Private equity firms are more wary of currency risks than political risks in Africa.
A survey by the African Private Equity and Venture Capital Association (AVCA) shows that PE firms prefer investing in resilient businesses that can counter currency risks.
The resilient businesses include consumer staples, healthcare and energy.
According to the survey, 69 per cent of the PE firms cited currency risk as the biggest challenge faced when investing in Africa, compared with 42 per cent who cited political risk. But they all agreed that political risk and currency volatility would continue to be a concern for all investors seeking to put money in Africa.
“Looking beyond the impact of political risk on investment returns, currency risk has become increasingly important for investors in Africa, particularly against the backdrop of the collapse of commodity prices from 2014 onward,” says the report dated November 2017.
According to the survey, currency and commodity price volatility are the factors that have had the largest impact on PE firms’ investments over the past three years, a period in which commodity prices, from oil, copper and iron ore, fell to their lowest level since the global financial crisis in 2008.
PE firms can however protect themselves from currency volatility by focusing on the quality of business operations, diversifying revenue streams, passing increased costs to consumers, hedging, buying insurance covers and reducing the need for hard currency by sourcing inputs locally.
For instance, since 2011, the Overseas Private Investment Corporation (OPIC) the US government’s development finance institution — provided insurance for investors against the risk of losses caused by expropriation, currency inconvertibility and political violence.
This year, investors bought $1 billion’s worth of sub-Saharan African risk insurance from the Multilateral Investment Guarantee Agency.
Other PE firms prefer diversification and avoidance of risky locations as the main ways of managing political risk.
The report notes that despite the deteriorating investment climate in some African countries, the total value of PE deals reported on the continent in 2016 reached $3.8 billion, up from $2.5 billion in 2015.
Although political uncertainty also continues to be a major issue for Africa-focused investors, the survey shows that the continent’s political situation is not uniform and is characterised by different types of political risks.
For instance, there are those risks relating to the political outlook of a country (that is its stability, prevalence of terrorism, and changes within the composition or policy focus of the government) and risks pertaining to individual sectors (such as regulatory changes or the interference of vested interests or political actors).
Other political risks are those pertaining to individual companies or projects of national importance such as the unilateral renegotiation of existing contracts by new governments.
An example of this is the termination of the PE-backed Rift Valley Railways’ concession this year by the Kenya and Uganda governments due to its alleged failure to meet the terms of its contract.
The investors cited political unrest and macroeconomic stability as major factors deterring their investment in emerging markets generally and Africa specifically.
However the report notes that Africa’s growing consumption and rapid rate of urbanisation continue to provide attractive investment opportunities for PE firms.
These opportunities are in the fast moving consumer goods, financials, real estate and energy sectors, which are relatively insulated from the economic headwinds created by the decline in commodity prices and local currencies.