Busting the myth that impact investing means lower returns, a recent report by McKinsey shows that impact investments in India have demonstrated an ability to employ capital sustainably while meeting the financial expectations for investors.
This has resulted in impact investments in India topping $1 billion for the second year in a row in 2016. The value of impact investments reached $1 billion for the first time in 2015, and surpassed that in 2016 with $1.1 billion investments.
The average deal size in the last six years has more than doubled from $7.6 million in 2010 to $17.6 million in 2016. The number of deals, however, continue to hover around the 60-80 range.
According to McKinsey’s assessment of 48 exits between 2010 and 2015, the investments gave a median internal rate of return (IRR) of about 10 per cent. The top third of deals yielded a median IRR of 34 per cent, exceeding investors’ expectations. PE firms typically target an IRR of 20-30 per cent in local currency terms.
The report also said that the average holding period till exit for impact investments has been about five years, which is shorter than the traditional 10-year time frame for a PE fund. This dispels the notion that impact investment requires “patient capital” with longer gestation period.
“Having grown at a mean annual rate of 14% over the last six years and now touching the lives of up to 80 million people, India has proved to be a real success story for impact investing, even as it continues to grow,” said Toshan Tamhane, a senior partner at McKinsey.
The total value of impact investments between 2010 and 2016 was around $5.2 billion, attracting over 50 active impact funds. According to McKinsey, impact investments in the country have the potential to grow 20-25 per cent a year to touch $6-8 billion annually by 2025.
Among sectors, financial inclusion and clean energy accounted for 64 percent of the deals in 2016, compared with 88 percent of the total in 2010, hinting at increasing diversification. Investments in sectors such as education, healthcare, and agriculture have all grown during this period, showing that investors are finding investable business models and enterprises in sectors that were previously considered unattractive from a scale or returns perspective.
As for exits, financial inclusion stands out for profitable exits. Data shows that nearly 80 per cent of the exits in financial inclusion were in the top two-thirds of IRR performance. Half the deals in clean energy and agriculture generated a similar financial performance, while those in healthcare and education have yet to catch up.
“With a limited sample set of only 17 exits outside financial inclusion, it is too early to evaluate the performance of the remaining sectors,” said McKinsey in its report.
The sources of capital for impact investment are now becoming increasingly diversified with more complementary sources of capital emerging.
Impact investors and conventional PE and VC firms bring critical and complementary skills to the table. While impact investors funded 65 percent of total deals by volume (including co-investment deals with traditional PE funds), these deals account for 52 percent of investments by value.
As business models in sectors such as financial inclusion and clean energy show significant scale, investor confidence has also grown. Impact investors have started participating in larger deals along with traditional PE investors, resulting in more investment from club deals.
The data reveals that while in 2010, club deals, where a private equity or venture capital firm invests along with impact investors, accounted for $130 million of investment, they almost doubled to $240 million in 2016.
Some prominent impact investors in India include Aavishkaar Venture Management, Omidyar Network, and Unitus Seed Fund.