How pension schemes can benefit from PE investment

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The East African Venture Capital Association (EAVCA) in partnership with Financial Sector Deepening Africa (FSD Africa) and International Finance Corporation (IFC) recently  launched an investment guide to enable regional pension schemes to invest in private equity (PE) Funds.

Globally, private equity is one of the sectors that has grown as a result of support from pension funds, with the typical 10-year fund tenure matching the long-term investment outlook for pension funds.

However, in East Africa, despite explicit allowance by regulatory guidelines for investments in private equity, allocation by pension funds remains muted, according to EAVCA.

The bulk of private equity funds is sourced from development finance institutions, which account for almost 70 per cent of funds held by private equity firms.

“As the private equity industry matures in East Africa, there is a need to systematically engage

pension funds to enable them to play their rightful role in driving growth of the private equity industry,” EAVCA notes in its latest market report(October 2019)—Private Equity Investing for Pension Funds inEast Africa.

The benefit of private equity investment to pension funds relates not only to diversification but also to exposure to the real economy.Private equity funds have been known to invest in sectors such as health, sustainable energy, education and consumer or retail.

The outcomes of such investments include: increased incomes and jobs, access to basic services and sustainable finance.

“Investment by pension funds in private equity will therefore enable them to actively participate in growth sectors of the real economy,” said Eva Warigia, EAVCA’s Executive Director.

The provision of a threshold, however, must also be considered within the context of the size of East African pension funds, EACVA notes. For example, a pension scheme with a value of $10 million, and allocation of $1 million to private equity would constitute a 10 per cent allocation.

Kenya, which is East Africa’s economic powerhouse, is among top markets where pension schemes can tap into PE funds, a trend which remains on the low.Average allocation to the asset class by Kenyan pension schemes for the year ended December 31, 2018 was 0.07 per cent.

For a pension scheme with an asset value of $10m (about KSh1billion – a large 5 scheme in the Kenyan pension scheme environment), an allocation of one per cent to private equity would equate to $100,000, industry survey has revealed.

Dubbed ‘Private Equity Investment Guide’, the tool is expected to deepen the understanding of private equity structures among pension fund managers and their trustees to unlock more investment into the asset class.

The Guide mainly covers three key areas – understanding the asset class and where it sits alongside other asset classes, why and how to invest in PEs and an overview of the benefits and risks of investing in PE.

The development of the guide was informed by a market study report that sought to investigate the low uptake of investment by pension schemes.

In Kenya, for instance, PE allocations by pension schemes account for only 0.08 per cent of the total industry assets under management. From a regulatory perspective, there are provisions allowing pensions to invest in PE funds across East Africa (Kenya, Uganda, Rwanda, Tanzania, and Ethiopia).

According to Kenya’s pension regulator, the Retirements Benefits Authority (RBA), though the country has had regulations that provide for diversification of pension funds away from traditional instruments, most pension schemes are still predominantly bond and stock investors.

“The Guide will be important in bridging the existing knowledge gap by trustees on investing in Private Equity whose uptake has been very low in the pension scheme investment portfolio. As a regulator we are positive and open to new ideas in broadening pension growth and continue to review the legal framework to keep pace with emerging trends and expand the investment horizon for pension funds,” says RBA Chief Executive Officer, Nzomo Mutuku.

Kenya’s Capital Markets Authority (CMA) says regulators are focused on creating an enabling environment for PE funds including safeguarding capital gains when they exit various ventures.

The authority recently supported the PE sector in retaining the capital gains tax (CGT) at five per cent for PE exits, after the National Treasury’s proposal to increase the tax to 12 per cent.

“An increase in capital gains tax from five per cent to 12 per cent as proposed by the Finance Bill would create uncertainty in the tax policy environment affecting middle to longer term PE investment appetite in the country,” said CMA Regulatory Policy and Strategy Director, Luke Ombara.

Across developed markets, the pension industry is the backbone of investments, supporting asset classes such as private equity with the patient capital to deploy in growing businesses.

Speaking at the launch, Warigia noted: “We are excited to be part of the evolution in Africa’s private equity industry. EAVCA has decided to proactively support regional capital markets through capacity-building and investor education that empowers local institutional investors.”

“Private equity is a catalyst that enables pension funds to access growth opportunities in the unlisted African companies,” Warigia added.

Read Also: Private Equity Firms in East Africa

FSD-Africa’s Director of Financial Markets, Dr. Evans Osano noted that PE investments facilitate active participation in the growth sectors of the real economy by pension funds, generating returns for investors while contributing to the creation of jobs and improving access to basic services.

“However, there is a need to up-skill regulators, fund managers and pension trustees to foster a greater understanding of the benefits, risks, and process of investing in PE funds,” Osano said.

“Pension schemes are guided by their Investment Policy Statements which provide guidance for strategic asset allocation for pension schemes. To boost trustees’, ability to make informed decisions about investing in private equity, the investing guide provides more information on policies and procedures to assist with risk management of the asset class,” said IFC SME Ventures Senior Operations Officer, Samuel Akyianu.

Meanwhile, EAVCA’s Private Equity Investing for Pension Funds in East Africa report has cited

knowledge gap on both pension fund and regulatory side, and the absence of regulatory oversight of the PE fund managers by local regulators, as some of the key impediments for pensions seeking to invest in PE funds.

The study surveyed 18 pension schemes from Kenya, Rwanda, Tanzania, and Uganda alongside 15 PE General Partners from Ethiopia, Kenya and the United Kingdom, and three pension regulators in Kenya, Uganda, and Tanzania.

Read  Also: How Private Equity is shaping investments in East Africa

Of the five Eastern African countries, Rwanda has the highest provision for pension fund investment in PE funds at 20 per cent followed by Uganda at 15 per cent and Kenya at 10 per cent while Tanzania and Ethiopia have no defined limits.

Uganda has the highest rate of pension fund investment in PE funds at 2.2 per cent followed by Kenya at 0.07 per cent while no data is available for the other countries.

“As part of Kenya’s Retirement Benefits Authority (RBA) vision to ensure an inclusive, secure and growing retirement benefits sector, we continue to work with the market to identify growth opportunities that safeguard the retirement benefits of the Kenyan people,” Mutuku said.

“For this, we have developed and continue innovation in their making, accessible products that generate investment value, further enhancing the sector’s growth, while at the same time providing impact to the economy,” he added.

As part of the RBA’s 2019-2024 strategic plan, the authority has proposed innovative ways to mobilise long-term savings to finance investment in the ‘Big Four Agenda’, which is part of Kenya’s Medium-Term III plans.

Private equity and venture capital are one of the investment asset classes available for RBA’s members in Kenya. The authority has allowed its pension schemes to invest up to 10 per cent of their assets under management in this class, with investments to date totalling 0.07 per cent.

“There is, therefore, still ample room for pension schemes to invest more funds in the asset class. The private equity sector exposes pension schemes to a variety of sectors, including those covered in the Big Four agenda , to expand the scheme’s range for portfolio earnings,” RBA notes.

“Knowledge and capacity enforcement remains a key consideration for RBA as we encourage our pension schemes to increase their exposure to private equity,” Mutuku said.

The undertaking by EAVCA, FSD Africa and the World Bank through the IFC, is expected to bridge the knowledge gap that will help investors with the right information to make investment decisions into the assets class.

Read: Why pension funds matter in Africa

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