Why Nigeria’s domestic institutional investors need to focus on infrastructure and blended finance
Nigeria’s domestic institutional investors, whose portfolios comprise a significant percentage of Nigerian government paper, are facing unprecedented losses as rising inflation creates negative real yields. To preserve capital, domestic institutional investors will need to diversify their portfolios and consider alternative asset classes.
Nigeria’s economy has encountered multiple hits in the recent past. Inflation stands high at 13.39 percent. Exacerbating an already difficult macroeconomic environment is the persisting COVID-19 pandemic, deep currency devaluation, declining levels of government revenues (reported as only 7 percent of GDP, and largely applied to servicing debt), and ballooning public debt currently estimated at $84 billion.
More diverse portfolios that leverage blended finance, the strategic use of concessional capital as a risk buffer, could help spread risk and create better performing portfolios. Moreover, long-term yield-generating, inflation-linked asset classes such as infrastructure provide a viable alternative to government securities, with predictable and stable cash flows. Channeling larger volumes of institutional capital towards infrastructure and other asset classes can create positive externalities for the struggling Nigerian economy.
The IMF estimates Nigeria’s infrastructure stock at 25 percent of GDP, well below the global average of 70 percent. It will require annual financing of $100 billion over the next 30 years to address this deficit. The multiplier effect created by robust and high quality infrastructure is well documented. The economic return averages 5-25 percent for every dollar spent, leading to inclusive economic growth, job creation, a stronger business enabling environment, and an improvement in living conditions given the provision of basic public services.
In addition, national productivity and competitiveness are often higher in countries with adequate infrastructure. Sustaining strategic infrastructure investment is therefore a critical and urgent requirement to transform Nigeria’s economic trajectory and to help it achieve its industrialization aspiration. However, it is clear that alternative sources of capital are required, given the already stressed public purse.
Pension assets alone account for N10.8 trillion (about $28 billion), but most of these funds are invested in government securities, whose yields have turned negative in real terms due to rising inflation. Given the inelasticity of demand for infrastructure and its stable cash flows, it is well aligned to the investment needs of pension funds.
The participation of other institutional investors, such as insurance companies (with assets valued at about $467 million for life insurance and about $648 million for non-life) and the Nigerian Sovereign Investment Authority (NSIA – the Sovereign Wealth Fund), are equally important. And, infrastructure facilitates the long-term asset-liability matching requirements of these investors.
In the immediate term, given the on-going portfolio losses of domestic institutional investors in the country, focus should be placed on alternative products and instruments that can be underpinned by blended finance approaches to preserve capital. The following examples are illustrative of the multiple possibilities available:
Infrastructure project syndications
Overall, syndications enable risk sharing. Prior to the 2008 global financial crisis, when market conditions were favorable, infrastructure projects were largely financed by syndicates of commercial banks or with underwriters selling down a portion of the debt to other lenders. However, with the 2008 financial crisis came stringent capital adequacy requirements, including Basel III, significantly constraining banks and declining bank syndications.
Infrastructure assets can provide banks and asset owners with higher yields through syndications. This is a more attractive investment option than government securities, which are diminished by rising inflation rates. Through infrastructure assets, banks can utilise their expertise in structuring and appraising infrastructure projects to syndicate loans with groups of domestic institutional investors who could provide longer tenors that match the overall project life, and additionally achieve better long-term asset-liability matching in their own balance sheets.
Qualified reputable banks and Development Finance Institutions (DFIS) can serve as the Mandated Lead Arranger (MLA) and lender of record (with preferred creditor status for the DFIS) to undertake the due diligence, appraisal, risk analysis and management, and ensure adequate pricing to generate attractive riskadjusted returns for all.
Blended finance can be applied through early stage project preparation grants and credit enhancement instruments where necessary. The International Finance Corporation’s (IFC) Managed Co-lending Portfolio Program (MCPP) is an example of a blended finance syndications platform that creates diversified portfolios of emerging market private sector loans to grant investors exposure to this asset class. It has raised over $7 billion from eight investors; which has been channeled to 96 commercially structured projects (a quarter of which are infrastructure) in 37 countries (a quarter of which are African).
Through its A/B Loan program, it enables institutional investors to establish an investment vehicle and contract IFC to originate transactions. IFC is the lender of record, while investors participate through B Loans. This structure has raised USD 1.6 billion from Allianz, AXA, and Prudential. It has raised $1.5 billion from Munich RE, Swiss RE, and Liberty Mutual Insurance; which can use unfunded structures to provide IFC with credit insurance or risk guarantees. Again, IFC lends for its own account, with the insurers’ credit coverage on a portion of the portfolio. Credit enhancement to improve the risk-return profile for investors is provided through IFC’S first-loss tranche; which is in turn backed by a guarantee from the Swedish International Development Cooperation Agency (Sida). This model can be adapted and replicated by local banks and regional DFIS to catalyse domestic institutional capital.
Structured blended finance products can provide attractive investment opportunities to domestic institutional investors without altering their commercial mandates and objectives
Araba