Institutional investors are playing a crucial role in promoting impact investing as the COVID-19 pandemic drives up demand for such capital worldwide, especially across emerging economies in Asia, according to seasoned investors.
From financial inclusion to affordable healthcare, investors expect that the amount of money to be invested in businesses with a social or environmental impact to increase, at a time when the prolonged pandemic is taking a heavy toll on the population in the developing world.
Impact investing, which accounts for a fraction of the overall investment industry, refers to investments made with the intention to generate positive, measurable social and/or environmental impact alongside a financial return.
“I think there is a bonafide effort on the part of GPs (general partners) and LPs (limited partners) alike to work together and create a framework that works [for impact investing],” said Saima Rehman, investment officer at IFC’s Private Equity & Funds, during a panel discussion at the Asia PE-VC Summit 2021.
She was speaking at a panel titled ‘Impact investing turns mainstream: What’s changing and what are the implications?’ on Sept. 29 — the second day of the four-day summit.
IFC, a member of the World Bank, has committed a record $31.5 billion to private companies and financial institutions in developing countries in the fiscal year 2021.
“We’re seeing that positive trend develop over the last ten years, and certainly after the COVID,” said Rehman, who specialises in PE investments in the eastern Asia-Pacific region. Impact investing nowadays is different from the time of its inception, she said, when investors were simply “riding that wave” and “following a new pool of capital.”
A June 2020 research from the Global Impact Investing Network (GIIN) put the aggregate value of impact funds at $715 billion across over 1,720 organisations around the world as of the end of 2019. But the sum is only a drop in the ocean compared to the wider investment market, which was at a size of $103 trillion by the end of 2020, according to US consultancy firm Boston Consulting Group (BCG).
A boost in popularity
Still a nascent market, impact investing has seen a boost in popularity during the pandemic due to increased awareness of challenges like unequal access to healthcare, racial and gender inequality, and climate changes, among others.
Fernanda Lim, a partner at London-based impact investment firm LeapFrog Investments, saw impact investing gain traction in three aspects, namely the supply of impact capital, the number of impact investors, and the demand for impact dollars.
“The supply of dollars behind impact investing increased in the last few years,” Lim said at the panel discussion. She cited a survey by Bank of America: “… And [it] will continue to grow,” as young-generation investors, such as America’s Millennials and Generation X, became more willing to invest for impact than Baby Boomers.
Impact fund managers seek to back “scalable commercial businesses” with “a large impact,” said Lim. In the old days, there were concerns over their “lack of authenticity.”
With about $2 billion in committed capital from LPs like Singapore state investor Temasek, LeapFrog has built a portfolio of companies providing healthcare and financial products across 35 countries in Asia and Africa. Its investee companies currently reach some 221 million people, a majority of whom are low-income consumers, typically living on under $10 a day per person.
As the firm aims to serve one billion people with essential services by 2030, Lim expects the demand for impact capital-backed product loans, insurance remittances, and healthcare services to rise after “hundreds of millions of people” are pushed back into poverty by the global health crisis.
Beyond virus-induced demand, Tan Shao Ming, chief investment officer at Singapore-based ABC World Asia, offered a different perspective. He emphasised the potential “penalties” that could come without enough impact capital helping address some of the world’s most pressing challenges.
“If you look at the world today, there are increasing consequences, including rewards and penalties for actions and inactions,” said Tan at the panel discussion. Tan leads ABC World Asia’s investments in themes ranging from climate change and wealth inequality to water solutions and sustainable food.
In an example of global warming, he pointed to estimates by the United Nations’ Intergovernmental Panel on Climate Change (IPCC). The estimates show that the world must halve global emissions by 2030 and further cut them to net-zero by 2050, in the prevention of global warming above 1.5 degrees Celsius that could result in catastrophic impacts.
Tan and his Asia-focused team are investing through their inaugural fund, a S$405-million ($297.8 million), 2019-vintage vehicle focusing on China, SE Asia, and South Asia. Established by Temasek’s philanthropic arm Temasek Trust in May 2019, ABC World Asia reported capital deployment of about S$98 million ($72.1 million) in 2020, according to its website.
“We’ll see more penalties such as emission-based taxes and quotas,” said Tan. “On the other hand, some companies are generating carbon credits – a new source of revenues that are unheard of previously.”
A risk-adjusted, return-driven strategy
Investors are increasingly finding impact investing as risk-adjusted and return-driven just as any other traditional approach.
In the case of IFC, the firm, at a minimum, invests in GPs that bring environmental, social, and governance (ESG) criteria “to the heart of their operations,” said Saima.
ESG, a set of non-financial evaluation standards for a company’s operations that focus on causing no harm, is viewed as the baseline for impact investing, which further seeks to achieve intentional, measurable, and positive social and/or environmental results.
“What we have found over decades of investing and working with good GPs,” she said, is that the best GPs use ESG and impact investing positively as “a lever for value creation” and “a tool for managing underlying risks.”
Some of the world’s major PE and asset management firms have jumped on this bandwagon. BlackRock, the world’s largest asset manager, established a partnership with Temasek in April to launch a series of late-stage venture capital and early-growth PE funds to help advance decarbonisation solutions. The partnership, called Decarbonisation Partners, targets to raise $1 billion for its debut fund.
TPG in July raised $5.4 billion for its inaugural fund under the firm’s climate investing strategy from high-profile investors including Allstate Corp and Hartford Financial. In February 2020, KKR & Co reached the final close of the KKR Global Impact Fund at $1.3 billion to invest in companies across the Americas, Europe, and Asia whose financial performance and societal impact are “intrinsically aligned.”
Others with dedicated impact vehicles include Bain Capital, Apollo, Morgan Stanley, and Hamilton Lane, to name a few. Globally, $2.3 trillion were invested for impact in 2020, equivalent to about 2% of global AUM, according to IFC’s latest estimate.
“Private equity is known to be hard-nosed and objective-driven. However, that can be seen as a strength when it comes to impact investing because we need the same pragmatism, the same level of rigour and discipline in driving companies to meet the impact goals,” said Tan.
“From risk management and investment perspective, companies with strong impact intentionality and measurable outcomes are generally more resilient, more sustainable. They can deliver healthy financial returns in the longer term,” he added.
But challenges exist when investors are trying to generate market-rate returns by identifying high-growth businesses that also care about good deeds, especially against a set of evaluation metrics that are yet to be standardised.
For LeapFrog, which claims an average annual portfolio company growth rate of 26.2%, investors use key metrics to assess a potential investment, such as the reach of the firm’s product, the product quality and affordability, its unit economics, and if the business can bring the expected returns when such unit economics is applied at scale.
“It’s growth on top of growth on top of growth,” said Lim. “We do have constraints. And the main one is related to our purpose, our impact, and the ESG filters that we apply… It is a natural challenge.”