Democratizing Alternative Investments in Nigeria
Strategies and best practices for deploying alternative investments in Nigeria
Alternative investments are becoming increasingly popular among retail investors seeking higher returns and diversification; hence, the democratization of this asset class in Nigeria is an important issue that merits further discussion and consideration. While traditional investment options like stocks, bonds, and cash remain popular, alternative investments can offer more complex and higher-risk opportunities with potentially greater rewards.
Private Equity is a form of investment in which institutional investors and wealthy individuals purchase shares or ownership stakes in private companies that are not publicly traded. This can include venture capital, growth equity, and buyouts. Meanwhile, Private Credit involves lending to businesses by non-bank institutions, with interest paid throughout the loan period and the principal sum returned at the end. Although Private Credit investors do not own any part of the company, they may impose certain obligations on the borrower as agreed in the loan covenant.
Hedge Funds are another form of alternative investment. They are exclusive pools of funds used to trade in short-term, relatively liquid assets, employing various investment strategies to maximize returns. Real Estate investments involve the purchase, management, sale, or rental of properties like land, buildings, and residential apartments. Finally, Peer-to-Peer Lending is a relatively new concept where online platforms provide loans for personal or business purposes, allowing investors to fund the loan and lend money to others.
Although the democratization of alternative investments has the potential to offer significant benefits to investors and the country, there are also challenges to democratizing these investment options. This can be overcome through various strategies such as technology platforms, public-private investment partnerships, and new investment vehicles.
By exploring strategies for increasing access to these investments and promoting transparency and education, we can help to create a more inclusive and diversified financial system that benefits investors and the wider economy.
Why should anyone be interested in the democratization of alternative investments in Nigeria?
Retail participation in alternative investments can mean that the benefits of this asset class can be shared more widely across the retail investment landscape. For instance, retail investors who previously had limited access to alternative investments can now access previously inaccessible investment opportunities. This increased accessibility also allows for greater diversification of investment portfolios, potentially reducing overall risk.
Moreover, alternative investments have consistently outperformed public equities over the past two decades. This is because performance is not tied directly to public volatility and opinion, but rather to the performance of the company in the case of Private Equity or Private Credit. As such, alternative investments are not influenced by unpredictable swings in the public market. In April 2021, a report from Hamilton Lane found that over the preceding three years, alternative investments generated a premium of 33% over public equities. This outperformance is especially significant during market downturns, as many alternative investments have achieved positive returns during these periods.
Furthermore, the democratization of alternative investments in Nigeria also has the potential to significantly increase investment in Nigerian businesses and entrepreneurs driving economic growth and stability. In 2019, private equity investment in Nigeria reached N277 billion, representing a 9% increase from the previous year.
Barriers to the Democratization of Alternative Investments in Nigeria
Lack of Investor Education
At the heart of democratizing alternative investments is the challenge of educating retail investors. The lack of education and awareness amongst retail investors is the biggest challenge to making private markets accessible to everyone. Lawrence Calcano and Marco Bizzoero of iCapital emphasized this point in a recent edition of Private Equity International, highlighting that transparency, education, and access to high-quality investments are the key routes to democratizing private markets.
Historically, the retail investment space has favoured assets that produce daily returns or can be liquidated in an instant. Education can play a crucial role in addressing investor need for instant liquidity because, a long-term view is often preferable, and riding out periodic dips in performance can ultimately lead to higher returns. As such, the ability to exit all assets immediately may not be the right approach for a retail client taking a five- or ten-year view of their investments, or even longer for retirement provision.
To shift away from the “cult of daily liquidity,” fund managers, advisors, and government must educate the broader public on the potential advantages of long-term assets. This means providing clear and concise information about the risks and potential rewards of alternative investments, sensitization on the potential benefits of less liquid assets, and ensuring that investors have access to professional financial advice to help them make informed investment decisions.
Lower Liquidity
Another challenge that comes with investing in alternative assets is liquidity. Private investments typically have a longer holding period than traditional investments, which means that investors may not be able to access their capital for a longer period. This creates liquidity challenges, as retail investors often require the ability to redeem investments at short notice. However, long-term assets are inherently illiquid since they are not traded on an organized market, have no market maker or centralized system for price discovery, and are complex to value, requiring transactional information and modelling. They can also be physical assets, such as property or infrastructure, which are bought and sold in their entirety.
This liquidity mismatch creates a challenge for fund managers to buy, sell, or value such assets quickly to meet redemption requests. A survey by the African Private Equity and Venture Capital Association revealed that 60% of Pension Fund Managers in Nigeria consider a perceived weak exit climate and unpredictable exit windows as barriers to pension funds investing in Nigerian private equity. While alternative investment investors may have long-term time horizons and are well able to invest for the longer term, retail investors are seen to work on shorter horizons and require the ability to redeem investments at short notice. This mismatch creates a challenge for fund managers to buy, sell, or value such assets quickly to meet redemption requests.
High Fees
Investing in alternative assets can be highly promising, but it can also come with high fees that investors may face in a democratized fund. These fees stem from the specialized expertise required to manage alternative investments and the illiquid nature of the investments. For example, in many private equity deals, fund managers must go through a rigorous and expensive process of sourcing private companies, negotiating the deal, managing the company, running a value creation program, and eventually finding a buyer to exit. All these factors drive the fees up, which can be a challenge for retail investors looking to access this asset class.
