5.2. Roadmap Step 3 – Investment Strategy Pillar
The investment strategy pillar focuses on the different ways mainstream investors can deploy capital into impact investments and how social and environmental impact is reflected in those investments. This includes integrating more traditional components of an investment strategy – defining the capital sources for investments, determining appropriate investment vehicles and sourcing investment opportunities – with impact-focused activities including defining strategies to target and measure impact. As an investor gains experience and as impact investing approaches evolve, we expect investors to iterate these approaches.
Investment Strategy – Capital Sources
The sources of capital for impact investments will vary by organization type. For example,organizations that are evaluating and piloting impact investing as well as organizations with fiduciary concerns about impact investing can consider making impact investments through a CSR function or through a corporate foundation. Such an arrangement could allow for the organization to test impact investing models on a small scale and determine what works. However, using this approach could risk causing impact investing to appear philanthropic in nature. In such a situation, internal advocates and champions should remain aware of risk and continue to seek opportunities to mainstream impact investing activities.
➊ Spotlight – Citi Foundation, Optimus Foundation
- Citi Foundation invests in Innovations for Poverty Action (IPA) which supports testing and evaluation of innovative product designs and product-linked financial education interventions for underserved populations.48
- See Section 4.3 for the example of UBS’s corporate client foundation, Optimus Foundation.
➋ Spotlight – Standard Chartered
- In 2013, as part of Standard Chartered’s US$ 100 million commitment to Seeing is Believing, its community investment programme which aims to improve access to eye care, the Bank launched a US$ 3 million fund specifically designed to support innovation in eye health. The Fund is focused on supporting innovators and social entrepreneurs who are experimenting with new approaches to eye health delivery in the developing world.
➌ Spotlight – BBVA
- BBVA has created a financial vehicle for private investors to invest in the social entrepreneurs identified each year through the Momentum Project, a programme of training and strategic support that allows entrepreneurs to grow and scale their social impact.49
➍ Spotlight – AXA, Morgan Stanley, Goldman Sachs, UBS
- AXA: € 150 million impact investing fund of funds50
- Goldman Sachs: Social Impact Fund51
- Morgan Stanley: Investing with Impact Platform52
- UBS partnership with Obviam53
➎ Spotlight – BNP Paribas, UBS, Credit Suisse
➏ Spotlight – Danish Climate Investment Fund
- In 2014 a Danish public-private partnership established the Danish Climate Investment Fund (DCIF) to create green growth in emerging markets. Four Danish pension funds (Pension Danmark, Paedogogernes Pensionkasse (PBU), Dansk Vaekstkapital and Pensionskassernes Administration (PKA)) committed DKK 1.2 billion at the first closing of the Fund. IFU, an independent government-owned fund which provides advisory and risk capital to Danish companies wishing to set up operations in emerging markets, is managing the DCIF. As the Fund develops, an additional DKK 200 million is expected to be provided by additional institutional investors. Below are two examples of investments that the Fund is considering:
- Wind Farm: Lake Turkana, Kenya
- DCIF investment: DKK 108 million (6.3% ownership), Total expected investment: DKK 4.8 billion
- 365 Vestas (Danish wind turbine company) will be installed in Lake Turkana generating 310MW which will be the largest wind farm in sub-Saharan Africa
- Planned exit through trade sale after five years or investors will be issued redeemable shares
- Expected return (IRR p.a.): 19%
- Solar: Male Water and Sewage Company (MWSC), Maldives
- DCIF investment: DKK 25 million (45% ownership), Total expected investment: DKK 55 million
- 8MW rooftop solar plan to be installed to partly replace diesel-based energy production
- Expected return (IRR p.a.): 17%
➐ Spotlight – Zurich Insurance Group
- In July 2014, Zurich doubled its planned investment in green bonds. It now plans to allocate as much as US$ 2 billion to green bonds, citing their growing appeal in Europe.56
➑ Spotlight – Prudential Financial
- In June 2014, Prudential committed to building a US$ 1 billion impact investment portfolio by 2020. Since 1976, Prudential has invested nearly US$ 2 billion in impact investments, with a focus on three core areas: social purpose enterprises, financial intermediaries and real assets.57 In 2013, Prudential made approximately US$ 100 million in social investments.58
➒ Spotlight – Big Society Capital
- Barclays, HSBC, Lloyds and RBS made £ 50 million equity investments in Big Society Capital.59
Investment Strategy – Investment Vehicles
As mentioned elsewhere in this report, the impact investing approach spans asset classes. Accordingly, investors should consider how impact will be reflected in each asset class. While some investors, notably certain family offices, have stated a goal to put 100% of assets into impact investments, this is not currently realistic for the vast majority of mainstream investors. Thus, it is recommended that when evaluating and piloting impact investments, mainstream investors target one or a handful of asset classes. For providers of financial products and services, offering an impact vehicle could mean offering a third-party product or developing a product in-house. Either way, it is recommended that the provider engages with clients and potential investors to determine preferences and sentiment around the attributes (including the social/environmental impact) of a potential vehicle.
