By Michelle Kathryn Essomé, CEO, African Private Equity and Venture Capital Association (AVCA)

African investors are gradually turning to private equity (PE) and venture capital (VC) but greater momentum could turbocharge the PE and VC ecosystems, supporting entrepreneurs and creating jobs at scale.

According to AVCA’s latest figures, the total value of African PE fundraising between 2013 and 2018 was $17.9bn. Yet only a small proportion of this capital comes from local investors. The majority of funds committed come from development finance institutions and international pension funds.

African pension funds have a vast pool of cash – $372bn according to the latest figures from RisCura – that could play a pivotal role in supporting the continent’s PE and VC ecosystems. In Kenya, we’ve witnessed the growth of pension funds’ allocation to PE and VC grow rapidly since reforms in 2016 to cap allocations to the asset class at 10%. According to the Retirement Benefits Authority’s latest numbers, there has consequently been an encouraging year-on-year growth in pension fund managers’ and trustees’ allocations to PE, which now total over KES1bn (about $10m).

But at just over 1% of total pension assets, this represents a mere drop in the ocean – and significantly less than the 10% allowed by law. This situation is mirrored across other African markets where pension funds can invest in PE and VC, such as Botswana, Nigeria and South Africa. This raises the question of what can be done to catalyse capital flows following regulatory changes.

The solution is education: African institutional investors – including insurance companies, which have assets of just under KES500bn ($5bn) in Kenya according to the World Bank – are often sceptical of PE as an asset class and typically don’t understand its risk-return profile, preferring instead to invest in less risky fixed income products. As the industry body representing the interests of private capital on the continent, we have been working hard to demystify the perception that African PE is inherently risky, both to local and global audiences. African investors are rooted in these markets, so they understand the operating environment intimately and are arguably even better positioned to assess risk than their international counterparts. The real issue must lie elsewhere.

On the opportunity side, fixed income instruments can be attractively safe, predictable bets and PE can seem less predictable and perhaps harder to sell to a typically conservative board of trustees. However, while pension holders expect their fund managers to allocate capital strategically, local institutional investors should recognise that their long-term liabilities are particularly well suited to PE. The asset class diversifies their portfolios, provides protection against downside risk and additionally means they don’t have to worry about exchange rate risk. Additionally, allocating to PE can bring about significant environmental, social and governance improvements, with these being areas of growing concern for millennials, the pension industry’s future customers. Moreover, by deepening their ties to local PE firms, institutional investors can potentially open up co-investment opportunities further down the line.

There are signs that we are making progress. We recognise that these are nascent developments and are encouraged by the fact that more and more Kenyan pension funds are making allocations to the PE sector. The formation of a consortium by 10 large Kenyan pension funds to invest in infrastructure projects last September is a significant positive development that will no doubt bear fruit – and is hopefully indicative of what is yet to come.

Meanwhile, on the VC front we’ve also witnessed the slow but encouraging growth of corporate venturing against a backdrop of exponential growth in the sector. Safaricom’s Spark Fund has been an industry pioneer, having invested in Kenyan start-ups that have grown to prominence including mSurvey and Eneza Education. Similarly, South Africa’s Naspers – the largest public company on the continent – is launching a $100mn VC fund to support South African tech start-ups.

Corporate venturing is particularly interesting because it solves two key challenges: that of instilling innovation within large companies that often struggle to adopt new technologies while allowing serious entrepreneurs to grow their businesses to scale and secure large-scale adoption. Local companies can reap tremendous benefits by targeting early-stage companies before they become too expensive. Despite this appeal, the sector is still in its embryonic stage.

As with African institutional investors’ allocation to PE and VC, much work remains to be done in corporate venturing, both in Kenya and further afield. But the outlook is positive, and all signs point to the gradual and sustained rise of local capital mobilisation in PE and VC over the next few years.