Impact investment funds are fast becoming the vehicle of choice for governments and donors looking to invest in African agriculture and encourage private sector investors to do the same.
Investments in African agriculture are rising faster than ever before, with a new wave of blended finance impact investment funds leading the way. But, while these are helping to harness private sector capital – including from African commercial banks and corporates – the bulk of initial donor and government money comes from overseas. Still, the impact of such funds on the lives of smallholder farmers is increasingly well documented and demonstrates that investing in African agriculture can be profitable for private sector players, as long as the right projects are financed and risk is well managed.
Development agencies and private sector investors are seeking to plug a stubborn agrifinance gap in Africa by investing in agricultural investment funds, whose number and size have grown rapidly since the start of the decade, according to a 2018 FAO report, Agricultural Investment Funds for Development. Food shortages and rising food prices have simultaneously pushed agricultural investment up governments’ and development agencies’ priorities and made the sector a more profitable proposition for private sector investors.
Many funds use a blended finance structure. This can be a catalytic tool for encouraging more capital into agriculture, explains Jerry Parkes, managing principal at Injaro Investments, an Africa-focused investment manager launched in 2009. With its €43.8 million closed-ended equity investment fund, Injaro Agricultural Capital Holdings Ltd (IACHL), has so far deployed €30.4 million – providing capital, business advice and capacity building to small and medium-sized enterprises (SMEs) in West Africa, Parkes says.
Impact investment funds’ expertise in targeting and measuring impact directly raises the likelihood that capital will reach intended beneficiaries and higher-risk agricultural value chains, emphasises Parkes. IACHL is on track to meet and possibly exceed its impact target to reach 1.125 million beneficiaries by 2023, having so far benefited around 900,000 smallholder farmers and people on low incomes. For example, Injaro funding helped Ghanaian animal feed brand, Agricare, implement a pilot outgrower scheme in 2016 to increase the proportion of maize it sourced from local smallholders. From 210 farmers with 250 ha under cultivation at its launch, by the end of 2017 the scheme had scaled up more than tenfold, directly benefiting around 1,200 smallholders with over 2,580 ha.
The missing middle
Impact investment funds are ideal for targeting the ‘missing middle’ – agribusinesses that are too big for microfinance, but need capital injections of €20,000 to €1 million. Achieving the 8-12% financial returns private sector investors typically seek – while factoring in credit, foreign currency and other risks associated with agriculture – would require regular funds to lend at interest rates as high as 50%, notes Florian Kemmerich, managing partner of Bamboo Capital Partners. However, by protecting private sector investments with money from donors that prioritise capital preservation over financial returns, private sector players are prepared to take a lower financial return because their risks are reduced.
Together with Injaro, Bamboo is manager of the International Fund for Agricultural Development (IFAD’s) Agri-Business Capital (ABC) Fund, which launched in February 2019 to provide loans and eventually equity investments for rural SMEs, farmer organisations, agricultural entrepreneurs and rural financial institutions globally. The open-ended fund, also supported by the Alliance for a Green Revolution in Africa, the EU, the ACP Group of States, and Luxembourg’s government, will seek to attract €200 million from investors over the next 10 years. It so far has €50 million committed in the ‘first loss’ tranche, and aims within the next 3-6 months to secure another €50 million, before reaching out to private investors, states Kemmerich. The involvement of IFAD – which has historically only made grants but, in February 2019, voted in a new resolution permitting it to make private sector investments – reflects a shift in the kind of investors becoming attracted to blended finance impact funds, says Parkes.
The EU-funded AgriFI facility also announced its long-awaited debut investment in April 2019, agreeing to inject up to €5 million of long-term equity in Incofin Investment Management’s Fairtrade Access Fund (FAF), which supports smallholder farmers, agri-SMEs and agri-focused financial institutions with finance and technical assistance. Since its 2012 inception, FAF has disbursed over €164.5 million, impacting the lives of over 254,000 African and Latin American smallholder farmers. FAF’s technical assistance facility, which uses grant funding to improve productivity, disease control and market access for farmer organisations, has reached over 54,000 smallholders in 10 countries.
Mixed financial performance
Impact investment funds that blend private sector capital with state or donor money must marry impact with offering investors an attractive financial return. This has proved challenging. Crises such as the coffee rust epidemic that has affected Latin America since the 2011/2012 season have dented the performance of some funds exposed to the region or reminded would-be investors that African agriculture faces equivalent risks, says Calvin Miller, former head of agribusiness and finance at FAO and co-author of the 2018 agricultural investment fund report.
It took 3 years to stabilise Incofin’s FAF and bring it to a profit, according to founder and managing partner Loïc De Cannière. This was partly due to teething issues as the fund established its risk management and due diligence procedures for producer organisations, but also because of external events, including Latin America’s coffee rust disease. Because FAF is exposed to underlying price volatility in commodities, as well as credit risk and governance challenges in farmer organisations, investors must absorb more risks than with many traditional microfinance or impact funds, he acknowledges.
FAF is now generating a 2-3% return on equity, helping attract new investors, such as Swiss wealth manager Lombard Odier in 2018. The recent AgriFI injection is also providing more comfort to new investors, with several contacting the fund since AgriFI’s investment was announced, De Cannière says. The very tangible nature of agriculture – with investors able to visualise the goods they are financing and appreciate the impact on producers’ lives – also makes them more committed to the fund’s overall goals, he adds.
Harnessing African capital
Still, local value chains, where investors are exposed to currency risk, remain under-served by impact funds in Africa. Finding a way to plug this gap will be challenging, but could present a good opportunity for the employment of African capital, De Cannière says. Like many funds, FAF focuses on export value chains, in which produce is priced in hard currencies like the US dollar or Euro.