➊ Spotlight – Cash / Cash Equivalents
- Impact investing allocations to cash assets typically take the form of certificates of deposit, savings accounts and money market accounts with community banks and local finance institutions. For example, Triodos Bank offers a range of liquid offerings to individual, business and institutional customers and only lends to and invests in organizations that benefit people and the environment.60
➋ Spotlight – Fixed Income
- Impact investments in fixed income can be in bonds issued by public sector or private sector entities. Such bonds typically result in a flow of capital to impact-focused enterprises or projects which address issues with social or environmental implications. Green bonds, microfinance bond funds and CDFI bonds are all examples of impact fixed income.
➌ Spotlight – Public Equity
- There are still relatively few publicly-listed companies which intentionally seek social or environmental impact alongside financial returns. However, several developments make this a potential area of growth. For example, a growing number of states in the US allow organizations to incorporate as benefit corporations. This type of legal entity is required to consider the impact of its decisions not only on shareholders but also on workers, community and the environment.61 Another supporting example is the UK’s Social Stock Exchange which lists companies that have a publicly listed security and that meet certain impact criteria.62
➍ Spotlight – Private Equity and Venture Capital
- Impact investments in private equity and venture capital target different impact themes, geographies and expected return profiles. Therefore, rather than profile a few examples here, readers are encouraged to examine the GIIN’s ImpactBase database63 or Impact Assets 5064 for examples of such deals currently in the market. However, given the high cost and small average size associated with directly investing in impact enterprises, mainstream investors often opt to invest through third-party managed funds.
➎ Spotlight – Real Assets
- Impact investments in real assets involve managing such assets so as not to deplete or damage their value, thus producing long-term benefit for society.
➏ Spotlight – African Agriculture Capital Fund
- In 2011, a group of six partners (USAID, Pearl Capital Partners, JP Morgan Social Finance, Bill & Melinda Gates Foundation, Gatsby Charitable Foundation and Rockefeller Foundation) launched a US$ 25 million African Agriculture Capital Fund (AACF). Pearl Capital Partners, a specialized African agriculture investment fund manager based in Kampala, Uganda, will invest the US$ 25 million in approximately 20 agriculture businesses in East Africa, targeting to raise the productivity and incomes of at least 250,000 households. Pearl Capital Partners was established in 2005 and manages US$ 46 million across three agriculture funds. USAID has guaranteed 50% of an US$ 8 million commercial loan from JP Morgan and the three foundations have jointly provided a US$ 17 million equity investment. Under President Obama’s Feed the Future initiative, the Fund also has access to US$ 1.5 million of technical assistance to help improve investee companies’ operations and competitiveness. The Fund is targeting a 15% gross annual compounded return. Figure 11 graphically illustrates how the Fund is structured and Figure 12 illustrates how the AACF investment review process is conducted.65
➐ Spotlight – California Freshworks Fund
- The California FreshWorks Fund is a public-private partnership loan fund which finances grocery stores and fresh food retailers in underserved California communities. From the Fund’s US$ 125 million loan pool, US$ 100 million was raised from banks and insurance companies and allocated to a senior debt tranche while US$ 25 million was raised from a group of mission-driven investors and allocated to a subordinated debt tranche. Additionally, US$ 7.5 million in grants has funded a first-loss reserve. Senior lenders are secured by collateral of the underlying loans from the FreshWorks Fund.66
Highlighted Challenge 1: Small Average Deal Size
Institutional asset owners sometimes comment that they cannot make impact investments because all impact investments are private equity or debt deals in the US$ 1-10 million range. While those deals certainly do exist, they are not the only game in town. Below are just a handful of examples of larger impact investments available to institutional asset owners targeting market rate returns:
- Investing 4 Growth: In May 2013, five local government pension funds in the UK issued a request for proposals under the name of Investing 4 Growth, seeking investments with economic as well as positive social and/or environmental outcomes in the UK. The five pension funds collectively committed £ 250 million. By the closing date in July 2013, 32 RFP submissions were received reflecting investment opportunities across property/infrastructure, energy, venture capital, mid-cap and social enterprises. As of March 2014, the five funds reported that three investable opportunities have been identified and that they are considering a collective investment of over £ 100 million.67
- Obviam: In September 2013 UBS completed raising CHF 50 million from clients for a fund-of-funds vehicle that will take equity stakes in small and medium-sized enterprises (SMEs) in emerging and frontier markets that drive social or environmental change. The Fund will be managed by Obviam who has 14 years of experience making impact investments.68
- Equilibrium Capital: Equilibrium Capital has approximately $900M across its platform of sustainability-driven real asset investment strategies, funds, and products. Equilibrium’s funds range from $150M-$250M in size, backed by institutional investors such as pension funds, endowments and foundations.69
- Storebrand: Since many pension funds need to deploy capital in investments in the $100 million range and cannot have more than a 10% stake in any fund, a scale challenge remains given that few impact investment funds would qualify under this criterion. Storebrand, a Norwegian pension fund, has a made a commitment to growing impact investing and has relaxed some of the size restrictions to facilitate growth of the sector. Of the approximately US$ 70 billion that Storebrand manages, they currently have a US$ 75 million allocation to impact investments (40% through private equity and 60% through private debt). Through these efforts they are able to support first-time managers and accept higher relative transaction fees based on the belief supporting the sector now can lead to more opportunities in the long-term. In addition to the impact fund investments, Storebrand is a significant investor in green bonds.
