By Eliot Pence
The rapid increase in the number and size of African pension funds arguably matters more than any other single trend in the continent’s economic development. The pace at which pension funds have grown is staggering. According to analyst reports, the top six countries’ pension funds alone are predicted to grow total assets under management to over $600 billion by the end of the decade (from $200 billion today). They are on pace to grow to over $7 trillion by 2050.
Over the next 10 years, Africa’s savers – more than its consumers – will define the nature of the continent’s growth. But there are as many challenges as there are opportunities in the changing institutional investment landscape.
Key Drivers of Growth
There are two significant trends underlying pension funds’ growth in Africa: migration and demographics. Growth in urbanization has led to an increasingly formalized urban labor force, which has led people out of informal savings mechanisms and into state or privately structured systems. A rising middle class has increased both the number of contributors and the per capita amount contributed to pension funds.
It’s important to note that though pension funds are growing rapidly, coverage itself remains low by international comparisons; most estimates put it at only 7.5% of the population. As the financial markets deepen and savings ecosystem evolves this number will undoubtedly increase.
The Malthusian Advantage
The era of high debt payments may not be over yet for African countries, but looking forward they have a distinct advantage over their developed country neighbors. In less than 20 years, Africa will have the largest working age population in the world, and a not insignificant amount of them contributing to pension funds.
In most cases, African pension funds are outpacing developed country pensions already. As a percentage of GDP, even Zimbabwe’s pension fund assets are greater than Japan’s. Considering the difference in population growth rates, this trend will continue. Japan’s dependency ratio – the number of people aged 20-64 per pensioner – will soon approach 1:1. In Zimbabwe, ten working age people will support the pension of one person well into the 2030s. Zimbabwe will have fewer future liabilities to pay out in the short term, but because there will be fewer claims on the pension assets, capital costs will be reduced substantially, opening up new investment opportunities in infrastructure.
The ability to invest in long term infrastructure projects will become increasingly critical for African governments as current investors, like China, pull back from the continent when their liabilities creep up on them starting in 2020.
Lions vs. Elephants
The rise of the African consumer is well documented. McKinsey’s 2010 report on Africa’s growth, “Lions on the Move,” put African consumers at the center of its analysis. The African Development Bank’s 2011 report advanced the argument, suggesting a rising middle class would sustain Africa’s future growth. The news catalyzed the investment community, setting off a raft of new private equity funds and investment theses focused on acquiring fast moving consumer goods companies (FMCGs) and buying the domestically listed equities of global consumer conglomerates like Nestle and Unilever (UL).
But by focusing on consumer exuberance, investors are missing the opportunities and risks caused by the growing African savings trends. A potential downside of growing savings trends for investors is that because pension funds don’t diversify well, they tend to inflate local listed equities prices, making African-listed equities a somewhat inaccurate reflection of company value. Growing pension funds do offer new capital pools for private equity firms. But in order to manage more of these new funds, PE firms should lobby African pension funds to change their regulations and increase asset allocation diversity.
The rise of the African pension fund will have the most direct effect on policy makers and public investment officials. Regulations, capacity and investment strategies will change dramatically. As pension coverage approaches 10% of the population and assets under management explode, the pressure to reform outdated practices, beef-up capacity and training will be immense.
For the meantime, the newfunds will be forced into still opaque systems of governance and dated asset allocation requirements. Debates about investment decisions will also become more political. Legitimate questions about why, for example, the rate Ghana pays on its USD denominated bonds far exceeds that which it invests in US Treasuries – even although it has a lower debt to GDP, better demographics and growth prospects – will stir debate about how and where to invest state funds. On top of this, policymakers will have more technical questions to answer, such as the need to assess the feasibility of emerging new pension systems (pay-as-you-earn versus pre-funded and defined-benefit versus defined-contribution) all of which remain largely untested in the African context. An additional emerging issue will be how linked pension fund liabilities will be with other institutional investment structures such as excess crude accounts and other sovereign wealth vehicles (growth in Africa’s sovereign wealth funds, prompted by a boom in resource finds, are also some of the fastest growing pools of capital in the world. To date, over ten have been established and a further twelve are in planning stages.).
Pension funds have yet to play a major role in the Africa’s transformation. But the scope they will have to influence the continent’s growth over the next ten years is substantial. A number of drivers will continue to increase their asset base and the policies and politics governing their management will be – if they aren’t already – front and center. If Africa’s lions got the attention last decade, it will be the elephants that get it in the next.
Eliot Pence is director of The Whitaker Group, a consulting firm focused on African business development.