- December 26, 2024
- Posted by: Kusumi
- Category: Articles
Nigeria’s private equity (PE) sector has the potential to drive significant economic growth by attracting capital from local institutional investors, particularly pension funds. By increasing their participation, pension funds can address the local capital shortage in the PE industry with the add-on effects from SME expansion, job creation, increases in tax revenue, which ultimately enhance economic growth.
Pension funds in Nigeria have grown significantly, with assets under management (AUM) surpassing ₦22 trillion ($13 billion) in October 2024, a more than fivefold increase since 2014. Figure 1 shows the trend in total assets under management with pension funds in Nigeria. Growth in AUM is the result of the critical role pension funds play in ensuring long-term financial security for Nigerians.
Figure 1: Pensions Assets under Management (2013 – 2024)
Source: PENCOM
Pension funds invest in a diverse set of assets classes – equities, bonds (corporate and government), real estate, infrastructure, and alternative assets. However, their allocation to private equity remains low, averaging 0.4% of total assets over the past decade. Pension portfolios are concentrated in government bonds/treasury bills and money market instruments each contributing to 68% and 11% of the total asset base. Evidently, their allocation to private equity remains low at 0.5% of total assets in 2024 YTD.
Figure 2: Pensions Assets Portfolio Composition 2024
Source: PENCOM
Pension fund involvement in the PE industry began in December 2020 after the National Pension Commission (PENCOM) authorized investments in alternative assets. Regulators have sought to boost pension fund participation by reducing the minimum local investment requirement for PE firms to from 75% to 60%. Pension funds are now permitted to invest in PE funds whose global portfolio comprises up to 10% from 5%. These changes were designed to encourage greater involvement from pension funds as limited partners in private equity funds.
Private Equity as an attractive asset class for pension fund investment
PE in Africa, though still developing, has experienced significant growth. According to the Africa Private Equity and Venture Capital Association (AVCA), the volume and value of deals from 2013 to 2023 grew at CAGRs of 9% and 13% respectively. In 2023, the total value of PE and venture capital transactions reached $7.6 billion across 450 deals. West Africa remains a key player, contributing 26% of the deal volume and 11% of the value in 2023, although slightly down from 31% and 23% in the previous year. West Africa accounted for an average of 25% of volume and 22% of value of deals between 2017 and 2021. Total funds raised by African PE firms stood at $1.9 billion in 2023, down from a peak of $4.4 billion in 2021.
Figure 3: Volume and Value of PE Deals in Africa (2013 – 2023)
Source: AVCA
Nigeria, the dominant player in West Africa, is poised for growth, driven by an expanding SME sector, a young and growing population, and a significant scarcity of capital for SMEs. This makes Nigeria attractive to both regional and international investors, creating an opportunity for increased PE investments. However, PE firms in Nigeria remain heavily dependent on foreign capital from development banks, sovereign wealth funds, and impact investors. Expanding the pool of both local and global limited partners (LPs) would help diversify funding sources and ensure that private equity fund structures and models are suited to the local context in Nigeria, taking into account the specific market nuances.
Pension fund participation in PE funds offers several benefits. First, PE investments provide pension funds with opportunities for portfolio diversification and enhanced returns, PE as an asset class are expected to continue to outperform listed investments over the long term. Data from Morningstar and Hamilton Lane reveals that, on average, private equity outperforms listed equities by 5% over 15 years, 7% over 20 years, and 8% over 25 years.
Figure 4: PE Fund performance vs listed equity performance
Source: Hamilton Lane & Morningstar
Second, with Nigeria’s inflation rate at 34%, private equity stands out as one of the few asset classes capable of delivering positive real returns, offering pension funds a vital opportunity to preserve and grow the wealth of the Nigerian people amidst challenging economic conditions.
Figure 5: PE fund returns vs FGN securities
Source: CBN, World Government Bonds
Fixed income, primarily government securities, provide pension funds with yields of 21.2% on average, whereas PE & VC has the potential to generate above 35% over the 10-year fund life. There have been examples of successful exits in the ecosystem which delivered over 10x returns such as Verod’s investment and exit from GZ Industries and Paystack’s acquisition by Stripe.
Third, PE’s typical 10-year fund cycle aligns well with the long-term investment horizons of pension funds. Lastly, PE investments support higher employment and value creation by investing in domestic SMEs and high-growth sectors
A comparison with South Africa’s PE market highlights the potential impact of pension fund involvement. South African pension funds have allocated 27% of their maximum allowed allocation of $50 billion to PE funds, compared to 59% in Botswana and just 0.5% in Nigeria. Adjusting for size, South African pension funds hold $13.5 billion in PE assets, against $310 million in Botswana and $60 million in Nigeria. If Nigerian pension funds were to allocate the maximum 5% allowed to PE, it could unlock up to $593 million (₦950 billion) in additional capital for PE funds which will have significant trickle-down effects to SMEs and hence the overall economy.
