Mobilizing Kenyan Pension Funds to Invest in Local Infrastructure
USAID INVEST is driving local pension funds into investments in resilient infrastructure in Kenya and paving the way for local institutional capital in emerging markets to take on a more prominent role in their growth. USAID funding brought together a consortium of Kenyan pension funds to invest in Kenyan infrastructure collaboratively for the first time, with one of their first transactions a groundbreaking financial instrument to finance a Kenyan road project. The $17 million project bond, which was 157% oversubscribed by Kenyan pensions, will meet a critical development need and provide a replicable financial template for more local capital mobilization into key impact sectors that achieve climate and sustainable development goals. It will also deepen local capital markets and increase investor confidence in emerging market opportunities.
Strong infrastructure, such as road development, supports economic growth, trade, and job creation. However, it is complex and costly. Like many countries, Kenya faces a sizable financing challenge to close its infrastructure gap. For example, only about 15% of Kenya’s road network is paved, and its unpaved roads are more vulnerable to damage from the increasing storms and floods caused by climate change. Stronger, climate-resilient infrastructure presents an attractive opportunity for some private-sector investors.
In many countries, institutional investors — such as pension funds and insurance companies — are major investors in project bonds to finance infrastructure. These bonds are a good match for institutional investors because they are long-term, standardized, and take advantage of local capital market regulation and liquidity. However, only a handful of project bonds have been issued in Africa, and there are not nearly enough local private investors who are comfortable investing in infrastructure as an asset class.
Most institutional investors on the continent invest mostly in government bonds; they lack the know-how, comfort level, and regulations to invest in other sustainable assets. This prevents African countries from driving a greater percentage of their local assets into real economy investments, makes them more dependent on sovereign financing and foreign currency debt, and limits their ability to build strong economies. Even when other vehicles are available, many pension fund trustees are unfamiliar with or skeptical of these options. This limits their ability to build strong, diversified investment portfolios for their workers and retirees.
The Opportunity
Because of demographic and savings trends, pension funds in some African countries have accumulated significant assets that are approaching scale-level amounts in relation to their overall economies. This is the case in Kenya, South Africa, Nigeria, and Botswana. These pools of local currency assets offer countries the opportunity to finance infrastructure development with their own national holdings. The key constraint is giving these groups the know-how and comfort level to deploy this capital into bankable transactions with reasonable levels of market risk for higher returns than the usual government bond rates.
In Kenya, the government identified a need to upgrade about 3,000 kilometers of roads in the country. Using a transparent public-private partnership (PPP) framework, it procured private concessionaires to build and maintain the roads. The government also established a dedicated fund drawn from fuel taxes to pay these concessionaires for the operation of roads, defray some of the risks to their cash flows, and attract financing.
One of these concessionaires issued a project bond, known as the Lot 3 road development project bond, through Stanbic Bank to raise capital. To help de-risk the investment, it secured a 100% guarantee on principal and interest payments from multilateral guarantor GuarantCo. This bond represents an opportunity for local pension funds and insurance companies to get comfortable with resilient infrastructure investments through a new type of standardized financial instrument in Kenya that provides low risk and high returns and diversifies their portfolios.
The Solution
In support of Prosper Africa, USAID’s Kenya and East Africa Regional Mission brought together a group of local pension funds into the Kenya Pension Fund Investment Consortium (KEPFIC) in 2020. Through the INVEST initiative and its partners MiDA Advisors and CrossBoundary, USAID provided technical assistance to educate pension fund staff and board members on new types of investment opportunities — especially in resilient infrastructure. This activity built their capacity to develop a pipeline of investible transactions, pursuing them collectively to spread transaction and due diligence costs across a wider number of institutions.
USAID and its partners identified the Kenyan road project bond as a viable opportunity and presented it to KEPFIC. They extensively engaged with individual KEPFIC members, enabling pension staff to make informed investment decisions. Building on the advocacy work and support from USAID, the Kenya Government’s Retirement Benefits Authority established an allocation for infrastructure in 2020, opening the door to many more transactions like the road project bond in the future.
