Solving the conundrum of permanent capital vs closed-ended funds for African Private Equity

Adansonia Fund Manager Private Limited announced it has received its Registered Fund Management Company (“RFMC”) licence from the Monetary Authority of Singapore (“MAS”) in an informal event arranged under the Connect Africa initiative. Adansonia Group’s co-founder and Director Brendon Jones stated that it will allow the group to now manage funds under the Variable Capital Company (“VCC”) regime in Singapore.

The event was also attended by Adansonia Group CIO, Rudolf Pretorius, who addressed the incisive questions posed by Amit Jain, Director of the NTU-SBF Centre for African Studies, in a thought-provoking Q&A session focusing on various issues facing the African Private Equity (“PE”) industry, including resolving the conundrum of permanent capital vs closed-ended funds for African PE.

Edited excerpts from the exciting Q&A, which brought to the table a sharp Africa-centric investment focus with expert insights on hidden gems such as tin mining in the DRC and poultry farming in Tanzania:

Could you explain what the stated conundrum between closed-ended private equity and permanent capital is all about?

Many large PE firms in the USA including industry leaders such as Sequoia Capital discovered, after investing in early-stage tech companies such as FAANG (Facebook – now Meta, Amazon, Apple, Netflix and Google – now Alphabet) stocks in their infancy, that they left huge profits on the table after exiting shortly on the heels of listing these companies. The early exits are a consequence of PE funds typically being closed ended, with the need to return capital to investors at a defined point. As a result, Sequoia recently announced it has started a permanent capital umbrella vehicle to ensure that they can maximise the return on their investments by being able to hold them for longer.

The same issue faces African PE players, and we started thinking along the same lines because of our own experience on a smaller scale. As an example, in the second fund that I co-founded and managed in South Africa, we invested in a data centre tech start-up called Teraco which did very well. There was pressure from our investors at the end of life of the fund to sell the investment, but we managed to get special permission from the fund investors for 18 more months before we had to spin off the business. We finally sold Teraco in 2016 to another PE fund from the UK for around US$100 mn. Recently, Teraco changed hands again for US$3.5bn. In effect, we left 35 times the value of the business on the table! That, to me, sums up the basic problem of closed-ended PE – you don’t have time on the really good ones to get your return.

The alternative is to raise permanent capital, which typically must be listed to provide investors with an exit mechanism. But we see cautionary tales such as that of the Johannesburg Stock Exchange-listed Naspers. The South-Africa based global tech group owns 30% of the Chinese technology and entertainment conglomerate Tencent (bought for US$35 mn early in the 2000s). Currently, Naspers is trading at a whopping 50% plus discount to Net Asset Value (“NAV”), which simply cannot be justified as a mechanism to return capital to investors!

Thus, both scenarios, closed-ended PE funds and listed permanent capital vehicles, come with their own flaws. The challenge is to try and bridge the gap.

How do you resolve this conundrum with your newly set-up VCC structure in Singapore?

So, when Brendon and I founded the Adansonia Group in Mauritius, it was clear that we did not want to simply run yet another closed-ended PE fund but rather manage a permanent capital vehicle instead. Of course, the problem of permanent capital vehicles is that investors will have queries on the route for getting their money back. We managed to resolve this conundrum using the Singapore VCC structure. Let me explain what this entails and how it allows us to have permanent capital, and for investors to obtain liquidity at NAV.

We are currently migrating our Adansonia PE Opportunities Fund’s assets from Mauritius to a Singapore VCC under a structure where we value our assets every six months  – and only at that point do we allow in new investors for a short period. We calculate all the cash proceeds generated from assets in the previous six months (dividends and asset sales) and use that to make a pro rata buy-back offer at NAV to all shares in issue for longer than five years. That gives the fund a perfect liquidity match – we never buy back shares without having the cash, and we never use cash from freshly issued shares to buy back existing shares. In effect, everyone who invests will have to wait five years before their shares qualify to be bought back. We expect that not all investors will always accept the first buy-back offer they receive, giving us additional capital. We aim to rotate assets on an eight-yearly basis which (on average) means that investors who accept all buy-back offers will receive their capital and return within eight years.

Simply stated, we have the ability to raise fresh capital from new investors at NAV every six months, and we give our investors (who have been invested for five years) the choice to either continue to remain invested or to redeem their investment at NAV as and when liquidity from asset sales allows it.

Why the move from Mauritius to Singapore?

The first reason was to take advantage of the Singapore VCC structure.  When we started planning the structure, Mauritius did not have VCC legislation, although we note it has recently  implemented its own VCC regime.

The second reason was to leverage investments from a growing HNWI pool in Southeast Asia by channelling such funds from a jurisdiction that has their trust.  Africa offers an exciting new frontier market to such Southeast Asian investors. We believe Africa will maintain a high economic growth rate off a very low base over the next few decades given its high population growth rate and with rapid urbanisation taking place alongside.

We will continue to route such investments from Singapore to Africa via Mauritius if needed. The rationale for the continued use of Mauritius would be to take advantage of the plethora of Double Taxation Avoidance Agreements (“DTAA’s”) that it has in place – 18 with African countries – compared to the 7 that Singapore has in place with the continent’s economies. It places us in a very complimentary situation of utilising both jurisdictions.

All in all, we feel that our Fund – with presence in both Mauritius and Singapore – allows us to optimise structuring of investment flows from Southeast Asia to Africa.