Investment Strategy – Investment Sourcing
The sourcing of impact investments presents similar challenges as the sourcing of traditional investments. Most notably, while it might not be difficult to find impact investments – indeed, there are many resources for that listed in this report – finding quality investing opportunities can be challenging. Investors are encouraged to survey the universe of investable deals and develop relationships with partners that have shared investing strategies and principles.
➊ Spotlight – Incubation Partnerships
- Leapfrog Investments: Leapfrog Investments invests in high-growth companies in Africa and Asia that offer financial services to consumers in emerging markets. LeapFrog’s investors include large financial institutions such as JP Morgan, Swiss Re, Prudential and TIAA CREF.70
- DBL Investors: In 2008, DBL Investors was spun out of the JPMorgan Bay Area Equity Fund I. DBL Investor’s strategy is focused on investing in companies that have the potential to deliver top-tier venture capital returns while enabling local social, environmental and economic impacts.72
- Finance In Motion: Finance in Motion is a leading asset management firm focused on development finance with € 1.3 billion committed capital. While Finance in Motion is majority owned by management and staff, Sal. Oppenheim (European private bank) and the Apax Foundation (corporate giving arm of global private equity firm Apax Partners) are also shareholders.73
- MicroVest: MicroVest, a private investment adviser, is majority owned by non-profit institutions CARE, MEDA and the Cordes Foundation. MicroVest builds on the combined experience of these institutions in international small business development and investing.74
- Sarona Asset Management: Sarona Asset Management is a private equity firm that manages investments in frontier and emerging markets. Originally a part of Mennonite Economic Development Associates Inc. (MEDA), a private investment company, it was spun off through a management buyout in 2011 as MEDA evolved into a non-profit international economic development institution. MEDA currently has 10% ownership in Sarona Asset Management.75
- Impact Ventures UK (IVUK): LGT Venture Philanthropy (LGT VP) and Berenberg Bank raised € 24.8 million for their social impact fund, IVUK, in December 2013. IVUK’s investments will focus on the creation of social return for disadvantaged communities in the UK as well as financial return. The Fund builds on LGT VP’s experience in social impact investments and Berenberg’s connections to the UK’s social enterprise community.76
➋ Resource List – Impact Investing Forums
- Impact Forum (Singapore)
- Investors’ Circle Beyond the Pitch (US)
- Sankalp Forum, an Intellecap initiative (India)
- Social Capital Markets (SOCAP) (US)
- Put Your Money Where Your Mouth Is Community (PYMWYMIC) (Netherlands).
- Toniic (Global)
➌ Spotlight – Impact Community Capital
- Impact Community Capital is a for-profit corporation founded by leading insurance companies. It focuses on promoting socially responsible investments in underserved communities specifically though the pooling and securitisation of community investment portfolios and the use of federal new markets tax credits to finance community childcare and healthcare facilities. Impact also provides equity funding for workforce and in-fill housing, as well as to grow small businesses.77
➍ Resource List – Social Venture Listings
- Social Stock Exchange (UK): Platform designed to connect the general public (not just accredited investors) with publicly listed impact investments.78
- Impact Exchange (Singapore): Listing of social entrepreneurs, impact investing funds and non-profits (roll-out in process).79
- Social Venture Connexion (Canada): Online portal connecting capital-seeking social entrepreneurs with accredited investors.80
- Mission Markets (US): Private capital marketplace for US accredited investors which provide offering documents for due diligence and deal-closing support through a broker-dealer partner.81
➎ Spotlight – SNS Impact Investing
- SNS Impact Investing (SNS) is the impact investing arm of Dutch bank assurance company SNS REAAL. SNS uses independent advisers to source investment deals as well as to perform due diligence and write investment proposals. SNS retains responsibility for setting investment policy, evaluating investment proposals and making investment decisions. The process for selecting an investment adviser is similar to the process used by pension funds, insurance companies and professional asset managers. The evaluation of advisers focuses on their track record of returns, their capacity to deploy sufficient capital, a solid financial position and the quality of management. Once the adviser has been selected, an “investment advisory agreement” is agreed to which details the conditions the adviser has to meet before and during the contract period.82
➏ Resource List – Crowd-funding channels:
Highlighted Challenge 2: Lack of track record
The lack of a track record to prove the viability of impact investing is sometimes mentioned as a reason why mainstream investors are reluctant to act. While there are some managers with an impact investing track record greater than five years, there are a great many more with a non-impact investing track record that investors can take into account. In other areas of the impact market – green bonds, housing, microfinance debt, and private equity – a track record is less of an issue because investments can be made without use of an intermediary and because we can see notable examples of investment returns and exits. The following set of exits and fund returns highlights the potential for impact investments to achieve attractive financial returns.