Ultimately, two insurance companies and 88 pension funds across Kenya, including KEPFIC members, made bids to invest in the Lot 3 road development project bond. Even though it was a greenfield project and the first of its kind in the Kenyan market, the bond was oversubscribed by 157% and has crossed a threshold that will increase appetite for similar instruments of its kind, deepening Kenya’s capital markets.
The Impact
IMPROVED, MORE RESILIENT ROADS. The roadwork that will be financed by this bond will have a strong development impact. It focuses on sections of unpaved road in a poor, fragile, conflict-affected area of northeastern Kenya near the country’s borders with Ethiopia and Somalia. Paved roads in good condition shorten travel time, have a reduced carbon footprint, improve safety, and reduce transit costs. They are also less vulnerable to damage from extreme weather or flooding. Transit reliability improves, which drives economic growth, job creation, and regional trade.
STRONGER LOCAL CAPITAL MARKETS. Deepening local markets benefits investors, companies that are trying to raise money, and countries looking to drive long-term investment. For companies seeking financing, deeper capital markets often offer better pricing and longer timeframes for repayment. They can offer funding for development activities and innovation, as well as access to domestic currency financing. For investors, deeper capital markets offer transparency, standardization, liquidity and diversification, reducing risk. However, most investors don’t want to be the first to invest in an untested vehicle or market. By building a track record for this relatively new financial instrument, USAID and guarantors can unlock future private flows of local capital, increasing the scale and sustainability of donors’ impact.
BETTER INVESTMENT OPTIONS AND DIVERSIFICATION FOR KENYAN PENSIONS.This transaction offered pensions, even small ones, a chance to diversify their portfolios and help finance local infrastructure development, driving local assets into the Kenyan real economy.
BUILDING ALTERNATIVE PATHWAYS TO SUSTAINABLE DEVELOPMENT FINANCE. Many African countries have grown dependent on and burdened by foreign currency debt and financing with unfavorable terms to fund their infrastructure investment gaps. Local institutional investors offer a transparent and responsible way to help finance development by tapping into local private markets. Since local institutional investors are naturally risk-averse and conservative in their decision making, particularly with unfamiliar financial instruments, they will initially need expertise and significant risk mitigation solutions to make investments. In support of Prosper Africa, USAID and its partners are now building consortia of pension funds in other markets, including South Africa and Nigeria, that build on the experience in Kenya to launch similar financial instruments.
Lessons Learned
OPPORTUNITY AND APPETITE EXIST — WITH A FEW CONDITIONS. Mobilizing local institutional investors can have an impact, but a few preconditions need to be met: a stable government, an operating capital market, reliable regulation, pension funds or similar investors with assets to invest, and viable projects or investment vehicles for them to consider. This pioneering transaction showed that Kenyan insurance companies and pension funds, even small ones, are willing to invest in project bonds for a well-structured greenfield infrastructure project — if it is guaranteed by a highly credit-worthy guarantor. It also demonstrated the willingness of a large guarantor to guarantee this type of bond to crowd investors in and begin to establish a track record for an asset class in a developing country.
USAID AND OTHER DONORS CAN PROVIDE VALUABLE FACILITATION AND FINANCIAL SUPPORT. It’s important to consider the investment environment, or ecosystem, as an enabler in a transaction like this. USAID can play a role in bringing together local pension industry players to share information, market opportunities, achieve scale in the investment, and advocate for changes in laws and regulations to better incentivize institutional investment. At the same time, new vehicles need subsidies or guarantees at first. First-time vehicles or issuers in developing countries often require donor or DFI support to build an initial track record so the market can benchmark performance. Providing this support can create a pathway to unlocking private capital at scale without donor support in the future.
TECHNICAL ASSISTANCE HELPS INVESTORS UNDERSTAND RISK AND OPPORTUNITIES. Many pension fund staff and board members are risk averse, and their institutions have limited capacity to entertain new asset strategies. They may be unaware of or skeptical of investment opportunities that would, in fact, be a good fit for their mandates. Donor-funded technical assistance to support education and pipeline building can help. While USAID cannot provide guarantees, it can identify transactions with significant potential impact and build demand for them or subsidize the costs of bringing them to market.
