We are far from achieving the Sustainable Development Goals (SDGs) after establishing them seven years ago. The OECD estimates that the SDG funding gap has mushroomed to $4.2trn annually from the $2.5trn estimated in 2019. Africa’s annual SDG funding gap alone is estimated to be over $200bn.
Mobilising capital at scale is urgent and the capital is here. Institutional investors in sub-Saharan Africa hold about $1.9trn in assets of which only a percentage is needed to meet the continent’s development goals.
Currently, most of these assets are invested in government securities with only a fraction invested in SDG-tailored investments including alternative investments such as infrastructure. With institutional investors facing risks such as credit risk and the bulk of African economies facing rising inflation rates, domestic institutional investors are having a harder time hitting their return targets.
To build resilient portfolios, they must diversify their investments – and investing in alternatives is one way to do this.
It’s also getting easier. We have observed an upward revision in allowable limits and an expansion of permissible asset classes by regulators. For instance, South African and Kenyan pension funds can allocate up to 10% of their assets to alternative assets. Nigerian pension funds (tier II) can allocate up to 5% of their assets, Namibian pension funds up to 3.5% and Botswanan pension funds up to 2.5%.
These alone add up to an estimated $52bn that is available for direct investments in alternative assets which can contribute to the achievement of the SDGs. This demonstrates the potential impact institutional investors can have towards development.
However, institutional investors have long shied away from investing directly into the SDGs and alternative assets, due to associated high perceived risks and a low understanding of the asset class.
Blended finance – the use of catalytic capital from public or philanthropic sources to mobilise private sector investment in sustainable development – addresses some of these perceived risks. Blended finance instruments such as concessional capital and the use of risk mitigation instruments such as guarantees can offset some of the risks and could increase the comfort of private investors to participate in transactions.
Globally, many institutional investors have already participated in blended transactions. Convergence has captured about 150 blended transactions to date that have commitments from at least one institutional investor, representing aggregate committed financing of $4.6bn. Sub-Saharan Africa domiciled institutional investors represent 16% of all the institutional investors that have participated in these blended transactions captured by Convergence. Of the 150 transactions, 46% targeted sub-Saharan Africa and were focussed in the energy sector and generalist private equity funds.
One of these transactions is Climate Investor One (CIO), an $850m blended vehicle designed to accelerate the development of renewable energy infrastructure projects in emerging markets. The fund is comprised of three inter-linked investment funds – a development fund, a construction equity fund, and a refinancing fund aimed at providing fit-for-purpose financing across the project lifecycle.
The structure of the fund allowed for investors with different risk appetites and return requirements to participate.
Blended finance structures have also facilitated direct investments into infrastructure projects across the region and multiple sectors. One example is South Africa’s Kouga Wind Farm. The 80MW project received project preparation grants from the Seed Capital Assistance Facility (SCAF) and Inspired Evolution.
These project preparation funds were used to finance engineering studies, environmental assessments, financial modelling, and other general development activities, which increased the bankability of the project. The project crowded in diverse investors including Liberty, Stanlib, and Mergence Investment Managers Ltd.
Achieving the SDGs calls for concerted efforts by all stakeholders towards closing the funding gap. Blended finance makes it possible for institutional investors to meet their fiduciary duties, build resilient portfolios, and create impact through their investments.
It’s time for African institutional investors to increase their activities towards closing Africa’s SDG funding gap and grab the opportunity presented by blended finance while ensuring their own profitability and resilience.
Co-authored by Claire Njoki, Senior Associate, Africa, Convergence (former) and Esther Kenga.