Private Equity’s Increasing Impact in Africa
Vital Capital’s Head of Impact, Tamar Pashtan, talks about driving transformative change and delivering market-rate returns in developing economies – particularly sub-Saharan Africa.
Capital allocation in impact investing has continued to expand over the past decade, with a maturing industry and investors focusing on aligning their investments with their values, as well as achieving market-rate returns.
While developed markets, such as Europe and the US, have seen the greatest growth over the past five years, emerging markets are also benefitting from an uptick in asset allocation. For example, sub-Saharan Africa (SSA) saw a 14% compound annual growth rate between 2017 and 2022, to US$25.1 billion, according to the Global Impact Investing Network’s (GIIN) 2023 report.
More than half of investors (56%) in the GIIN survey stated plans to increase impact assets in SSA over the next five years. Tamar Pashtan, Senior Director and Head of Impact, Vital Capital, is confident that this will help to strengthen the region’s impact investing market.
She shared her insights on the evolution of private equity’s role in SSA impact investing, highlighting the growing development of the practice – particularly over the past three years.
“I have witnessed [the change] in conferences and industry discussions,” Pashtan told ESG Investor. “Previously, there wasn’t much focus around impact investing in SSA, and we didn’t feel that we had much of a peer group across the continent. But the industry has matured and the rigour around investing has improved a lot.”
Solving for basic needs
Launched in 2011, Vital Capital is a private equity impact investment fund targeting businesses in emerging markets that are trying to solve critical social and environmental challenges.
“Zeroing in on basic needs is a winning strategy because it drives real transformative change, such as first-time access to potable drinking water and essential nutritional improvements in the form of proteins and dairy products,” said Pashtan. “We are also able to make great returns for investors, which is how we can hit that double bottom line [of being financially profitable and socially responsible].”
At the beginning, the fund’s main focus was to build an impact investing practice in a nascent private equity industry. “Vital was one of the first funds to begin to define impact and its ESG approach, as well as create impact investing tools,” Pashtan said.
As a signatory of the Operating Principles for Impact Management, the fund ensures that impact and ESG are integrated from the investment screening phase – all the way through to the exit.
Vital has developed a proprietary environment and social impact management system, as well as created impact measurement tools, such as the Vital Impact Diamond, which determines the type of investments the fund considers.
“Essentially, this tool allows us to ensure our capital is channelled to where it’s the most transformative and delivers market-rate returns,” Pashtan explained.
Vital focuses on four themes: food, water, healthcare, and sustainable infrastructure. For each of the those, it has developed a pathway to ensure it is driving real-impact outcomes for each investment.
For example, the fund is involved in the SSA food and agro-industry space. “We discovered that many middlemen sat between farmers and processors in East Africa’s dairy industry,” said Pashtan. “Our aim was to connect farmers directly to industry infrastructure, help improve farming practices, increase yields and income, and ensure the dairy processors receive better quality and more milk.”
To achieve this, Vital connected with a local partner and built a dairy processor that is now producing fresh milk and UHT – or long-life milk – alongside yoghurt.
In another example, the fund established a water infrastructure platform in India focused on three areas: potable water provision, irrigation infrastructure, and wastewater treatment.
“We built a water platform from the ground up to deliver the types of outcomes that we want to achieve, such as improving health-related outcomes and reducing inequity,” Pashtan said.
As part of its efforts to guarantee that investments are channelled towards areas facing increased climate-induced migration, Vital works with a company in India’s Karnataka region – one of the country’s most drought-prone regions.
“The water projects are providing more than two million people with first-time access to potable water infrastructure,” Pashtan explained.
Through its water infrastructure platform, the fund is also exploring opportunities in Central America. “This is part of focusing on the [four] themes and our technical expertise to ensure that we drive real impact outcomes in all of our geographies,” she added.
A distinctive strategy
According to Pashtan, Vital’s approach differs from other private equity firms in that it “builds and rebuilds” investments.
