Responsible investing: Less stringent criteria needed for impact investments

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on July 9, 2018 - July 15, 2018.
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While impact investing has seen substantial traction in the past few years, the lack of high-quality investment opportunities or deals remains one of the biggest challenges in the industry, says Kevin Teo, managing director of the Asian Venture Philanthropy Network’s (AVPN) Knowledge Centre.

According to him, there has been a shortage of such opportunities for many years. While there is an abundance of deals, most of them are not aligned with investors’ requirements as they tend to fall short in areas such as governance, reporting standards and having a track record.

Investors should adjust their expectations, says Teo. They should not do the standard due diligence in impact investments as a lot of the standards used in conventional investments do not exist in the social enterprise (SE) space.

“Take governance. In mainstream due diligence, investors want to see independent board members. However, the formation of a team of leaders at SEs is often heavily based on trust, where the board is typically made up of friends and family,” says Teo.

Thus, impact investors often eliminate these potential investee companies based on such criteria. “However, the SEs are doing this to protect their mission. If investors are not prepared to accept this, they will just have to forego the deal,” says Teo on the sidelines of AVPN’s 6th annual conference in Singapore recently.

According to the network’s “The Continuum of Capital” report, which was published on May 31, there is a weak pipeline of investment-ready enterprises in South and Southeast Asia due to the fragmented nature of SEs in the region. The majority of them are too small to be deemed investment-worthy, lack business skills and need a lot of technical support.

So, some impact investors go the extra mile to provide capacity building to get the SEs investment-ready, says Teo. “This includes training and smoothening out the internal processes. Not many investors would do this, and that is why they are not finding deals — because they want ready-made ones. It is like they have a mould and the SEs have to fit into their mould. If the SEs do not, the investors will reject them.”

Quality deals are also limited because some investors require onerous reporting, which can be difficult for smaller companies, he adds. So, investors need to adjust their expectations and take the time to assess which reporting standards will and will not work in the SE space as smaller companies typically avoid stringent reporting requirements out of fear of not being able to meet them.

Abhilash Mudaliar, director of research at the Global Impact Investing Network (GIIN), concurs. He says investors should adjust their expectations in line with their risk-return parameters to come up with a shortlist of opportunities that would fit their investment goals.

“Investors should not confine themselves to only one type of impact investment to find opportunities as impact investing cuts across different asset classes, geographies and sectors. Surely, there are deals they would be interested in if they look in the right places,” says Mudaliar.

“The opportunity is still tremendous — an estimated US$4 trillion per year is needed to meet the UN’s Sustainable Development Goals. Compared with that, impact investing is just a drop in the ocean. This indicates there will be more activities and deals going forward.”

To increase the flow of financial, intellectual and human capital towards social impact, AVPN introduced its Deal Share Platform (DPS) at its 2016 conference. The curated platform was designed to help AVPN members share, promote and connect with recommended social purpose organisations, as well as to collaborate with each other.

“We have seen tremendous growth since. The DPS currently has 297 live deals, participated by 160 members. That means we have more headroom to grow as we now have more than 490 registered members,” says Teo.

On a global level, impact investing has become very diverse, says Mudaliar. Citing the GIIN’s Annual Impact Investor Survey 2018, he says that last year, impact investors came from a wide range of organisations, including family offices, foundations, and institutional investors from different industries.

Mudaliar says the diversity is also reflected in the investment sectors, which range from financial services, access to energy, healthcare and education to housing for the lower-income population, clean energy and conservation. He points out that more than half of the 229 respondents in GIIN’s survey this year made their first impact investment in the last decade, which indicates the growing demand for such investments.

“One of the things we do to see growth is compare the assets under management (AUM) of organisations that completed the survey five years ago with their AUM this year. We found that the AUM of these respondents had grown at a commendable rate of 13% per annum,” says Mudaliar.

He adds that investors are generally satisfied with the performance of their impact investments. The majority of them (75% to 82% of the respondents) indicated that their investments had met their impact and financial performance expectations since their inception. Meanwhile, 10% to 15% of the respondents indicated that the performance of the investments actually exceeded their expectations.

“One of the most unfortunate persistent myths about impact investing is that it necessitates a reduction of returns. But that is simply not true. Each year, we ask investors: What type of returns do you principally seek? Typically, two-thirds of them say they are seeking competitive market returns and are not looking to make a cut [in returns] while the rest say they would make a sacrifice because they were pursuing a certain strategy,” says Mudaliar.

While impact investing is a lot more mature in the West, Southeast Asia has had one of the fastest growing impact investment spaces in the world in the past five years, says Mudaliar. That is because of several drivers. First, it is a large region with a significant population challenged by social and environmental issues that impact investors are ready to address.

“Second, compared with other emerging markets, Southeast Asian markets are reasonably friendly to investors and have a reasonably good business climate. Third, it offers good diversification opportunities. Historically, there has been more capital going into other parts of the world, so moving to Southeast Asia offers investors an opportunity to diversify their portfolios as well as have a positive impact on the social and environmental challenges in the region.”

Mudaliar and his team are currently working on a research project that analyses the impact investing landscape in Southeast Asia. The report is scheduled for publication in August. One of the preliminary findings is the significant growth rate of funds deployed by private impact investors in the region over the past decade, which is worth about US$900 million in total and growing at a rate of 30% per annum.

“[The growth] started at a very small base of US$10 million in 2007 to about US$160 million in 2017, so the growth rate can be exaggerated. It’s exciting where we are now after starting at a small base,” says Mudaliar.

“The most popular countries are Indonesia, Cambodia and the Philippines while the most popular sectors are financial services — which account for almost half the allocations — followed by energy and agriculture. That is the data on private investors. But on the development finance institutions' side, the amount deployed is even larger at US$11 billion over the last decade.”