Domestic investment is an important source of capital for agriculture, with African donors, lenders and corporates helping African money flow along agricultural value chains. But, while impact investment funds say funding of local banks for on-lending to agribusinesses will improve such lenders’ understanding of agriculture and encourage them to lend more in the long term, the vast majority of money pumped into such funds still comes from outside the continent.
Low financial inclusion, with many rural Africans having no bank account, means a relatively small portion of money passing through African economies reaches banks, notes Carlijn Nouwen, partner at Dalberg Global Development Advisors. Banks are therefore under-capitalised compared with European or North American institutions, leaving less money available for lending to agriculture.
Local commercial banks also face external hurdles in lending more to agriculture. While farmers often complain about unrealistic collateral requirements, these are imposed on banks by regulators charged with maintaining financial system stability, Nouwen notes. The high interest rates charged for agricultural loans also reflect banks’ own high operating costs, while agriculture must compete for bank capital with lower-risk, higher-return sectors.
Small agribusinesses across Africa therefore remain mostly informally funded, either from entrepreneurs’ own pockets or through loans from friends and family, she says. Larger corporates and wealthy individuals in Africa also invest in agriculture, either as joint ventures with the entrepreneur or through equity investments, but transactions are not always publicised so are harder to track, notes Miller.
There are signs of progress though. Uganda’s aBI Finance, a funding vehicle that offers local lenders government- and donor-backed guarantees for 50% of their agricultural portfolio, has been instrumental in encouraging banks and microfinance institutions (MFIs) to lend more to the sector, says De Cannière. aBI’s guarantees have, for example, helped the country’s Finance Trust Bank build a credit portfolio that is nearly 30% comprised of agricultural loans. This is funded by nearly €35.8 million of deposits from local Ugandan savers.
Joined at the hip
A common characteristic of solutions that are successful at getting both African and overseas money flowing to agriculture is that the funder and borrower are ‘joined at the hip’, with closely aligned interests, says Nouwen. Input providers, for example, increasingly provide credit to farmers by not requiring payment for fertiliser or seed until they have sold their harvest. Although not a formal flow, she explains that it is a vital source of ‘funding in kind’ that farmers have come to rely on. While agriculture has to compete with other sectors for bank capital, such input providers are reliant on farmers for custom so have no option but to continue providing ‘credit’ to farmers even following defaults and disaster years.
Similarly, the success of Nigeria’s Babban Gona – an investor-owned social enterprise that says it has disbursed 16,000 profitable loans so far among its membership of over 1 million farmers – is inextricably intertwined with that of its members. Babban Gona works closely with farmers to design and implement a package of inputs, training, offtake agreements, marketing services and incentives that benefit them and the company, Nouwen notes. “It’s not one lever that changes agriculture – it’s a whole range of things and you need to lean on all of them,” she says. Governments and donors should direct more of their resources towards initiatives like these, which will continue lending to agriculture once funding and guarantees expire, she advises. Indeed, in March 2019, AgriFI approved a planned €5 million investment in Babban Gona.
MFIs and microfinance banks also tend to be well aligned with farmers’ needs while their licenses often allow them to be flexible with collateral. However, many are barred from taking deposits, leaving them under-capitalised and prone to collapse, Nouwen notes. For the sake of financial system stability, she cautions that central banks must ensure that agriculture does not become overly reliant on non-bank lenders like MFIs, input providers or other corporates.
Sustainability is key
There are promising signs that African governments are starting to see the potential of impact funds. For instance, in March 2019 the government of Togo decided to provide seed funding to Bamboo’s blended finance BLOC Fund, which invests in companies using technology to solve social and environmental challenges, says Kemmerich. At a time when technological advances like blockchain and renewable energy are creating opportunities for African SMEs to build businesses and connect to markets, governments are keen to play a catalytic role in reducing poverty by attracting private capital to sectors like agriculture, he says.
Impact funds are a welcome addition to the limited array of funding vehicles available for agriculture, acknowledges Nouwen. But, while ‘first loss’ tranches and subsidised money have a good track record of attracting private sector investors to the table and encouraging local banks and MFIs to lend, such funders too often withdraw from riskier value chains once incentives are removed. This, she argues, must be front of mind for donors and governments before they make any investment. Only through the funding of crops and projects that can earn sustainable profits for private sector players will ‘catalytic capital’ truly live up to its name, she concludes.
How impact investment funds work
Blended finance impact investment funds combine public and private sector money to achieve a specific social or environmental impact, as well as a financial return. The idea is that public investors shoulder more of the fund’s total risk for no or low returns so private investors are encouraged to fund an area where high risks mean they would usually have to be rewarded with high profits.
Funds can be divided into two or more ‘tranches’ or portions. One tranche – sometimes referred to as ‘catalytic capital’ because it helps the fund pull in other investments – is filled with money that is either donated or invested as long-term equity by philanthropic organisations, governments or development banks. This can play a ‘first loss’ role, meaning that if the value of the overall fund falls, an initial proportion of any losses will be absorbed by this pile of money, before other investors take a loss on their investments. It can also be used to pay for technical assistance which, in agriculture, could involve training farmers to improve yields to reduce the risk that beneficiaries will not repay debt or prove a profitable investment.
Money from private sector investors is typically put into a separate tranche, often referred to as ‘senior capital’, which earns a higher interest rate or equity return. However, the reduced risk – due to the technical assistance or ‘first loss’ tranche – means that investors are happy to accept lower interest rates than they would usually demand.