portfolio of investments. The AII Barometer showed that across East Africa, West Africa and Southern Africa, ESG integration had the heaviest weighting as a percentage of total assets compared to the investment strategies discussed below, and therefore is the most common strategy implemented by African impact investors.
Investor engagement: Impact investors in Africa also used the investor engagement strategy, in which the relevant investor takes an active role in influencing company behavior through board participation, proxy voting or creating a dialogue with management on ESG matters. This was particularly prevalent in Southern Africa, where investor engagement had the second-highest weighting as a percentage of total assets (after ESG integration) compared to the other investment strategies.
Screening: Some investors, particularly in East Africa, opted to implement a screening process for prospective investments. For example, this includes positive screening to select suitable investments, negative screening to exclude certain types of investments, and norms-based or best-in-sector screening processes.
Theme-based strategy: Finally, some investors chose a theme-based strategy, focusing on a particular ESG factor, for example only selecting investments that related to environmental sustainability. This strategy was particularly popular in West Africa, where it had the second-highest weighting as a percentage of total assets compared to the investment strategies outlined above.
Each of the above strategies seeks to ensure that any investments selected by impact investors generate positive, measurable social or environmental impact as well as a financial return.8
Investment trends
The GIIN 2018 Impact Investor Survey provides interesting insight into the minds of impact investors and current market trends.9 The GIIN Impact Investor Survey included 229 organizations participating in the impact investing industry globally in 2017, together managing more than US$228 billion in impact investment assets. The survey showed a strong presence in Africa, with 12 percent of these assets located in sub-Saharan Africa, 36 percent of respondents listing sub-Saharan Africa as one of their top-three geographies for capital deployment, and 6 percent of respondents having their headquarters in sub-Saharan Africa.
The AII Barometer provides a snapshot of impact investing trends on the continent. It shows that, as of the end of July 2017, approximately US$428.29 billion of investment assets in sub-Saharan Africa were dedicated to impact investment strategies, representing just over half of the total assets under management surveyed. Southern Africa was by far the most popular region for impact investment in Africa, representing approximately 93.3 percent of impact investment assets, while East Africa represented 4.3 percent and West Africa represented the remaining 2.4 percent.
Key challenges
Impact investment is a market area that continues to grow, with some large, mainstream players entering the industry in the last year.
Impact investment has increased in Africa in recent years and has the potential to contribute much to the continent's economic growth and development objectives by plugging the funding gap. However, the practice has yet to reach its full potential and still faces a number of significant challenges.
The GIIN 2018 Impact Investor Survey asked respondents to indicate what they viewed as key significant challenges facing the impact investing industry. For investors focused on sub-Saharan Africa, the two most commonly cited issues were:
The current lack of consensus regarding definition and segmentation in the impact investing market (52 percent of respondents)
A lack of appropriate capital across the risk/return spectrum (44 percent of respondents)
Other significant challenges cited by Africa-focused investors were a lack of suitable exit options (35 percent), a need for more innovative deal or fund structures (35 percent), the impact measurement practice's low level of sophistication (32 percent) and a shortage of high-quality investment opportunities with an appropriate track record (32 percent).
Two main issues emerge from these interrelated challenges. First, there is a gap in appropriate funding and deal structure suitable for entities in the early stages of growth. Second, there is a lack of consensus regarding appropriate definitions and performance measures in impact investment.
Funding early-stage entities
The GIIN Impact Investor Survey found that in 2017, the overwhelming majority of investments (88 percent) were directed toward mature or growth-stage companies. Only 11 percent of investments were allocated to venture and startup businesses. Institutional investors have a fiduciary duty to their clients, so they must invest prudently and protect their financial interests. Accordingly, investors typically prioritize shorter-term returns and look for entities that can demonstrate historical performance. However, to achieve impact, fund managers may need to become comfortable with smaller average deal sizes (which drive up costs) and longer timeframes. This might not align with their investment approach or risk appetite. Early-stage enterprises often require financial support (as well as other forms of support such as regulatory, policy and training support) to develop and become "investment-ready," but providing this support at such an early stage, without a demonstrable track record or tested business plan, is risky and costly for investors.