Strategies for Achieving Democratization of Alternative Investments in Nigeria
1. Leverage technology-driven platforms for retail investors
Technology has brought about exciting possibilities for democratizing alternative investments, and the most significant benefits are reducing the barriers to entry and providing much-needed liquidity to retail investors. With the advent of new technologies, such as blockchain and platforms that support secondary markets, alternative investment funds can connect with retail investors seamlessly.
In Nigeria, crowdfunding platforms like Propcrowdy have been using technology to enable retail investors to invest in real estate, while Future Africa targets private equity investment in African tech startups. Platforms like Piggyvest and uduX’s PopRev have also emerged, allowing fans to invest in musicians’ projects and democratizing retail investment in the music industry.
Beyond Nigeria, the impact of technology on the democratization of alternative investments is equally impressive. In Asia, ADDX is using blockchain to democratize private investments among Singapore’s mass affluent. Crowdfunding platforms like Seedrs, Republic, Fundable, and Wefunder are allowing companies to raise capital from retail investors. Meanwhile, Moonfare and iCapital in the United States leverage technology to offer access to alternative investments for a minimum investment of $125,000 with a secondary market providing liquidity even before the investment cycle is complete.
Thanks to technology, it is now possible to connect alternative investment funds with retail investors seamlessly, reducing barriers to entry and creating new opportunities for all types of investors to diversify their portfolios.
2. Public-private investment partnerships
Public-private investment partnerships have the potential to democratize alternative investments in Nigeria. By fostering collaborations between the government, alternative investment firms, and stakeholders, these partnerships can create opportunities for retail investors. A notable example is the partnership between the Nigeria Exchange (NGX) and the Bank of Industry which seeks to deepen the capital market in Nigeria for inclusive growth. Through the promotion of retail participation and listings, enhancing information flow to stakeholders, and supporting market development, this partnership is set to drive capital market solutions in Nigeria.
Similar partnerships and agreements can be entered particularly in the areas of impact investing and venture capital. However, for these partnerships to succeed, it is crucial to have a strong regulatory framework, adequate infrastructure, and a conducive business environment. This will enable stakeholders to navigate challenges such as high fees, illiquidity, and lack of education and awareness, which have historically hindered the wider adoption of alternative investments. By creating a supportive ecosystem that encourages innovation and collaboration, public-private investment partnerships can help democratize alternative investments and drive inclusive growth in Nigeria.
3. Introduction of New Investment Vehicles and Fund Structures
Alternative investments have traditionally been seen as the preserve of high-net-worth individuals and institutional investors. However, with the democratization of private markets, retail investors can also participate in these investments. One way they can do so is through Exchange-traded Funds (ETFs). ETFs have grown in popularity in recent years, offering investors a diversified portfolio of stocks or other assets. In the context of alternative investments, ETFs can provide retail investors with exposure to funds focused on Nigeria, reducing the minimum investment requirement, and providing liquidity.
In addition to ETFs, Investment Syndicates (IS) have emerged as another popular investment vehicle. These are funds that pool capital from multiple investors to invest in a company. In Nigeria, the Future Africa Collective is one such syndicate that allows retail investors to pool funds for as low as $2,500, increasing access to venture capital investments. The collective also provides vital information on the startups they invest in, making it easier for retail investors to make informed investment decisions.
Another way for retail investors to participate in private funds is by investing directly in the main fund alongside institutional investors or indirectly through an “access fund,” which acts as a feeder fund to the underlying fund. This access fund can be managed by the sponsor of the underlying fund or by a third-party manager. To address the issue of liquidity, fund sponsors can adopt a semi-liquid or a hybrid fund structure.
4. Complementary Regulatory Framework for the Nigerian Alternative Investment Landscape
While technology platforms and secondary liquidity offer opportunities, they may not be suitable for all asset classes and investors. Without a regulatory framework that fosters investment products that reflect illiquid asset returns, products may have liquidity mismatches that impede long-term investment objectives. A nuanced approach from regulators, appropriate product development from asset managers, and sound advice from intermediaries can all play a role in achieving objectives. By moving away from a one-size-fits-all approach to liquidity requirements, stakeholders can work together towards democratizing private investments.
Regulators around the world are taking steps to address issues surrounding private investments. In the UK, proposals for regulatory change include the Professional Investor Fund (PIF) and Long-Term Asset Fund (LTAF), while the European Long-Term Investment Fund (ELTIF) has been introduced in the EU to support the real economy. In the US, although federal laws do not restrict investment firms from adding illiquid assets in pension plans, they are typically not included in individual account plans due to fear of litigation. However, the regulatory landscape is changing, with the US Department of Labor issuing an information letter in 2020 allowing alternative investments in target date funds and other vehicles managed by professionals to be offered to retail investors. The Securities and Exchange Commission has also redefined the term “accredited investor” to include defined measures of professional knowledge and experience, in addition to income and net worth.
Overall, regulatory changes will play a critical role in democratizing alternative investments in Nigeria. The Nigerian government’s concern for the growth of small businesses should motivate it to create the enabling environment for the players. By promoting transparency, accountability, and investor protection, more retail investors can invest in alternative investment funds with confidence, driving economic growth and development in Nigeria.
Conclusion
Democratizing alternative investments in Nigeria offers numerous benefits but also presents challenges and risks. These challenges can be addressed using technology platforms, public-private partnerships, new investment vehicles, and complementary regulatory changes. While substantial progress has been made, additional efforts are needed to allow for robust democratised alternative investments in an emerging market like Nigeria.
