The Practice of Impact Investing
The World Economic Forum’s report, From Ideas to Practice, Pilots to Strategy, is a collection of articles that offer concrete approaches and actionable insights for professionals interested in engaging more with impact investments.
The Overseas Private Investment Corporation (OPIC) is the US government’s development finance institution. Working exclusively with the private sector for more than 40 years, OPIC mobilizes private capital to help solve critical development challenges in emerging markets. With a portfolio of $18 billion and operating in more than 100 countries, OPIC achieves its mission by providing investors with debt financing, guarantees, political risk insurance, and support for private equity funds.
In recent years, OPIC has made it a priority to support impact investing through requests for impact investing fund proposals; new product development to address specific market gaps and needs; and identifying and highlighting impact investments in its portfolio.
In 2012, we set out to determine how much of OPIC’s business met the strictest definition of impact investing: investments with partners whose very business models aim to address social or environmental problems while generating sustainable financial returns. We conducted a full review and “tagging” process of our portfolio to apply this test to each of our investments, and found that determining intent was often subjective and not always clear-cut. Knowing this, we first identified OPIC commitments in sectors whose investors tend to be socially motivated, such as agriculture, health, education, renewable energy, finance, housing for the poor, and water and sanitation.
From there, each individual investment was examined against the intentionality test to identify those investments that were specifically intended to bring positive social impact alongside financial sustainability. The review revealed that of OPIC’s $3.6 billion in financing and insurance committed in 2012, $333 million qualified as impact investments. This same methodology was applied to OPIC’s commitments going back to 2008, ultimately identifying 129 impact investment projects over the five-year period totalling $2.4 billion in commitments.
IMPACT INVESTMENTS V. INVESTMENTS WITH IMPACT
All OPIC transactions aim to have development impact, but not all are tagged as impact investments. Two examples illustrate the distinction
Tagged as an OPIC impact investment: MicroEnergy Credits (MEC)
OPIC committed a US$10 million loan to MEC for the development of carbon credit programs. Low-income populations’ access to clean energy products, such as clean stoves for cooking and heating, water purifiers and solar lighting, will be made easier and more affordable through this loan that directly links the purchase of those products to the generation of carbon credits. MEC is an environment-and-social-first investor that qualified as an impact investor through OPIC’s tagging process.
Not tagged as an OPIC impact investment, despite being an excellent venture: Sante GMT (Sante)
OPIC provided a US$10 million loan to Sante, the largest dairy and juice production facility in Georgia. The loan enabled the company to improve milk production and distribution, with 20 new milk collection centers throughout the country and strong local job creation. Sante has had a powerful development impact; however, according to our definition, it did not qualify as an impact investment because it was undertaken strictly as an economic venture.
Lessons Learned from OPIC’s Portfolio Review
- Identify and adhere to the industry’s standard definition for impact investing—investments with intent to address social or environmental problems while generating sustainable financial returns
- Create a process to assess and document the intent behind each investment
- Do not underestimate how difficult it will be to draw a line between those investments that had social and financial intent at the outset, and those that did not have this dual intentionality
- Value quality over quantity (To truly understand this sector and its role in a portfolio, it is better to have an inventory of truly impact investments than a large number of investments that fall in a grey area.)
- Develop a methodology that tracks the performance of each financial instrument
- Do not expect financial return data right away (We sought to determine if our impact investing portfolio performed differently than the rest of our portfolio; however, we were unable to draw clear conclusions as most of OPIC’s financing and guarantees, while commercially priced, have long tenors, often with multi-year grace periods. Since few of these investments have come due, it is not yet possible to determine if this portfolio is performing differently relative to OPIC’s wider portfolio of assets.)
OPIC Impact Investment Tools
In response to the needs of the impact investment sector, and to address the gaps in the sector, OPIC tailors its range of financial and insurance products to support impact investing.
Impact investing equity funds: In 2011, OPIC issued a request for proposals for impact- investing funds. In response, 88 groups—including 63 funds, 7 “funds-of-funds,” and 18 debt and microfinance vehicles—submitted proposals. The result was a historic commitment to impact investing, as OPIC approved $285 million in funding for six impact investing funds, which are expected to catalyse $875 million in investments.
Example: Sarona Frontier Markets Fund 2, LP (Sarona). Sarona, a fund-of-funds, is targeting funds that invest in frontier countries with per capita GDP of less than $12,000, and in sectors such as water, healthcare, education, access to finance and sustainable agriculture.
- Fixed-income notes for impact investors: OPIC issues fixed- and floating-rate notes to eligible investors and portfolio managers seeking to fill socially responsible investing or impact investing portfolio allocations that meet the impact investing test. These notes carry the full faith and credit of the United States, have maturities of 1 to 20 years and are priced at the relevant US Treasury note plus a small spread.