- In October 2013 Bamboo Finance (a commercial private equity firm founded in 2007 with US$ 250 million under management specializing in investing in business models that benefit low-income communities in low-income countries in emerging markets) announced the sale of Xac Bank resulting in returns above 25% and two times its investment. Xac Bank started in 2001 as a non-profit microfinance lender to Mongolia’s herding community. At the time of the sale, it had grown to a fully regulated commercial bank and the fourth largest in Mongolia in terms of assets. It has 500,000 customers. The sale was made to ORIX, the largest leasing company in Japan, who intends to leverage Xac Bank’s business platform to expand within Mongolia and further the development of the country’s financial services industry.83
- In December 2013, Leapfrog Investments (an impact investment firm launched in 2008 with US$ 135 million under management as of 2013 and targeting to raise a second fund of € 300 million)84 announced the sale of Express Life to Prudential PLC. Express Life is a micro-insurance company based in Ghana, a country where less than 2% of the country’s 25 million people have access to insurance. While the terms of the deal were not made public, Leapfrog, in part through its approach to actively work investees, was able to help Express Life post a five times growth in monthly revenues in the first year of the investment. Furthermore, the sale of the company to a mainstream insurance company speaks to the viability and growth opportunities of the business and that exits from impact investment deals are possible.85
- Bridges Ventures is a private investment firm founded in 2002 on principles of pursuing both social and environmental outcomes as well as aiming to achieve financial returns. In March 2013, Bridges exited an investment in Wehlan Refining, which was re-engineered to be the first waste oil refining plant in the UK. The re-engineering helped to divert 100,000 tons of waste oil from being used as low grade fuel and produced a net savings of 300,000 tons greenhouse gas emissions. Since the initial investment in 2006, the exit resulted in a 33% IRR and 4.7 times the total investment.86
Investment Strategy – Impact
Mainstream investors should define an impact strategy upfront which reflects the organization’s specific context. Specifically, some investors will have organizational principles or an operating context which guides where and how impact is sought – for example, the private office of a family which has made its fortune in book publishing may focus on making an impact in education. Other types of organizations may be open to making investments which have a wide range of social and environmental impact. Identifying those guidelines upfront will inform the investment vehicles which should be targeted. On an ongoing basis, impact due diligence will need to be performed and actual impact will need to be measured. Guidelines for these processes can also be laid out upfront, but it is likely that they will change as investments are made and monitored.
➊ Spotlight – Standard Chartered
- Standard Chartered has a longstanding presence in Africa, providing a full suite of banking products and services to SME clients that include payroll, foreign exchange, letters of credit issuing/confirmation, trade finance and loans. A portfolio review of the loan book in eight markets in Africa in May 2014 showed that Standard Chartered is serving over 100 social enterprises, which are defined by Standard Chartered as companies creating jobs and generating societal benefits. These borrowing and non-borrowing clients belong to high-impact sectors such as off-grid renewable energy, agriculture, health, education, water and sanitation, as well as women-owned businesses. This segment of Standard Chartered’s client portfolio is a good example of the demand from mature social enterprises for access to commercial debt and working capital in order to finance growth.
➋ Spotlight – Investment Opportunities Which Benefit Core Business
- Allianz: Micro-insurance providing socio-economic progress and allowing the insuring company to grow customers from micro to conventional business size (nearly 25 million lives insured in 2013).87
- Bradesco: Floating branches reach 250,000 people otherwise without access to banking services. More than 30% of current accounts opened in 2012 were for customers with incomes below US$ 500/yr.88
- Over 70 large banks around the world are members of the Equator Principles which is a framework for determining, assessing and managing environmental and social risk in project finance transactions.89
➌ Resource List – Impact Investing Metrics and Tools
- GIIRS (Global Impact Investing Rating System)
- IRIS (Impact Reporting and Investment Standards)
- B Impact Assessment