Scaling up Impact Investing
Impact investing is a growing industry that has gained in popularity and importance in the last few years. This is not surprising, says Harvard Professor Michael Chu: It is driven by the concept that a social or ecological problem may be addressed via a commercial platform, which many people find attractive. Due to the high demand, some of the main focus points of the industry are now to launch new and risk-adjusted products, as well as to "mainstream" the market.
Sara, 9 years old, is an eager student in her classroom a few hours outside Kampala. She is back in school since last year when a teacher in the community started a small private school close to her home. Until then it looked like Sara wouldn't make it through primary school – the only school in her region was a long and dangerous 7km walk each way, to get to a public school where teachers often did not show up for days at a time. The risk and cost were high and educational outcomes low. So what happened? The local teacher was able to obtain a loan from a microfinance institution specialized in education finance to build a school and hire and train teachers. Sara's parents need to pay a small fee, but despite their small income, they are willing to do so. That fee is part of the school's cashflow, which pays back the loan to the MFI which pays back its investors, a combination of development agencies, private individuals and foundations.
Entrepreneurial concepts of this kind and investments in companies that deliver both a social and a financial return have become increasingly popular in recent years and are collectively referred to by the term "impact investing." It was just five years ago that the WEF in Davos held its first-ever "Impact Investment Session;" back then, only very few investment institutions were involved in impact investment in any way. Abigail Noble, currently CEO of the ImPact, a member network of prosperous families, and formerly Head of Impact Investing Initiatives of the World Economic Forum and co-author of the 2012 WEF report "From the Margins to the Mainstream," emphasizes how rapidly the market has changed and gained in popularity in the meantime. Indeed, none other than Pope Francis praised this investment strategy at the "Vatican Impact Investing Conference" in 2016, and prominent celebrities such as the singer Bono are likewise turning their attention to these types of solutions.
"What we need is to mobilise patient capital that makes a social difference and has a positive impact on biomass through a business approach to conservation – that is impact investing to me" says David Ryan firmly. In 2004, this South African entrepreneur set up luxury tour operator Rhino Africa, which is dedicated to leaving a legacy in conservation and education in Africa. David's current impact investment project – which diversifies Rhino Africa's traditional activities – combines developing a luxury eco resort, which drives the ROI on the project, combined with job creation and rehabilitation of marine and bird life on the social and environmental impact side.
A Combination of Impact and Profit
Experts like Harvard Professor Michael Chu explain impact investing as an investment strategy that seeks to provide a measurable response to a targeted social or environmental problem, while at the same time delivering a commercial return. It is this aspect that distinguishes impact investing from philanthropy, for example. In May 2017, the Global Impact Investing Network (GIIN) published its "Annual Impact Investor Survey" for the seventh time. In the study, 98 percent of respondents said that the resulting social or environmental impact had exceeded their expectations, while for 91 percent this was likewise true of the financial performance of their investment. This clearly highlights the potential of impact investments, particularly in view of the fact that two out of three respondents were looking to achieve a risk-adjusted market return.
"Intention is crucial – you can only be an 'accidental impact investor' once, thereafter you either consciously want to do something or you don't," explains Abigail Noble. However, impact investing is also appealing to investors for other reasons. Olivier Rousset, Head of Impact & Philanthropy Solutions at Credit Suisse, points out, for example, that impact investments are also of interest in volatile markets, as they help to diversify a portfolio. The cash flows of such investments usually do not depend on the capital markets, but on the operations of the social enterprises that form the underlying investments and are tied to a real economy.
Rapidly Developing Market
When Credit Suisse launched its first investment product in the sphere of microfinance 15 years ago and co-founded ResponsAbility, now one of the globally leading asset managers in the area of development investments, it was viewed as a pioneer. Rousset admits that it was difficult to find investors at the outset, but points out that this segment of the investment universe experienced a great surge in popularity five years later. Up until 2010 at Credit Suisse, the focus was entirely on microfinance; in recent years, the bank started to introduce other impact investment solutions. The bank currently has some 5,000 clients who are invested in impact investment products. Alongside institutional clients such as pension funds, a significant proportion of the client base is made up of private investors. A further expansion of the market is expected as a result of demographic change, as having a positive social and environmental impact is of great importance to younger generations such as millennials.
