Deep impact

Combining an desire to create social value with traditional commercial metrics, impact investing has begun to emerge as an asset class in its own right. Is this shift inspired by a necessary change in how investors are viewed, and how they view their own role in society? Or is it just good business?

From his company headquarters just off Nairobi’s Mombasa Road, Binoy Zachariah, chief executive of Kenya’s Bio Food Products, has just deployed his new mobile milk-processing unit to one of his suppliers.

Even though agriculture remains the largest employer in Kenya by some stretch, the sector as a whole remains relatively under-developed. Infrastructure and storage facilities are poor, particularly in rural areas. The milk-processing unit, which was designed and built by the company itself, is based around a solar-powered refrigerated container that can be taken directly to farmers, chill the milk on site and keep it in hygienic conditions until it can be brought back to the central facility. This way, Bio Food, which provides yoghurt and other dairy products for the retail and hospitality markets, is able to maintain its consistency of quality, but also build the capacity in its supply chain.

“In most of the areas where the farmers are, there are no roads, just tracks,” Zachariah says. “We’ve taken the trouble of going to where the farmers are and trying to work on a scheme whereby by going there, we will be able to interact even more with them, educate them more and try and improve things for them all round, obviously helping ourselves in the process.”

As many social initiatives in the country are, the new outreach programme and the mobile milk truck were partly funded by international capital – but by commercial investors, rather than donor funds. African economies, in particular Kenya, have been attracting considerable attention from private equity and venture capital groups in recent years, and Zachariah had received a dozen approaches, he says. It was the thirteenth that he accepted, from Willow Impact Investors, a boutique investment firm that typifies a new breed of funds who are looking for more than just a financial return on their capital.

Negatively screening investments for religious or ethical reasons is a well-established practice. Shariah-compliant vehicles exclude companies engaged in sectors that are haram, or forbidden under Islamic law, while some secular investors have begun to reduce their exposure to businesses that are seen to have adverse environmental or social effects. This so-called socially responsible investing, or SRI, has been in the mainstream consciousness for several years and has been credited with driving listed companies to embrace more sustainable practice by creating incentives for them to improve their corporate, social and environmental governance.

Though it is difficult to pin it down to a narrow definition, impact investing takes this process a step further, integrating an active desire to create social value with each investment and combining it with traditional commercial metrics. From a relatively nebulous, academic idea with its roots in US philanthropic organisations, impact investing has begun to emerge as an asset class in its own right over the past few years.

In part, its proponents say, the surge in interest has been prompted by a necessary change in how investors are viewed and how they view their own role in society. The financial crises that rolled from country to country at the end of the last decade have left indelible marks on how societies and governments see the financial sector. The economic downturn that followed showed the profound real-world effects that investors’ decisions have, and highlighted the unsustainable nature of nakedly acquisitive market structures and institutions.

The so-called Arab Spring too, which was as much a crisis of economic opportunity among disenfranchised youth as it was a reflection of a desire for political self-determination, serves as a reminder for the custodians of the region’s wealth that society at large must see the benefits of economic growth, through the creation of jobs and the freedom to create and build entrepreneurial businesses.

In Dubai, a trading hub at the pivot of the Middle East, North Africa  and South Asia (MENASA), the region’s challenges are sharply drawn, says Nicolas Farah, one of the co-founders of Willow Impact Investors. The UAE, of which Dubai is a part, had its own financial crisis, prompted in part by the exuberant debt-backed expansion of its real estate sector. UAE companies have also expanded across the region, gaining direct exposure to the political changes that have characterised the last two years.

“You don’t have to have been long in Dubai and travelled the region to see and to understand the pressures of the demographic explosion that the region is going through,” Farah says. “The [MENASA] region is going through tremendous flux, and unless we think about how to harness this change for the better – and there is no better way of doing it than through business – then the prognosis going forward is actually quite a bleak one.”

For all of the scale, scope and potential of its economy, Egypt’s youth unemployment rate hovers at more than 40 per cent. Bangladesh’s booming textile industry has been marked by a string of fatal tragedies, often caused by low safety standards. India, the 10th-largest economy in the world, also has the largest number of people below the poverty line and has seen inequality grow for the past decade.

In the run-up to the financial crisis in the developed world and since, demographic shifts were often touted as one of the region’s most compelling selling points: the vibrant, ambitious young populations surging to cities, consuming and creating. On those terms, the past few years’ turmoil was prefaced by a surge in appetite for investing in emerging markets, which has waxed and waned since, along with sentiment and the availability of liquidity globally.

If these social and demographic changes are going to remain as opportunities instead of becoming further crises, the approach to doing business in the region has to change.

“I think there was a certain revulsion in the way traditional investing had happened up until now, particularly in Dubai which saw a catastrophic falling off the cliff in 2008-2009. People were beginning to wonder whether traditional ways of investing couldn’t be improved upon,” Farah says. “There’s a real imperative when you sit in Dubai, which is that business must go hand-in-hand with economic development if we’re going to create successful businesses for the future.”

