Introduction

With a net asset value of nearly €400 million as of 2012, SNS Impact Investing¹⁸ is the world’s third largest foreign-private-capital provider of microfinance after responsAbility Investments AG (Switzerland) and Oikocredit¹⁹ (Netherlands). SNS Impact Investing invests in microfinance institutions (MFIs) across the globe through the SNS Institutional Microfinance Fund I (Fund I) and the SNS Institutional Microfinance Fund II (Fund II). The investments are made on behalf of institutional investors aiming for attractive financial returns while adding social value. 

Since its inception in 2007, Fund I has provided more than 256 loans to 123 MFIs totalling approximately €850 million²⁰. Fund II has provided 184 loans to 99 MFIs totalling €260 million since its launch in November 2008. In addition, the Funds have equity stakes in six MFIs. 

SNS Impact Investing is responsible for structuring funds, fund governance, investment decision-making, monitoring the investment advisers, and constant communication and reporting vis-à-vis its participants. Once an investment decision is made, SNS Impact Investing works closely with investment advisers who source the investment deals, perform the due diligence on the investments, write investment proposals and monitor MFIs. 

Fiduciary Responsibility: “Professional First”, not “Impact First” or “Finance First” 

Investing on behalf of institutional investors requires taking into account their fiduciary responsibility towards their beneficiaries. In continental Europe, and particularly in the Netherlands, pension funds and insurance companies include a focus on their investees’ ESG performance. After all, institutional investors on the Continent increasingly want to invest in a world worth living in – now and in the future. Using the PRI as their framework, most European pension funds and insurance companies have integrated social and environmental aspects into their investment processes. 

While open to foreign investors, Fund I and Fund II, both non-listed, closed-end mutual funds, are funded almost exclusively from Dutch institutional investors²¹. As these investors have fiduciary responsibility to invest the capital in the best interests of their beneficiaries, SNS Impact Investing is responsible for upholding that fiduciary responsibility. Satisfying fiduciary responsibility usually (but not always) means looking for a market-rate, risk-adjusted financial return. In 2009, the Monitor Institute qualified these investors as “finance first”, as opposed to foundations, family offices and high-net-worth individuals (HNWIs) who are seen as “impact first” investors. However, SNS Impact Investing’s institutional investors are likely to remark that they are “professional first”, not “finance first” or “impact first” investors.

“Professional first” investors seek investments that satisfy several aspects, in addition to achieving market-rate financial returns. First, these investors seek impact investing fund managers that demonstrate a convincing track record in the investment area. This means that the investors will be unlikely to invest in first-time offerings or in funds with a previously below-market-rate performance. In addition, these investors put much emphasis on cost-efficiency. In an environment where returns are under pressure, driving fees down becomes an important consideration for investors. Generating net annual returns of approximately 6%, adding value to microfinance institutions and clients, and charging the lowest fees in the market have helped SNS Impact Investing to convince investors that microfinance investments can make sense – even for institutional investors.²² 

Second, “professional first” investors seek the fund managers whose impact investment pipeline needs to meet the requirements of pension funds, insurance companies or mainstream asset managers. Most often, the constraining requirement is the size of the deal. Depending on the size of their investment portfolio, institutional investors will want to invest at least US$ 40 million to US$ 70 million per investment. To complicate things further, institutional investors often want to mitigate their risks by taking no more than a 20% to 30% share in the fund. As a result, impact investing funds targeting the institutional investment market must be able to accommodate at least US$ 200 million to US$ 250 million in investments. Apart from infrastructure, microfinance, responsible agriculture, renewable energy and clean tech investments, there are few categories that can absorb the size of capital disbursement brought by institutional investors. However, the number of potential investments and investment funds that can accommodate the amounts required by institutional investors will grow rather fast in future years. In addition, new areas will emerge like large-scale water projects, or refertilization of deserts making them productive for sustainable agriculture. While such infrastructure projects focusing on societal impact are currently in their infancy, they will come to market quite rapidly.

Third, “professional first” investors seek fund managers who demonstrate their (potential) impact on the economy or community in which the investments will be made. Thus, in addition to information on the direct social or environmental outputs, investors increasingly require the fund manager to report on the outcomes of the fund’s investments. For microfinance, this means that apart from knowing how many microfinance loans have been provided to the poor and how many poor families have been given access to finance, investors also like to receive information on the effect of the loan provision on the well-being of microfinance clients. 