This funding gap contributes to a situation often referred to as the "missing middle," where early-stage companies are unable to establish themselves properly, leading to a low volume of established small and medium-sized enterprises and sustainable social enterprises.10 Particularly in Africa and other emerging markets, the general underdevelopment of the impact investment ecosystem may compound the situation. Lack of sufficient support structures to encourage and foster social entrepreneurship imposes further challenges.
Measuring performance for impact
The balance between producing both financial and social or environmental returns is a hallmark of impact investing. However, the tracking and measuring of these social and environmental outcomes is inconsistent across the sector, with no universally adopted metrics. This makes it difficult for investors to assess and compare potential investments against impact criteria, creating an additional barrier to their ability to source viable investment opportunities. In emerging-market economies such as those in sub-Saharan Africa, limited reliable third-party data exists with which to develop benchmarks or verify standards of social and environmental performance. In the 2018 GIIN Impact Investor Survey, 24 percent of respondents indicated that they do not set impact targets or track social and environmental performance over time, citing the difficulties created by the diversity of their portfolios. In addition, sustainable enterprises in Africa receive no universally accepted legal status or certification. A recognized "sustainable enterprise" status would provide some sort of accreditation as to their legitimacy and credibility, and comfort third parties, investors and customers regarding ESG value creation.11
Clearly, it will take more work to develop suitable metrics in the field. As one respondent to the GIIN 2018 Impact Investor Survey explained, "Only by setting impact targets—and subsequently tracking performance—can we test our impact hypotheses and improve our understanding of impact creation for future investments.12 However, given the wide range of investors' priorities and scale in impact investing, and the diversity across the geographies of investees' sectors and business stages, employing standardized quantitative targets and arriving at an inclusive definition of what it means to be a sustainable social enterprise is a challenge in itself—and would likely be costly and time-consuming. Imposing too narrow a definition or strict legal requirements would likely deter both investors and prospective social enterprises.
Other emerging market risks
Investors in Africa and other developing markets may face additional impact investing challenges. These include emerging-market risks relating to unpredictability and market volatility, as well as the regulatory, political and economic environment. In the GIIN 2018 Impact Investor Survey, 46 percent of sub-Saharan Africa–focused investors identified "country and currency risks" as severe when it comes to making and evaluating investments. When providing additional color to risk experiences in 2017, respondents highlighted corruption risks, climate change-related disasters such as drought, and complex and changing economic and political environments, specifically citing recent political events in Kenya as an example.
What's next for impact investment in Africa
Impact investment is a market area that continues to grow, as seen by the entrance of some large, mainstream players into the industry in the last year. However, the expansion of impact investment into more mainstream consciousness also brings additional risks. In particular, the GIIN 2018 Impact Investor Survey highlights the risk of "impact washing,"13 where investors merely adopt the label of impact investing externally, without meaningful internal intention to affect change. However, investors in the GIIN 2018 Impact Investor Survey also understood the importance of greater transparency around impact to mitigate this risk. Increased transparency and reporting may also help to collect data and build a sufficient knowledge base to develop benchmarks for best practices in impact measurement.
To further this goal, some countries are considering making ESG investment mandatory. The Financial Sector Conduct Authority in South Africa, a hub for impact investment in Africa, proposed that it be compulsory for pension funds to report on how they incorporate ESG factors into their investment decisions. This would include demonstrating how they apply ESG factors to assets they intend to buy, how regularly they measure the compliance of their assets to their sustainability criteria, and how these provisions are being met in both financial statements and annual trustee reports.14
Given Africa's limited resources with which to finance the furtherance of the SDG objectives, impact investing will be a crucial catalyst for additional capital flows to address socioeconomic issues. While impact investment in Africa is growing, barriers still hinder the development and expansion of the practice on the continent. African governments must push to make inclusive growth and sustainable development a reality. The United Nations Procurement Division calls for greater engagement in general between key stakeholders across the sector and for Africa's policymakers and business community to join forces to develop a roadmap to advance the impact investment sector and create a supportive policy and regulatory environment. If these developments occur, impact investment could be an important tool for African governments going forward.
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