We note there are two funds by Adansonia – an existing fund with a cross-sectoral investment mandate, and a new FinTech-focused fund which will achieve its first close in September. Will both funds be migrated to the VCC regime?

Yes, the existing Adansonia PE Opportunities Fund is sector-and-country-agnostic, and typically invests in more mature investments that are easier to regularly value. It will be redomiciled into a Singapore VCC as discussed above.

On the other hand, the new tech fund we are launching will be managed via a more typical closed-ended VCC PE structure because of its focus on earlier stage companies that are harder to value early on. Six-monthly valuations in this case may not be accurate enough to do justice to allowing new investors in and exiting older investors, as is the case with our existing fund.

Could you tell us how you go about the process of selecting investments under the existing fund? What are the promising sectors and countries in Africa that are ripe for investment?

We started in Mauritius as a corporate service provider supporting corporates and international funds investing in Africa. So, we were seeing a lot of deal flow coming from clients who were investing into thriving entities or starting new businesses in Africa. Indeed, we were sitting on the boards and investment committees of many of these companies, and we could see that there were opportunities for co-investment, on a disclosed basis, of course. That is when we established the current fund, which is an opportunistic co-investment vehicle into Africa-centric businesses, in many cases referred by our corporate administration clients.

In terms of our investment methodology, we follow a bottom-up rather than a top-down approach. In other words, we evaluate each opportunity on its own merits rather than based purely on an assessment of the country and the sector. We place a high reliance on the investment having skilled in-country management in place. Following this approach, we presently have exposure to 10 African countries, with our biggest being in the DRC.

Indeed, our flagship investment into tin mining in the DRC, which makes up 53% of the portfolio, represents the clearest example of what a bottom-up approach means. We were introduced to this opportunity – incidentally at the start of exploration drilling operations – by a United States-based fund that had invested into this mine, which is situated in the middle of the jungle in the Kivu Province, which has historically been a volatile area in the Eastern part of the DRC. The Americans made it very clear that the mine would be run under the most ethical corporate governance standards in adherence with the Foreign Corrupt Practices Act (“FCPA”), with all their employees duly trained under the FCPA regulations. We saw the drilling results coming through, witnessed first-hand how the mine was being built, and drew comfort from our observations to invest in the business, which is listed on the Toronto Stock Exchange. The mine, which currently covers only 60 cleared hectares in the jungle, was commissioned in 2019 and already produces 4% of the world’s tin (with a forecast of producing 7% of the world’s tin by December 2023). Finally, the mine cost around US$250 mn to build, and in terms of payback, the cash flow from the mine will be in excess of US$300 mn in the current year.

But you need to be fully diversified from a risk point of view in Africa. For instance, our investment in Ethiopia is currently a big concern for us. Ethiopia is an incredible story, as an investment destination with  110 mn people that was one of Africa’s fastest growing markets with GDP pushing 10% p.a. for the last 20 years. Attracted by the growth story, China was investing in a big way, and so was the West. What we did not foresee was that the country – a lynchpin of regional security in the prosperous East African zone – would soon be in the throes of a civil war. That civil strife has basically destabilised foreign investment and caused currency shortage in the country. Our investee was an FMCG company supplying sunflower-based edible oil and soap in Ethiopia. Our sunflower oil is imported mainly from the Ukraine, and the price of this essential commodity has gone up four-fold in local currency for consumers in Ethiopia. Currently, the factory is running at a fraction of its capacity, and although all is not lost, we decided to provide heavily against the investment. Suffice it is to say that what was one of the most exciting markets is currently looking like a high-risk investment.

As a moral of the story, that’s why you need geographic spread and time in Africa – it is simply crucial to do so from a risk diversification perspective.

With ESG being such a big word in the investment community nowadays, any thoughts on this aspect of fund management?

Speaking again to our flagship investment in tin mining in the DRC, the business is the first, formal, tax-paying business in the North Kivu Province. We also believe it has been a massive contributor to starting a formal economy in a very remote outpost of Africa, with a direct employment footprint of 1,100 workers. In addition to the direct employment impact, we committed to spend 4% of all our expenditure on ESG. In concrete terms, this currently translates into projects such as five schools, internet cafes, agricultural projects to assist the local community in food production, and the provision of clean water in the most far-off reaches of the province.

Altogether, this has been a most satisfying investment not merely in terms of the returns on investment but also in terms of our impact on the community.

What makes Africa a land of investment opportunities? How would you convince investors from Singapore to partake of these opportunities that otherwise appear so far off and remote to them?

Africa makes up 19% of the world’s population and comprises merely 3% of the world’s economy. So, the continent must grow strongly to start catching up as the wealth inequality between Africa and the rest of the world is simply unsustainable – it really is no longer a question of if but when.

We believe the consumer markets hold out great potential, be it rapidly growing smartphone penetration or consumption of essential commodities like branded food staples that occur with fast urbanisation trends. For instance, we have a corporate service provider client that runs a thriving poultry farming business with presence in Botswana, Mozambique, Tanzania and Zimbabwe, where they are the biggest players. Their progress in Tanzania, which has been difficult to operate in for many foreign investors, has been strong. We think their prospects are great given the extremely low rate of poultry consumption per capita in most African countries – poultry remains one of the cheapest sources of protein and is growing in tandem with rapid urbanisation. 

For investors in Singapore, our investment returns clearly show that exceptional opportunities exist. Our challenge is to maintain that. While we have a mixed bag of investments – like most portfolios anywhere in the world – we have significantly more winners than losers, and we hope to sustain the trend.