Impacting Investing: An Innovative tools to drive Infrastructure in Africa

LAGOS, Nigeria, Capital Markets in Africa: Africa’s infrastructure gap It is a well-documented fact that there exists a significant infrastructure deficit in Africa1 to support the continent’s expanding economies, rapid urbanisation, and surging trade levels. While total spending in infrastructure is growing at a rapid pace globally, Africa’s share continues to remain stagnant. As a result, economic growth in many African countries is constrained by poor infrastructure, particularly in energy and roads3 . In addition, much more investment is required to provide access to and improve the quality of health, education, water and sewage and information and communication technologies (ICT).

Before looking into the status quo of infrastructure financing in Africa and exploring new ways to bridge the current gap, it is important to note that the continent is often homogenised, but exceptions do exist. We should, therefore, be mindful of the differences across different countries and sectors while considering the most suitable infrastructure financing options, and indeed how impact investing is applied.

Focusing on peripheral parts of infrastructure financing 
To address this infrastructure gap, governments are looking beyond finite amounts of public funding and aid to mobilise private investments into building power supply, roads, hospitals, schools and water supply systems. Established precedents of Public-Private Partnerships (PPPs) have been constrained by the nature of infrastructure investment itself and also by the region’s “weak enabling environment that underpins infrastructure development”. A few factors that present challenges to leverage private infrastructure investment in Africa include:

• Long investment horizon: infrastructure projects such as roads and power grids take years to complete, adding to complexity and uncertainty that dampen investor appetite.
• Mismatch with investors’ returns expectations: project financing for infrastructure has been dominated by debt and debt-like instruments (alongside equity), which limits the universe of potential investors who have varying risk-return expectations. Some sub-classes of infrastructure suit private equity type funds, but are often have bespoke characteristics and requirements.
• Top-down approach: infrastructure projects are often state-led, which tend to be less efficient and adaptive to community needs compared to market-based and/or community-led approaches.
• Complex regulatory and policy frameworks: infrastructure projects are subjected to multiple layers of regulatory and policy frameworks, such as tariff setting and procurement. These frameworks are different across the region and can change abruptly due to political situations (most often extending beyond concession terms).
• High transaction costs: based on the above factors, infrastructure projects often incur high transaction costs, require high levels of human resources and relevant experiences from investors, which makes the investment only “worthwhile” if there are significant economies of scale.

Despite these challenges, governments, multi-lateral agencies and Development Finance Institutions (DFIs) are working to attract private investments into building Africa’s infrastructure by encouraging more PPPs, supporting policy reforms, improving governance and exploring innovative forms of financing.

Impact investing: complimentary, adaptive and empowering
While there is no universal definition of “impact investing”, the term is widely used to describe investments “made into companies, organisations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return”5 . Impact investing differs from traditional commercial investing in a number of ways. Although it is a relatively new discipline, impact investing is already gaining traction from individual and institutional investors, from banks, pension funds, and private equity firms to development finance institutions, private foundations, and High Net Worth Individuals (HNWIs).

Recent examples of impact investments have demonstrated a number of ways in which impact investing can address the immediate needs that conventional infrastructure financing may take a while yet to address:

• Adaptive to immediate needs on the ground: impact investing can mobilise different types of capital from an array of funders and investors within a short period of time, thus accelerating the response to immediate local needs. For example, the Kenya-based company Sanergy builds a network of high quality branded toilets and franchises them to local micro-entrepreneurs. Within 5 years of establishment, Sanergy is providing affordable and accessible hygienic sanitation to 30,000 people on a daily basis. The business has attracted investments from international and local impact investors, such as Acumen and Novastar Ventures; as well as a mix of grant funding from USAID, Gates Foundation etc., and private capital from HNWIs and DFIs6 .
• Flexibility across different asset classes: impact investing can syndicate investors with varying degrees of risk-return expectations across different asset classes. “Blended finance”, the complementary use of grant and non-grant financing, provides financing on terms that make projects financially viable and sustainable, and catalyses participation from private investors by mitigating risks and/or boosting returns. For example, M-KOPA, a “pay as you go” solar energy supplier to off-grid homes in Africa, has adopted the use of blended finance in its funding round in 2014. The company raised US$20 million of investment, which consisted of debt from the Commercial Bank of Africa (CBA), equity investment from Gray Ghost, as well as grant funding from Bill & Melinda Gates Foundation, LGT Venture Philanthropy and UK Department for International Development . The investment supported M-KOPA’s expansion, and in just three years since its commercial launch, the company has connected more than 280,000 homes to solar power in Africa.
• Building capacity at grass roots level: impact investing is often made into locally owned and run businesses, thus empowering and equipping local communities to improve their own livelihoods. For example, Living Goods operates a network of community health entrepreneurs who sell effective, essential health products at prices affordable to the poor in Uganda. In remote areas where hospitals and clinics are inaccessible, Living Goods trains local health entrepreneurs who go door-to-door to teach families how to improve their health and wealth by selling life-changing products such as simple treatments for malaria, safe delivery kits, water filters, and solar lights. Through the generation of retail revenue, Living Goods empowers local communities and reduces child mortality significantly for a yearly cost of less than $2 per person reached8 . The business attracted support from impact investors, family and corporate foundations such as Omidyar Network, Jasmine Social Investments, and Cisco Foundation etc.
• Lower transaction costs and reduced complexity: impact investing typically operates within the private sphere and outside of the large-scale infrastructure regulatory and policy frameworks – hence projects tend to “get done” more quickly and are not usually influenced by changes in government.

Nonetheless, we should not view impact investing as a panacea to fill the infrastructure deficit. Impact investing seeks to address part of the wide gap between early-stage grant funding and late-stage commercial investment that still persist. Impact investors and intermediaries are still establishing successful cases with relevant cost structures, fund economics and realistic financial returns, which then can be applied to larger deals.

Although impact investments may be made within a shorter time frame compared to traditional infrastructure project financing, it is often referred to as “patient capital” where investment horizon is still longer than commercial investments to allow enough time to realise both financial and impact potentials, especially in emerging markets. In the case of infrastructure in Africa, we are also aware of the varying political and socioeconomic contexts across the diverse countries, which present different barriers for the development of impact investing.

Impact investing is a useful tool that complements the status quo of infrastructure project financing where adaptive, flexible and commercial solutions are needed to solve local needs in the immediate time frame – the perfect solution would be for this early stage, smaller components of infrastructure to link up with the large scale conventional infrastructure.

What’s next?
 The appeal of impact investing in emerging markets continues to grow. This sentiment is shared by speakers and participants of Palladium’s Impact Investing in Emerging Markets Conference held in June 2016 in Oxford, UK. Representatives from Governments, aid organisations, DFIs, investment banks, venture capital funds and other investment firms convened to explore practical ways to bring investments, jobs, infrastructure and impact to Africa and other emerging market countries.

In response to the change in donor and investor landscape, Palladium became the first international development consultancy to create an impact investing arm that bridges the gap between aid and impact investing. We seek to provide an “exit strategy” for donor-funded projects and “investment pipeline” for impact investors. Leveraging Palladium’s established global operational footprint across 90 countries and deep expertise in international development, our impact investing team adopts a three-pronged approach to source investable solutions globally from our projects, partners and proprietary tools.

Authors Profile
Tracey Austin, Director, Impact Investing, The Palladium Group joined Palladium in March ’15 to lead the Impact Investing proposition from the CDC Group plc. At CDC she was the acting head of the DFID Impact Fund and prior to that, she completed the research and co-drafting of CDC’s initial Frontier Investment Strategy. With over 15 years of experience in investment banking, centred on infrastructure and natural resources —she spent her time across multiple emerging markets. Prior to CDC, she was a partner with BlueCrest Capital (special situations team), successfully managing and divesting distressed gold mines in remote locations (Western Australia & Colombia), before she left to pursue a career in impact investing.

Karen Ng, Interim Associate, The Palladium Group joined Palladium’s Impact Investing team after pursuing an MBA at the University of Oxford. Previously, Karen was the Associate Director of Investment at Social Ventures Hong Kong (SVhk), a venture philanthropic fund with impact investment across affordable housing, education, transportation and other sectors. Prior to SVhk, Karen was an Investment Banking Analyst at Deutsche Bank, specializing in IPOs. She is a Youde Scholar and holds a BSc in Government and Economics from London School of Economics.

This article was featured in the INTO AFRICA August edition, with focuses on Infrastructure Finance in Africa.