- Working capital: In many cases, we found that OPIC’s standard project finance is not well suited to the impact investment sector. Many innovative impact investing businesses are distributing retail products for low-income households, such as single-home power sources, LED lights or cookstoves. These businesses primarily need working capital to finance the growth in inventories, but working capital finance is new to many OPIC origination and credit teams. We have since been developing guidelines to enable the institution to offer working capital finance.
Financial intermediary facilities: OPIC provides financing and political risk insurance to financial intermediaries that lend to the impact investment sector. OPIC can leverage the outreach and track record of proven performers, which increases access to capital in various impact sectors through a portfolio approach.
Example: Grassroots Business Fund (GBF). GBF provides financing and business advice to for-profit companies that have a strong commitment to bringing measurable and sustainable social and economic impact. GBF uses a $20 million OPIC loan to invest in high-impact businesses in Latin America, Africa, and Asia. With its two complementary vehicles, a private investment fund and a non-profit organization, GBF expects to invest in 40 to 50 businesses over the next five years, providing economic opportunity for millions of people.
Example: Global Partnerships. OPIC is investing up to $15 million in the Global Partnerships Social Investment Fund 5.0, which works to expand opportunity for people living in poverty in the Latin America and Caribbean region. Global Partnerships provides loans to social enterprises, as well as microfinance investment vehicles that combine financial support with other non-financial services such as health care, education, or training.
Early-stage equity capital and co-investment opportunities—aligned capital: Most investments need different types of capital at different stages of the investment life cycle. Many impact investments that OPIC has reviewed have required early-stage grant or equity capital to cover operating losses or to establish proof-of-concept and make the project financeable. On the other hand, an early-stage risk capital provider may need access to larger amounts of capital to scale up its successful project. Philanthropic capital is a solution here; it can be invested in a way that catalyses DFIs, which in turn catalyse commercial capital, creating a powerful leverage effect. As OPIC has neither an equity nor a grant instrument, we have partnered with grant and equity investors who wanted to benefit from OPIC’s origination and due-diligence capabilities by investing alongside us.
Example: Portfolio for Impact (Pi). Pi is a new initiative to increase OPIC support for smaller, highly developmental and innovative early-stage companies in the impact investment space. This platform represents a response to the growing demand for OPIC to provide financing that supports the scaling-up of socially-oriented enterprises. OPIC will underwrite deals of up to $5 million and create a portfolio of up to $50 million over two years. Consistent with OPIC’s interest in aligning different types of capital, Pi will present co-investment opportunities for other socially-minded investors in a more efficient manner, and serve as an important bridge between philanthropic and private capital.
Example: Rockefeller Foundation partnership. In a collaboration supported by the World Economic Forum’s Global Agenda Council on Social Innovation, OPIC is entering into a partnership with the Rockefeller Foundation to co-invest in impact investments globally, combining the Foundation’s programme-related investment capability with OPIC's origination, due-diligence and debt-financing capabilities. The partnership aims to create an innovation in process, whereby the two parties—and more parties in the future—can collaborate on and co-invest in impact investments that each institution would otherwise not have been able to consider on its own.
Political risk insurance for impact investors: OPIC offers insurance products that significantly mitigate specific risks posed to impact investors in developing countries. Political risk insurance offers protection against losses to tangible assets, investment value and earnings that result from political perils in 150 developing countries. Without this insurance, potentially impactful investment may not take place.
Example: MicroVest Capital Management LLC (MicroVest). OPIC provides political risk insurance on loans made by investment funds managed by MicroVest to microfinance institutions throughout the developing world. OPIC can also provide insurance against changes in government regulations (e.g. changes in interest rate caps for microfinance institutions).
Next Steps for the Impact Investment Sector
- Clarify the definition of success. The impact investing field urgently needs common definitions and clarity about expectations, by investment instrument, of both social and financial return. The sector should strive to compile good information to demonstrate a track record across the range of investment products with a full spectrum of financial, social and environmental returns. This data gathering can more clearly situate impact investing in relation to corporate social responsibility and socially responsible investing.
- Align different types of capital to grow and support investment-ready enterprises.
- Work with development finance institutions. They are powerful bridges, providing the financing and risk mitigants that remove barriers to allocating capital for impact investments.
- Beware of overpromising. While the impact investment sector has the potential to be truly transformational, it is in its early stages and will take many years of slow, hard work to deliver on its promise. We must be careful not to let expectations get ahead of reality and need to be both optimistic and realistic, pushing hard and aiming high, but also nurturing the sector with patience.