Pension funds and other institutional investors hold more than $100 trillion in assets, and their stakeholders are increasingly interested in utilizing those funds to make socially responsible investments. At the same time, countries in Africa are growing fast — but risk falling behind if they can’t finance the necessary infrastructure to support their growth. On the surface, it would seem like a perfect union of returns and social responsibility. Yet only a fraction of institutional investors hold assets in developing countries. What is holding them back? And how can donors like USAID help?
By Lauren Yang, INVEST Communications Advisor, and Vanessa Holcomb Mann, INVEST Strategic Investment Advisor
In March 2020, the then-heads of three of the world’s largest pension funds — the California State Teachers’ Retirement System (CalSTRS); the Japanese Government Pension Investment Fund (GPIF); and the UK’s Universities Superannuation Scheme (USS) — wrote in an open letter:
As asset owners, our ultimate responsibility is to provide for the post-retirement financial security of millions of families across multiple generations. Since our commitment to providing financial stability spans decades, we do not have the luxury of limiting our efforts to maximizing investment returns merely over the next few years. If we were to focus purely on short-term returns, we would be ignoring potentially catastrophic systemic risks to our portfolios… As asset owners with the longest of long-term investment horizons, more inclusive, sustainable, dynamic, strong and trusted economies are critical for us to fulfill the responsibility we have to multiple generations of beneficiaries.
Pension funds belong to a group of institutional investors known as asset owners, which also includes insurance companies, sovereign wealth funds, and similar entities that own the underlying assets. Discretionary assets under management of the world’s 100 largest asset owners total $19 trillion, up 1.7% from last year. To put it in perspective, a draft report by the Organisation for Economic Co-operation and Development (OECD) identified five OECD countries where pension funds’ assets exceeded the GDP, and six where insurance companies’ did the same. Compare that to the $161.2 billion in official development assistance from all donor countries to the developing world recorded in 2020, and it’s clear that a small shift in institutional investor assets could go a long way in helping to bridge the $3.7 trillion annual financing gap for the sustainable development goals (SDGs).
In surveying pension funds, OECD found a promising eight percent of their total assets were invested in developing countries. However, those assets sat overwhelmingly in Asia and Latin America, with only a small fraction in Africa — the continent that houses both seven of the globe’s 10 fastest-growing economies and over two-thirds of the global population without access to electricity. Pension funds have barely scratched the surface of African countries’ potential to generate both economic and social returns. By investing in assets like infrastructure in Africa, institutional investors could both catalyze and benefit from the resulting growth and development.
Institutional investors would seem to be the perfect fit for helping African countries meet their infrastructure needs. They possess long-term, patient capital that is not as dependent on immediate returns, as well as significant assets under management. Their stakeholders increasingly place weight on socially and environmentally responsible investments. The money is there. The desire is there. So what’s holding them back?
You Don’t Know What You Don’t Know
Many global institutional investors hesitate to move into newer markets like Africa for two reasons: lack of awareness and risk — perceived and real. Without a footprint on the continent, they don’t have the flow of information or established track record to help identify and assess opportunities. This compromises investors’ abilities to distinguish between risks seated in reality versus those driven by perception. As a result, they view the vast majority of investments in these markets as inherently risky — a perspective not helped by decades of media portrayals characterizing African countries as poverty-ridden and lacking technology, business and innovation.
In 2017, the U.S. Agency for International Development (USAID) launched the Mobilizing Institutional Investors to Develop Africa’s Infrastructure (MiDA) Program to bring investors like Angela Miller-May (at the time, Chief Investment Officer of the Chicago Teachers’ Pension Fund; now, Chief Investment Officer of the Illinois Municipal Retirement Fund) to Africa. Through this program, Miller-May and her peers learned firsthand about the continent’s investment opportunities. Funding delegations like these can be a cost-effective way to engage institutional investors; through the program, USAID used $2 million in funding to mobilize over $1 billion in two-way investment. MiDA continues to work with USAID via INVEST under the Prosper Africa institutional investor program in support of priority Agency objectives.
Additionally, many pension funds have an emerging manager allocation — or funds they have set aside specifically to engage up-and-coming fund managers. In the U.S., this fund allocation is increasingly being used to fund work with gender-, regionally- and racially-diverse managers. On the African continent, it could help to support local fund managers as they work to attract much-needed, international capital to lesser known geographies and ventures. For example, the Chicago Teachers’ Pension Fund used its emerging manager mandate to make smaller investments with two emerging managers in Africa to “test the waters.” The Fund gained exposure to new markets, and the fund managers got an opportunity to prove themselves worthy of more capital in follow-on funds.