Table 1: Pension investments in PE across selected countries
Source: Regulatory Agency Websites
Private Equity as an attractive asset class for pension fund investment
PE firms in Nigeria must tap into pension funds as a crucial source of capital. However, several factors currently limit the allocation of pension fund capital to private equity. Pension funds are only allowed to invest in PE funds registered with the Securities and Exchange Commission (SEC), which limits their options. The process for fund managers to register with the SEC has historically been a cumbersome process. Moreover, Nigerian PE firms typically raise capital in U.S. dollars, while pension funds face some restrictions on foreign currency investments in local companies and would prefer to invest in local currency.
The image below highlights the responses to a survey by AVCA displaying the key challenges faced by pension funds when investing in private equity. These include limited liquidity options, limited track record, currency risks, regulatory hurdles, and a lack of familiarity with the asset class.
Figure 6: Challenges to pension fund investment into PE
Source: AVCA
A path forward for growth and partnership
To foster deeper collaboration with pension funds, PE firms in Nigeria must implement several strategic measures that address the key concerns of institutional investors and demonstrate the value of PE as an asset class. These strategies include:
Enhancing liquidity options: According to 60% of respondents, the primary challenge for pension funds participation in private equity is the weak investment climate and unpredictable exit windows, which conflict with the need for ongoing liquidity. The slowing volume of private equity exits in Africa is illustrated below. To mitigate these concerns, private equity firms can develop flexible investment structures, such as self-liquidating instruments or alternative fund structures which offer liquidity at different stages of the fund lifecycle. These options would provide pension funds with exit opportunities, making private equity a more attractive and viable investment option.
Figure 7: Volume of PE exits in Africa
Source: AVCA
- Developing local currency funds: Currency risk poses a significant concern for Nigerian pension funds, as they generally prefer to avoid foreign currency-denominated investments. In fact, 33% of respondents in a survey highlighted this as a major issue. Private equity firms can address this challenge by creating local currency funds, which would align with the pension funds’ currency preferences. This strategy would allow pension funds to invest with greater confidence, reducing their exposure to foreign exchange risks and making PE a more attractive investment option. In addition, local currency investments ensure that fund managers will direct all of their investments into Nigerian companies, above the 60% threshold required by PENCOM.
- Improving returns profile: For pension funds, return on investment is crucial. PE firms need to demonstrate a strong track record of delivering strong returns net of fees that outperform inflation and generate long-term value. By focusing on net returns rather than gross returns, and fully disclosing all fees and costs, PE firms can build greater confidence among pension fund managers. Highlighting successful exits and strong performance across market cycles will further reassure institutional investors.
- Increasing transparency and communication: Private equity firms should enhance transparency by providing pension funds with clear, frequent reports on their investment strategies, risk management, and historical performance. This builds trust, ensuring pension fund managers that their capital is being invested responsibly in high-potential opportunities. Regular updates on fund performance and investment progress are essential. According to the AVCA survey, 27% of respondents cited the lack of transparency as a major barrier to pension fund investment in private equity. Addressing this issue is key to attracting more institutional capital.
- Building capacity, education, and marketing: Many pension funds hesitate to invest in private equity due to unfamiliarity with the asset class. PE firms can address this by offering training, workshops, and case studies to educate pension fund managers on the risks and benefits. This builds trust and fosters informed, long-term relationships. Additionally, engaging in industry forums and conferences can boost visibility and position PE firms as reliable partners.
Nigeria’s private equity industry is poised for significant growth, but it requires more active participation from local institutional investors like pension funds. By increasing their allocation to private equity, Nigerian pension funds can diversify their portfolios, enhance returns, and support local economic growth. Private equity firms, in turn, must take proactive steps to address pension funds’ concerns and tailor their offerings to meet the needs of long-term institutional investors. Through collaborative efforts, the partnership between PE and pension funds can unlock a new era of sustainable growth for Nigeria’s economy.
About Aruwa Capital
Aruwa Capital Management is a Lagos-based, female-founded and managed growth equity firm that invests in high-growth SMEs in West Africa, particularly those that are female founded and led or female focused. Aruwa focuses on mid-market businesses, which are too late for traditional venture capital but too small for traditional private equity, providing growth capital to companies in critical sectors. Aruwa Capital Management currently manages two funds backed by global and local institutional investors such as Mastercard Foundation, Visa Foundation, FSD Africa and Bank of Industry.
Written by Gboyega Aderogba
Investment Analyst and Portfolio Manager