managers

available for investment in any fiscal year can be invested in social infrastructure projects that promote economic development in underserved sectors or regions of nigeria and may present less favorable financial return potential. nIF seeks to recover at least the total cost of operations during the life of the project (net of any government subsidies the project may receive). All potential projects are submitted to an outside committee set up for this purpose by the national Economic council that decides whether nSIA may invest in them. A comprehensive feasibility study is required to demonstrate how a prospective project serves the public interest and has clear potential to provide economic and employment stimulus (see the nSIA-nIF case study in appendix A).

In such exceptional cases, catalyzing private capital in contexts of market failures may require the sovereign or quasi sovereign of the SIF to consider offering sweeteners to the fund manager, commercial investors in a mixed capital SIF, and co-investors in the fund’s projects. This mechanism could take various forms, as depicted in table 2.9. One such form of sweetener is to directly or indirectly reduce management fees for nongovernment investors by the sovereign or quasi-sovereign entity taking on a larger proportion of these fees (typically 2 percent is the industry standard). This mechanism is pertinent when the sovereign or quasi-sovereign entity has co-investors at the fund level. But incentives have to be carefully designed to reduce moral hazard, and to ensure that co-investors in the fund still have an incentive to monitor the fund. Another mechanism is to provide downside protection or promise asymmetric positive returns to the nongovernment investors in the SIF or co-investors at the portfolio company level. Senegal’s FOnSIS, for instance, caps its returns— that is, it limits the profits the SIF can accept—on most investments to 12 percent, which can benefit its co-investors (FOnSIS does not have an external fund manager or co-investors at the fund level). Public sponsors also offer other perks. For instance, the Asian development Bank, which is a founding partner in the AcP fund, supports AcP in deal sourcing, due diligence, and fundraising, and through technical assistance facilities.

TABLE 2.9 Mechanisms for embedding financial incentives for SIF co-investors and managers

BENEFICIARY

Co-investor at fund level

REDUCED HURDLE RATE OR MINIMUM RATE REQUIRED BY INVESTOR

n.a.

Co-investor at project level n.a.

REDUCED MANAGEMENT FEES

The public sponsor accepts a higher proportion of management fees vs. other investors.

n.a.

Fund manager A reduced hurdle rate allows the fund manager to share in the profits of the fund earlier or at a lower threshold. n.a.

Source: World Bank. Note: n.a. = not applicable; SIF = strategic investment fund. CAPPED RETURNS

Government investor accepts capped returns.

DOWNSIDE RISK

For example, first-loss tranche can limit downside for fund level co-investors.

SIF accepts capped returns. For example, first-loss tranche can limit downside for project level co-investors.

Government anchor investor’s commitment to cap returns helps the fund manager mobilize additional investors for a larger fund size. n.a.