The expectations of fiduciary responsibility have also evolved with the recent financial crisis. Influenced by the European Commission, the European Central Bank, national banks and other supervisory authorities, the focus on managing financial and non-financial investment risk has increased tremendously in the crisis’s aftermath. Basel III and Solvency II have had a clear impact on the risk perception of institutional investors and the conditions under which risks are deemed acceptable or not. Institutional investors need to demonstrate an understanding of and management control over their investments. Since impact investments are often made into illiquid, long-term investment funds, the question is what does it mean to be in control? At present, investors and fund managers are still working on new tools for managing risks in illiquid investments and for reporting on these risks to boards and supervisory authorities.²³

In short, the financial crisis significantly reduced the appetite among asset owners for high-risk, long-term and illiquid investments. As a result, institutional investors have changed their policies and introduced tighter risk management procedures. For SNS Impact Investing, this development has resulted in the fund manager introducing quarterly investor meetings and reinforcing its risk reporting. Issues like market development, local currency policy, operational risks or social risks are now discussed with investors on a regular basis.

Responsible Management: Working with Impact Investment Advisers

To select and monitor investments, SNS hired an independent investment adviser. SNS uses investment advisers to: 

• Source investment deals
• Perform due diligence
• Write investment proposals
• Monitor MFIs once SNS Impact Investing’s Investment Committee has made the investment decision.

A structure with clear governance and division of tasks between manager and adviser can provide asset managers with an effective business model for impact investing. First, this structure prevents ‘deal blindness’, a common characteristic among investment managers performing both sets of tasks. Second, it ensures that the right expertise and oversight capabilities are working to provide maximum results in each step of the process. The fund manager employs portfolio and relationship managers with adequate understanding of the institutional investment and microfinance markets. The investment adviser employs specialists with expertise in sourcing, analysing and monitoring deals on the ground.

The process for selecting an investment adviser is similar to the process used by pension funds, insurance companies or 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, fund manager and adviser operate on the basis of an “investment advisory agreement”, which stipulates the conditions the adviser has to meet before and during the contract period. These conditions usually refer to issues such as retaining key personnel and guidelines for selection, due diligence, and monitoring investments for financial, operational and social performance. Table 1 shows the division of roles between the SNS Impact Investing fund manager and the investment adviser. 

Table 1: Division of Responsibilities between Fund Manager and Investment Adviser

Active investment monitoring is essential to ensure the fund manager is ultimately in control throughout the investment lifecycle. SNS Impact Investing monitors and oversees the investment advisers in several ways. First, the team visits the investment adviser annually for two days of meetings with key personnel. Separate meetings are scheduled with the adviser’s management board. Second, the team members will accompany the investment adviser on a site visit to perform due diligence on (prospective) investees. All relevant financial, social and operational matters are discussed in-depth during these visits, sometimes leading to adaptations of processes and activities. If the investment adviser does not meet key performance indicators of the investment advisory agreement, the fund manager can terminate the contract. 

Conclusion

For SNS Impact Investing, to work in the best interests of institutional clients means to focus on realizing market-rate returns, while creating added value to microfinance institutions and microfinance clients. As we have seen with predatory lending, prioritizing high financial returns may result in undesirable social outcomes – not only for investees, but also for investors.  

We understand that institutional investor behaviour is not guided by poverty alleviation, but by enabling the poor to manage their own financial affairs. By financing MFIs that are best situated to become commercially viable, we can serve the broader fiduciary interests of sophisticated and enlightened institutional investors while simultaneously serving the needs of microfinance clients. However, commercial investors cannot – and will not – completely replace the role of public financiers who are best positioned to serve the needs of the poorest of the poor. Both public and private investors have their own responsibility to stimulate access to finance, and sometimes they can help each other in producing outcomes beneficial to all – to private investors, the general public and the clients of microfinance institutions. 

By being focused on our investors’ financial and social interests as well as their risk concerns, and having extensive discussions with them over the years, we have been able to develop a stable yet dynamic business model. In 2007, what it meant to be “professional” was clearly different from the meaning of the word today. Currently, asset managers and other service providers to institutional investors need to be constantly and fully aware of challenges their clients face. Moreover, they have to act on this knowledge. The model we have provided here aims to create and maintain a “professional first” approach to investing. This approach is relevant to fund or asset managers working with independent advisers, and to those performing both the fund management and investment management functions themselves.