The BUILD Act provides the new US International Development Finance Corporation with the authority to make limited equity investments—a critical change aimed at helping the agency deliver on its development mandate. As Nancy Lee and Asad Sami pointed out in a post earlier this year, equity investments still make up a very modest share of most development finance institutions’ deals, which are predominantly lending-based—with the notable exception of the UK’s CDC Group. To better understand CDC’s unique experience with equity, including how it helps the London-based agency achieve development impact—and with an eye toward lessons for the USDFC—we posed a series of questions to CDC’s Chief Operating Officer, Colin Buckley. That exchange follows.
Q: Why does equity dominate CDC’s operations, when other DFIs tend to do much more lending? Is the case based on development impact or catalytic impact or both?
A: CDC is the world’s first development finance institution and we made our first equity investments in the late 1940s. Since then we have supported businesses with equity, both directly and through investment funds. We do this because we believe that with equity we can create the type of development impact that is more difficult to achieve with other financial products. Our experience tells us that some companies need equity rather than debt. Equity is the only tool that allows for the type of long-term patient capital that many businesses in developing countries need and it gives us a chance to take a more active role in the direction of the company helping to move it to achieve greater development impact, whether through job creation or by raising environmental or social standards. When we talk about long-term, patient capital that could mean a 5, 10 or 15-year partnership with a company. Although not typical, our longest investment dates back to the mid-1960s when we invested in the Ugandan bank, DFCU, a business that we still support today.
Q: Many DFIs complain about lack of investable projects. Does CDC struggle to find investable firms or funds?
A: We’ve been fortunate to find a steady flow of good projects and we believe we can continue to do so in the years ahead. In part, this is because historically we’ve invested more in equity than debt and have a long-established track record. We also have the time and expertise to develop investments for which other investors, especially commercial ones, aren’t prepared to bear the upfront cost. In short, the answer may be that there is currently more capital than investable opportunities in Africa, but it’s incumbent upon DFIs and others to try and unlock those opportunities and make them ready for investment. We can do this by demonstrating success, by creating businesses rather than just investing and by supporting the capital ecosystems in developing countries. One example I would give to demonstrate how CDC has used one its portfolio companies to generate further investable opportunities is Globeleq, Africa’s largest independent power producer which now has a generation capacity of more than 1,200 megawatts across five countries: Cote d’Ivoire, Cameroon, South Africa, Tanzania and Kenya. We’ve worked with the company to enter new countries to serve the growing demand for power and helped it expand its project development and operating ambitions, all the while creating new opportunities for investment.
Q: What are the most important kinds of development impact that you see from equity investments?
A: Equity investments allow us to target companies that have the potential to deliver the type of development impact we’re looking for. In recent years, our focus has been on job creation as a primary indicator of development impact. That means we targeted our equity investments at sectors that we know have good job creation potential such as manufacturing, construction, infrastructure, agribusiness and others. More recently, we’ve expanded our development impact goals and built on our previous focus on job creation across a wider global development agenda, including women’s economic empowerment, climate change; job quality and skills & leadership. Our equity focus has also allowed us to invest in new catalytic and higher-risk ways to tackle specific market failures that hold back development, such as improving the price of and access to medicines and health commodities and tackling electricity transmission and distribution in Africa.
Q: What are CDC’s goals for returns at the portfolio level?
A: The agreed target for CDC on our primary, commercial investing activities, excluding the higher risk portfolio mentioned in answer 3, is a 10-year average return of 3.5 percent. When we look at our portfolio as a whole and take into account those higher-risk, Catalyst investments then our shareholder wants us to break even and has set us a 0 percent 10-year rolling average return target.
Q: How do you manage the increased risk and volatility of equity?
A: First, you have to have an understanding shareholder. DFID understand the costs and risks of investing in equity and they support us because we’ve done this for a long time and have experience in equity investment. Second, you need experienced equity investment professionals who have the skills and expertise to understand and support businesses in emerging and frontier markets. They’re not always easy to find but you need to find them to do equity investment properly. Third, you have to have a willingness to roll up your sleeves and get involved. If a company you invest in has a problem then you need to knuckle down and solve the problem—it’s not possible to just walk away in the way that you might if you’re a debt investor. You need the staff and the willingness to commit resources to make it work. For example, a Central African agribusiness in which we invested equity directly needed our support. This means that at times we had the equivalent of three full-time staff working with the company.
Q: What do equity operations require in terms of human capital and staffing?
A: There’s been a significant, over ten-fold increase in staffing numbers for CDC in our direct equity team over the last six years as we’ve increased our direct equity investment levels from zero to around $700 million USD a year. In addition, the operations team supporting our direct investments, whether for development impact evaluation, environmental & social standards or business integrity have grown significantly too.