Impact investing turns out to be a sustainable business

Fence-sitters, naysayers, and doubting Thomases amongst investors who always sought proof that impact investing – investments made with the intent of generating environmental and social benefit alongside a financial return – is worthwhile and profi table can now write out their cheques without losing sleep.

The first ever global analysis, covering data from 1998 to 2010, on the financial performance of private equity and venture capital impact investing funds has busted the widely held assumption that investors who part with money for impact get only concessionary or muted rate of returns. The analysis — Introducing the Impact Investing Benchmark 2015 — conducted by Cambridge Associates, a US-based investment advisory, and the Global Impact Investing Network (GIIN), a non-profit impact advocacy, has caused quite a stir amongst the investing fraternity. The hard evidence proffered is beginning to change the nature of the debate.

Generous Returns

The findings indicate that impact investment funds can return as much as conventional or mainstream funds and that, on same parameters, the returns can be even better. The impact funds (51 funds with total fund assets of $ 6.4 billion) in the study have posted a net internal rate of return (IRR) of 6.9% as of June 30, 2014 as against 8.1% for a comparative universe of nonimpact investment funds (705 funds with total fund assets of $293 billion.)

It’s even better for ‘emerging market’ impact funds. They have returned 9.1% to investors compared with 4.8% for ‘developed market’ impact investment funds. “Many often perceived impact investing as philanthropy in a new avatar,” says Amit Bhatia, CEO, of the New Delhi-based Impact Investors Council, an industry regulatory body. “This analysis proves that impact investing is indeed a sustainable business.” He also points to the exceptional performance of smaller impact funds in the benchmark.

Impact funds that raised under a $100 million returned a net IRR of 9.5% to investors. These funds outperformed similar sized funds in the comparative universe (4.5%). (Impact funds over $100 million though yielded returns of 6.2% compared with 8.3% in the case of similar-sized funds in the comparative universe.)
The revelations have come as a booster shot to the impact investing fraternity as the hype around this space had waned lately given the huge excitement surrounding the new darling of investors — e-commerce.

However, despite the talk and buzz around impact, the amounts invested in India were rather modest. Only around $1.6 billion had been invested in 220 social or impact enterprises from 2000 to 2014, according to a 2014 Intellecap study. And 70% of the total investments were in microfinance and financial inclusion. In the Cambridge-GIIN study too, over a quarter of impact fund capital is focused on financial services sector, largely microfinance.
The returns during the study years are not consistent. The pooled IRR of impact funds for the years 1998-2001 was 15. 6% compared with 5.5% for the comparative universe in the same period. It then goes downhill (see Impact Funds Vs...) Much of the performance in the more recent years of the study is unrealised.
Even so, investors believe the first credible and comprehensive attempt at data crunching in the sector augurs well for the future. “It (findings) is not as bad as everyone thought it would be,” says Vineet Rai, CEO & MD, Aavishkaar.

Rai’s impact advisory and fund management company has launched over five funds in a decade and a half. It has 51 investments in 44 companies deploying $89 million. Total exits stand at 19. Aavishkaar I, one of his earlier funds with 23 investments, has seen 15 exits with a gross IRR of 12-47% (excluding writeoffs and exits at discount).

It’s in line with the generally held belief that impact investing in India fetched a return of 12% or so. Impact investors, the true-blue ones, also walk a tight rope. They are mindful of going overboard in the rush for returns as dealing with the underprivileged sections of society has its own complexities. Rai indicates that windfall returns would attract moral hazards. “The taint of exploiting the vulnerable is never far,” he says.

Almost coinciding with the impact benchmark study, McKinsey, the global consultancy, in June 2015 released a study on the performance of Indian private equity (PE.) The PE performance revelations are jarring in the context of impact performance.

The gross returns on PE exits have dropped to 7% after 2008; it was around 21% until 2007. Amit Bhatia likes to highlight the fact that Indian PE returns dropped to zero in 2009 and that it has been hovering around 7-8% in recent years.

The McKinsey finding, in a way, is another fi llip to the impact sector. “Businesses can have a heart and do well,” Bhatia insists. “Impact investing is a sustainable industry and we are here to stay.”

Long Road Ahead

Both Rai and Bhatia, though elated by the GIIN findings, are also cautious. They know for certain that it is a long haul and it will take a while for the Indian impact market to establish.

Bhatia thinks it’s about time policymakers take note of the trends and lend a helping hand by according impact investing its rightful space in the policy domain by classifying it as a distinct asset class, as in the US and UK. “We also need to do much more work by creating companies that matter, create and demonstrate value,” explains Rai.

For the present, will the GIIN benchmark revelations help the impact sector raise capital with more ease than before? Hopefully, fence-sitters will note the new evidence and enter the impact waters.

Raising capital, in a hard-nosed business environment, boils down to returns, regardless of the intent of the investment. Vineet Rai should know as he is in the process of raising a $300 million fund. Now, if sacrificing returns are not asked of investors, things may begin to look up.

“If an investor in a social enterprise, addressing a deep societal challenge, can hope to get returns similar to investments in tobacco, for instance, where would he or she put his money,” asks Bhatia. “What would make him or her feel better?”