The correlation between investment and economic growth – why South Africa is an outlier?

Private Equity Funds have always had an aura about them, mainly due to high profile cases of leveraged buyouts, whereby many jobs are shed to maximise profits. The private equity industry is perceived to prioritise profit over the health of companies. The WOW report on the South African Private Equity Industry peeks into trends in this sector and this mysterious world of finance. The report highlights interesting findings for those wanting to know more about this sector, and its importance to a country’s economic growth.
The value-adding role of private equity funds in growing economies is not in dispute. It is a worthwhile exercise to establish whether the industry is a fundamental driver of economic growth.

Statistics on the relationship between private equity and average GDP growth

Private Equity investment activity in relation to GDP (2018) and average GDP growth 2015-2020 – WOW Report 2023

The data set above show the relationship between private equity and the average GDP growth of different countries. It is interesting to note that where private equity investment is higher, GDP is also on the higher side. This is not a definitive conclusion but worth investigating further.
It is notable that in developing countries, a larger share of private equity investment has a positive correlation with average GDP growth. However, it looks like South Africa is an outlier, showing a higher private equity investment but low GDP growth. The correlation between the BRICS countries excluding South Africa is 66%, but once South Africa is included, it drops to 12%.
The general trend seems to confirm that private equity investment as a share of GDP grows as the development of a country progresses. China and India as developing countries clearly achieved much higher growth rates than the other BRICS partners with their private equity investments as a share of GDP in the higher brackets. Again, South Africa is the exception.
Looking at the developed countries, admittedly the Anglo-Saxon way of doing business seems to suggest that, higher private equity investment has contributed to a higher GDP growth rate. Based on the above premise, it can be said that private equity investment has a significant impact on the economic growth of a country. South Africa’s outlier status could possibly be a result of the country’s historically advanced development of its financial sector. Its comparatively higher level of private equity investment does not translate into economic growth indicating that a higher level of private equity is a positive contributor but not the only influencing factor.
In South Africa, perhaps as in other countries, the private equity sector derives a lot of its attraction from the cost efficiencies, driving innovation and cost reduction. For many SMEs and companies, the alternative is a listing on the stock exchange which results in onerous and costly obligations to maintain a compliant listing.
Private equity professionals are well versed in financial analysis and company valuations, and one might expect that in most instances, their valuations approach the valuation a wider market might bestow on a company in the listing setting.
This does not mean infallibility. The investment in Edgars in South Africa did not end well for private equity investors. Such mishaps are not only the preserve of private equity. Walmart’s US investment in South African Massmart has so far only produced huge investment losses for Walmart.

The difference between entrepreneurs and private equity investors

The difference between entrepreneurial and private equity investors lies in their commitment. Private equity firms do not invest with a view to increasing commitment to deal with unexpected adverse events, whereas entrepreneurial investors are more fully committed to the investee company. An example is a scenario played out between the South African Infrastructure Fund and the French Bolloré group when they took a decision to invest in Comazar for rail concessions in Côte d’Ivoire and Cameroon. Bolloré followed through on additional investment and regained control it had lost, whereas the South African Infrastructure Fund, a private equity investor, did not. Venture capital investors share more of the high risk than private equity.

There is no magic in finance or private equity

A humorous piece reported in the Financial Times will invoke some caution for investors. In Arguments for Private Equity are not always Convincing, written by John Kay in 2007, he said: “Sitting on my desk is a prospectus for a fund of private equity funds. It offers me some of the best names – Blackstone, Permira etc. I have just received a large cheque for my holding in Equity Office Properties and, if a similar bidding war for Sainsbury’s takes place, I will have a lot of cash to reinvest.
“But wait a moment. Was it not Blackstone that just bought Equity Office and is not the names in the frame at J Sainsbury almost exactly those in my fund of funds? The prospectus invites me to buy Equity Office Properties and Sainsbury from myself, at prices around twice what I recently paid.”
The bottom line is that it is advisable to always be careful when investing. The issue remains –South African private equity investment can only do so much to make a difference in the country’s economic growth. The complex regulatory environment exacerbated by political uncertainty or as other commentators mention – a shortage of good quality assets – does hinder the longed for and much needed high growth trajectory.