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All About Risk: Part Two
Local institutional investors also struggle with risk, but for a different reason. Traditionally, they invest in listed assets (i.e. government securities and locally traded equity investments) and have little experience with funds and alternative assets. They often lack the capacity and expertise to evaluate other, potentially promising investment opportunities to diversify their portfolios, instead viewing them as an exposure to risk.
In 2017, MiDA and World Bank began working with Kenyan pension funds to help build their capacity to invest in alternative asset classes, such as infrastructure and private equity. As a result, several local pension funds joined forces to form the Kenyan Pension Funds Investment Consortium (KEPFIC) and share costs, knowledge, and due diligence teams to help evaluate new investment opportunities with the intention of mobilizing more than $229 million in five years. By 2020, the consortium consisted of 25 pension funds with nearly $3 billion in assets and a robust pipeline of infrastructure projects under consideration. Multiple members have made allocations for infrastructure investments in both Africa and Kenya specifically.
Another risk mitigation tactic can serve both international and local investors: co-investment. Local investors benefit from working alongside another party that has the expertise, reputation, and additional capital resources to complement their own. International investors appreciate their local counterparts’ knowledge and understanding of contextual factors, as well as the fact that there’s local skin in the game.
Finding a Product That Fits
African infrastructure assets present an opportunity to diversify and de-risk institutional investors’ portfolios. Much of U.S. institutional capital is invested domestically, meaning the vast majority of returns are tied to a single market with fairly low interest rates. Africa’s markets, on the other hand, are least correlated with developed markets, and default rates on debt for African infrastructure projects are lower than those in many developed regions (North America) and other emerging market regions (Latin America and the Caribbean). It’s home to some of the world’s fastest growing economies, populations, and workforces. Taken at face value, investment in Africa could help pension funds spread the risk of their portfolios and meet their obligations to retirees by offering the potential for better returns.
However, pension funds have specific mandates and requirements for how they invest their capital. They need appropriate investment products with strong track records to fit within their investment allocation strategies and match the prudent investment mandates preferred by their pensioners. Unfortunately, many African markets lack the appropriate products to appeal to international institutional investors — and more specifically, pension funds.
One product that could draw more pension funds into emerging and developing markets is a fund of funds, or a pooled fund that invests in other funds. By investing in this type of product, investors spread risk and diversify assets by investing across multiple fund managers with different capabilities, strategies, and asset selections. In other words, it’s a highly scalable form of diversification. Global institutional investors gain exposure to multiple funds within a region (or regions) which can span across asset classes, so it’s a win for fund managers, as well.
Similarly, sponsors can structure new products for the African market that meet the needs of international institutional investors reluctant to invest in offshore vehicles that may not comply with their regulations and standards. For example, through its implementing partner MiDA, USAID is supporting South African investment firm RisCura to establish a new entity under U.S. regulation that will provide an emerging markets fund-of-funds strategy. USAID funding will provide technical support to launch this new entity that will offer investment strategies to satisfy both U.S. regulations and investor preferences; it will also support African fund managers — potential investees of the fund — with technical assistance through established incubation programs that build their capacity to manage their portfolios for strong returns.
These are just a few examples of products that could attract more institutional capital to the continent. Donors can support the proliferation of a range of offerings (listed funds; private, investment-grade offerings offered in the U.S. and other international markets) to meet financing needs in infrastructure and other critical development areas. The backing they provide can vary as widely as the types of offerings: risk mitigation; advisory services for structuring and navigating placement in new markets; or technical assistance to build a strong pipeline of investments.
Think Like an Investor
There’s no silver bullet to mobilizing more institutional investment in the African continent, especially when it comes to pension funds. Success requires a portfolio approach: just as investors evaluate an investment based on how it impacts the entirety of a portfolio — rather than its isolated (de)merits — so must USAID and other donors consider opportunities to increase both local and international institutional investment. Supporting complementary efforts allows a donor like USAID to diversify its “investments” and increase the chances of success of the “portfolio” as a whole. For example, backing an activity to raise awareness of opportunities among target investors as well as one geared towards developing appropriate investment products.
No single donor can tackle this massive challenge on its own. But many donors, learning from and iterating upon their “portfolios” as they come to better understand the risk considerations and preferences of this class of investors — that might just move the needle.