JPMorgan Chase and the Global Impact Investing Network (GIIN), a US-based association that convenes practitioners from across the spectrum of investors, from family offices and philanthropic foundations through to commercial asset managers, surveyed investors about the sector in 2012. Their research showed that respondents had committed $8bn to impact investments last year, and forecast an increase to $9bn in 2013. While this is a drop in the ocean compared to the scale of commitments to more traditional investment vehicles, the asset class is growing in strength.

“The universe of players, where the growth is coming from, is really across a fairly broad spectrum,” says Luther Ragin Jr, the CEO of GIIN. “It includes philanthropic players, development-focused players, [and] commercially-focused players, who are finding opportunities that generate social and environmental benefit and generate rates of return around their parameters.”

While those players have different motivations and mandates, two-thirds of those surveyed last year said they expect a market rate of financial returns with their impact investments. Even so, until the asset class has built a long track record of success, there will be a continued question mark over whether, and how much, the burden of ensuring social return weighs on more commercial factors.

“The essence of impact investing is taking your social return as seriously as your financial return, and not having any tradeoff between the two,” says Stewart Langdon, partner at Leapfrog Investments, which specialises in investments in financial inclusion in the developing world. “That would have been a very easy mistake for the impact investment community to make.”

Echoing other impact investors, Langdon says that the methods that they and their portfolio companies employ can be a commercial differentiator in difficult markets. Just as Bio Food mitigates its supply chain risk by taking an active role in developing its partners, impact investors who improve their investees’ corporate governance practices and human resource development help to mitigate some of the most pressing social and political risks that exist in frontier markets. Meanwhile, focusing specifically on low-income communities and individuals can open up huge opportunities at the so-called ‘bottom of the pyramid’.

“What you’re going to see over the course of the 21st century... is billions of people moving out of poverty in Africa and Asia and joining the consuming classes,” Langdon says. “We see that as really one of the greatest market opportunities that has ever existed. We don’t see this as a purely social activity. We think it makes financial sense to capture that customer, to give him the tools he needs to climb out of poverty and continue serving him into the future. We think that’s a great way to build profitable business.”

Healthy returns

A small private facility in the heart of the Kenyan capital, Nairobi Women’s Hospital (NWH) boasted a modest 56 beds when it was approached by an investment fund in late 2009. The Africa Health Fund (AHF), which had been established earlier that year by the Abraaj Group, the Bill & Melinda Gates Foundation and a number of other investors, injected capital that has since allowed the hospital to expand to more than 220 beds.

The AHF is configured to invest in businesses while ensuring that at least 50 per cent of the people who use their products and services come from the ‘base of the pyramid’ (BOP), the largest but poorest socioeconomic group that comprises 4 billion people who exist on less than $3000, in local purchasing power, per annum. At NWH, which specialises in maternity and paediatrics, and offers medical and surgical wards for both male and female patients, regular studies are conducted to ascertain the percentage of people from the BOP who are actually using its services. According to the hospital’s latest figures, 63 per cent of patients fall under the BOP banner.

“There are three areas one can target in terms of approaching the BOP: access, quality and affordability,” says Shakir Merali, manager of the AHF. “Access means increasing the availability of services where once they didn’t exist. Quality is about ensuring this is availed at a level of quality that is, certainly at a clinical level, as good as anywhere else in the world. Affordability is around payment, and reducing the price point of these services.”

Access has been boosted through the establishing of a 24-hour outpatient centre, as well as the opening of clinics in densely populated urban areas of Nairobi, where the majority of residents are classified as BOP. Improvements in the quality of services and care are reflected in the hospital’s infant mortality rate, which now compares favourably to some Western nations including Canada. And while revenues have more than doubled over the period since the AHF became involved, NWH is committed to ensuring that BOP patients are still able to afford treatment.

“In terms of price, we don’t pretend that our fund is set up to solve the problem of poverty in Africa: we are looking to invest in businesses that are making a profit from the provision of healthcare,” says Merali. “However, we try and price ourselves below the market rate of larger hospitals, and have some innovative pricing schemes as well, in order to reduce the burden on those paying for the services.”

Three and a half years after the AHF first injected funds into NWH, another investor has approached the hospital with a view to providing additional capital worth four times the AHF’s initial outlay. And while such interest would indicate a successful private equity engagement on behalf of Merali and his team, the AHF is determined to continue its efforts to cleanse the hospital entirely of the systemic weaknesses that stem from its days as a small-scale healthcare provider.

“There are difficulties ranging from issues with management, governance processes, cash haemorrhage, and fraud, to not being able to capture the information and statistics we want and need,” admits Merali. “It takes a while to be able to lock off all these areas, and it’s a process of evolution until the hospital becomes world-class. It’s far from being as successful as we want it to be, so there is plenty of work for us still to do.”