> Posted by Amitabh Brar and Paul DiLeo, Investment Manager and President, Grassroots Capital Management
Performance data on private equity funds is not easy to collect, and privately-held microfinance investment vehicles (MIVs) are no exception. Much less is known about the investment process within these MIVs, and how the three main elements of their governance — board, investment committee, and fund manager — interact to create value within these funds. A new Calmeadow study written by Grassroots Capital Management shines light on the elusive subject of governance inside a pioneer equity fund, AfriCap. The study, sponsored by a group of AfriCap investors, evaluates strategy setting and resetting, investment decisions, and portfolio management from the standpoint of the prime movers governing the fund: the board and its committees.
After three years of planning, AfriCap was launched in 2001 with $13 million to invest in support of commercial microfinance in Africa. The sponsors were inspired by the accomplishments of Latin America’s Profund, then in its sixth year, and indeed many of AfriCap’s investors had collaborated earlier on Profund. Fund investments were complemented with a $3 million technical assistance (TA) grant facility to strengthen investees’ capacity. AfriCap saw some spectacular early successes. Some of its investees are today well-recognized financial institutions, including Equity Bank (Kenya) and Socremo (Mozambique), among others. These early results led to increased investor interest and in 2007 new investors joined, tripling AfriCap’s capital to $42 million. The TA pool was boosted to $11 million. In addition, the decision was taken to transform the closed-end fund into a permanent investment company, and the manager into an African-owned and run management company with the ability to manage multiple funds
Yet, notwithstanding AfriCap’s early successes, the fund failed to recover investment costs in 12 out of 21 investments, and there were several write-offs. The fund ended up delivering only modest financial returns to its investors, and the results were especially disappointing for new investors who joined at the time of recapitalization. In 2013 the board approved a plan to liquidate the fund and return unused capital to the investors, reversing an earlier decision to run AfriCap as a permanent company.
The study found that the keystone to AfriCap’s investment strategy, set by the AfriCap board, was an Africa-based management team led by an African manager. This strategy provided local knowledge and presence that gave the fund a strong edge over other investors, enabling it to invest nearly $40 million in both equity and debt in 21 MFIs, more than any other equity fund investing in microfinance during that era. AfriCap closed investments in different types of institutions (NGOs, Banks, MFIs) spread across Africa. The investment committee operated in a transparent and ethical manner and required the same from investees, setting high standards for the emerging African microfinance industry. With the benefit of AfriCap capital and TA, the African microfinance sector generated solid examples of investable MFIs and led the way for other commercial investments in Africa.
Yet, in a dramatic change of fortune, fund performance faltered after seeing some spectacular early successes. The Grassroots study explores what aspects of the fund’s structure and governance were most influential in such a change of fortune. Was governance conducted appropriately and did the board and its committees, as well as the investors/shareholders, conduct themselves according to the mandate of AfriCap? The study explores these and other questions, collecting information and perspectives through interviews with AfriCap managers, staff, board members and investees, and other, publicly available information.
The study found that sponsors and investors set a very ambitious agenda for AfriCap from the start, and did not maintain a clear focus or prioritize objectives. A cautious approach in the early years was eroded by investor impatience, the success of some early investments, and a shift of focus to recapitalization, undermining investment discipline. The sponsors and the board, overwhelmed by the distance and geographical spread of the investments, were unable to serve the essential function of safeguarding a stable structure and strategy and ensuring effective risk management. While some members of the investor group were eager to increase the investment pace, others were concerned about quality, and management received conflicting signals. A dynamic developed where growth and innovation were encouraged, but focus and discipline were absent. The board failed to restrain shareholder and manager ambitions, and ensure that management capabilities were adequate to the task, even as the challenges of investing in Africa became apparent. Eventually the governance function lost effectiveness and value was lost as the portfolio languished while governance was revived and new management was put in place.
What led to this situation? How did AfriCap’s governance support or undermine its performance? Are there lessons in the AfriCap case study for other investors and boards of other funds? The study found that governance left its fingerprints everywhere on AfriCap’s successes and failures:
- Investors recruited an Africa-based team, but failed to support them with Africa-based board members, including independent members;
- The board failed to carefully manage succession and transitions; the fund was undermined by nearly simultaneous transitions of board, investment and technical assistance facility leaders;
- The pace of investments was impressive but the quality less so; the large number of investments made over a vast landscape and many in early stage companies challenged systematic portfolio management by a too-small investment team;
- Difficulties in the critical working relationship between board chair and fund manager were not addressed by the board;
- An extraordinarily open investment process followed by the investment committee served as a model in transparency and ethics but also undermined the committee’s ability to provide consistent guidance, effective oversight, and nurture investment discipline;
- A well-funded technical assistance facility set up to build portfolio companies also served to dilute the focus and accountability of the investment management team.
The study concludes by reflecting on AfriCap’s experience to suggest several areas in which industry guidelines on governance (CMEF 2012 Governance Guidelines) might be sharpened and refined.
Overall, the study found that AfriCap succeeded in demonstrating that microfinance in Africa is investable. Unfortunately for AfriCap’s own investors, it showed both how this could be done and how it could fail. Future investors and managers can take confidence from both the investment and exit track record of AfriCap and build on the lessons learned, both good and bad.
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