“Many private equity firms say that they’re operational, but we distinguish ourselves by identifying a market gap and then we find a local partner to build an investment from the ground up,” she said. “Effectively, we’re creating our own deal flow.”
In addition, Vital looks for strategic investors and local partners that are interested in purchasing the investments further down the line.
But the impact investing sector needs help to support local institutional capital increase allocations towards this type of investment, according to Pashtan. Specifically, foreign institutional capital providers should be further leveraged to support local institutional investors, such as pension funds.
“There are various ways to achieve this, such as incentivising local players or providing ‘hand-holding’ support – effectively educating and teaching them how to get more involved and see the opportunities,” she said. “If we are raising funds for any of our investments, our preference is to ensure that it’s local capital that’s receiving the most strategic support. It’s an area that we hope will grow.”
One development Pashtan highlighted is the Kenya Pension Funds Investment Consortium, which was launched in 2018 by five pension funds to pool knowledge and resources. Domestic regulation requires Kenyan pension funds to invest in alternative assets, and the pension funds are working together to present the impact-investing landscape to the industry.
“That is a positive example of where regulations have helped pension funds pivot towards impact investing,” Pashtan added.
Market developments
As impact investing matures in SSA, there is growing interest from investors to tap into opportunities related to climate mitigation and resiliency, according to Pashtan.
For example, a large proportion of the population doesn’t have any access to energy, which creates huge demand for renewable investments, she explained. She also pointed to an expanding middle class and an expected population boom.
“Where we and other investors see the biggest opportunity is through the great doubling effect – Africa’s population is set to reach 2.5 billion people in the next 25 years, meaning one in four people will be African by 2050,” she added. “Importantly, the population will be young, entering the consumer class for the first time. As such, if investors want to benefit [from the demographic shift], they must serve this market.”
The development of the SSA impact investing market has also been synonymous with an increasing number of consultancies, service providers and auditors working in the environmental and social space, which are displaying a greater level of knowledge and skill. Importantly, these partners are homegrown in the region, Pashtan highlighted.
“We work in a lean way with many partners in the field to ensure that we’re collaborating closely with [local] people who understand the different social and environmental outcomes that are at stake,” she said. “This is particularly important in emerging markets because it’s a different type of analysis, rigour and understanding of the challenges happening on the ground.”
Complex environment
Despite recent advances in the SSA impact investing industry, private equity firms still face many challenges typical of emerging markets – such as the lack of a developed secondary market and exit options in the ecosystem.
“Many teams have raised a lot of capital that they need to deploy, but there are increasing concerns in terms of exit opportunities and deal quality,” said Pashtan.
The complex regulatory environment can also prove challenging in a region made up of 50 countries. To address this issue, Vital’s strategy is focused primarily in three cluster regions where it sees the best opportunities: Kenya and Uganda in east Africa; Ivory Coast, Senegal and Ghana in west Africa; and a southern cluster in Angola and the Democratic Republic of Congo.
“From our perspective, these countries are where we had both a prior experience and a better ease of doing business,” Pashtan explained.
Overall, one of Vital’s goals is to help mainstream impact investing. “We see it as a massive opportunity and want to ensure that there’s additional capital leveraged alongside us in sectors such as climate solutions, healthcare, agro-industry and technology,” she said.
As the impact investing industry becomes more sophisticated, the sector needs to move beyond measuring, managing and communicating impact – and focus on how the margin on impact can be improved, according to Pashtan.
“Looking at the different outcomes, we need to think more about how we can drive value for investees,” she said.
“It is no different to traditional investing in the sense of looking for market-rate returns, but additionally there is huge opportunity for investees,” Pashtan added. “This is where we can zero in on the approaches to impact – not measuring for measurement’s sake – to ensure we can improve companies’ practices, while increasing profits.”
The post Private Equity’s Increasing Impact in Africa appeared first on ESG Investor.