The long-term growth of the impact investing sector will depend on stable and positive development. "Banks such as Credit Suisse can act as catalysts to develop the industry responsibly, as they not only drive forward the development of products, they might also contribute to a further expansion of the market through corporate responsibility or corporate citizenship activities". Laura Hemrika, Head of Corporate Citizenship & Foundations at Credit Suisse, adds: "Credit Suisse very intentionally focused its corporate citizenship activities on technical assistance and capacity building to strengthen organizations on the ground and overcome the growth bottleneck of lack of management and operational expertise."
Product innovation is an important driver of this fast developing sector, helping to make it accessible to a larger base of clients or investors. As things stand, direct investments are principally the preserve of the most affluent clients. Professor Chu believes the onus is on the banks to structure the corresponding investment products, in addition to providing client advice, essential to explain the financial and social return of impact investing. Clients can invest in funds or structured products which select investees based on their financial and social performance, and then monitor both. Country-specific risks can be reduced by diversifying the mix of products in a portfolio. Solutions of this kind represent an attractive alternative to a direct investment, and come with a lower level of risk.
In 2014, Credit Suisse partnered with Prodigy Finance, an innovative cross-border online lending platform. Together they launched a new fixed-income product i entitled "Higher Education Note 1". Through this medium, talented international students coming mostly from developing countries obtain the loan they need in order to study at top universities, which they otherwise would not be able to attend. Investors earn a financial and social return through their investment in future leaders and higher education. As Rousset points out, once a new product has proven itself in the marketplace and can boast a good track record of performance, it can then be replicated. Credit Suisse has recently issued the Higher Education Notes 5 and 6, for example.
Visionary New Business Models
The dominant area of focus in recent years has been the developing world in particular, but clients in Europe and US also show interest in investments in their domestic markets. For this reason, explains Rousset, Credit Suisse is currently exploring impact investing solutions that finance companies in Switzerland and Europe with a clear social or environmental mission. Professor Chu is also keen to emphasize the possibilities of this market: "There is huge potential in these regions to use commercial platforms as a way of giving less privileged citizens access to services that will improve their quality of life."
Some of the companies in question may only just have been founded, deploying new and "disruptive" business models, says Professor Chu, with the potential to have a significant social and environmental impact. Therefore, risk management is crucial, and banks, together with the help of local specialized partners, have a key role to play.
To succeed, these new models require capital injections, but also skills and know-how, as well as a supportive ecosystem, both of which are often underdeveloped. Laura Hemrika explains that following the introduction of microfinance investment solutions, investment managers often found that potential investees lacked the operational and management expertise needed to scale effectively and responsibly, even if they were to obtain the investment capital, slowing down the growth of the sector: "We realized that, as a bank with a strategic approach to citizenship, we had many of the human and financial resources necessary to play an active role in the development of the market as a whole and of MFIs or other social enterprises on an organizational level. We introduced the Microfinance Capacity Building Initiative to work with pioneering organizations in technical assistance and thought leadership."
A Question of Timing
The MCBI, launched in 2008, seeks to exploit financial and expertise synergies in a systematic way: Philanthropic contributions finance NGO partners, in the relevant regions, that support MFIs and social enterprises in their development and promote innovation. Early-stage financial contributions like these, whether in the form of grants or other forms of "patient capital", are expecting no or a lower financial return and are crucial for helping these companies to develop, thereby creating a solid basis for follow-on investments by, for example, institutional or private clients who are looking for less risk and a higher return.
At the same time, employee engagement is facilitated through programs like the Global Citizens Program, led by the bank's Corporate Citizenship area. Through this program, Credit Suisse employees work directly with close to 75 microfinance institutions as well as fintechs, share their knowledge and build expertise locally, for example in risk management, marketing, HR and IT. According to Rousset, this comprehensive approach is having a very positive effect on the quality of impact investing products, which depends greatly on the stable and positive performance of the underlying companies.
How to Measure Social and Environmental Impact
With impact investing, great importance is attached to reporting on commercial performance and the measurability of social and environmental impact. The impact investing sector has developed a number of different approaches for this in recent years. But as financial institutions and other companies have often chosen to develop their own proprietary approaches, there is still a long way to go before impact measuring can be standardized – a problem that once plagued the measurement of financial ratios. In David Ryan's case, the question is: How to measure the social and environmental impact of his impact investments?
Ultimately, having a direct, positive impact on social and environmental factors is what distinguishes impact investing from other investment strategies. David Ryan laughs as he explains: "Clients and investors get to experience the natural environment and animals they are helping to conserve. This goes way beyond some abstract numbers on paper – it's real."