Responsible Investing (part III) : what really make a difference ?

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Impact Investing Direct investment in (not-listed) SMEs : are we inventing the

« social private-equity » ?

Xavier Heude [email protected]

Version - March, 2014

mailto:[email protected]

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1.0 - SRI negative screening (bad actors) ban certain activities … Return OR Impact 2.0 - ESG policies positive screening (good actors) choose the best in class … Return AND Impact 3.0 - Shared value Get positive impact being financially profitable … Return FROM Impact

EVOLUTION in the Sustainable Investment case

In the light of the dominance of capitalistic socio-economic models in our societies – and the lack of credible alternatives

the challenges of sustainability can only be overcome

if they are integrated into market logic

“How the SRI industry has failed to respond to people who want to invest with conscience.” Paul Hawken (Natural Capital in 2004)

« An unconventional perspective on Impact Investing » - 2011

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The scope of challenges facing society today can no longer be solved with a purely philanthropic approach : - threat of possible climate change - poverty leading to major political instability - human rights issues - supply change management (e.g. food security) - scarcity of primary resources - demographic challenges - etc …

The socio-economic context

Bamboo workshop (Vietnam) – copyright Xavier Heude

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Improve society Generate profit Drive innovation Produce goods and services

Enhance livelihoods

Enable progress Drive efficiency Exchange goods and services

Create wealth

Primary purpose of business … according to the Millennial Generation (% of survey respondents)

Source : Deloitte 2013 Nearly 7,800 participants from 28 countries across Western Europe, North America, Latin America, BRICS and Asia-Pacific about business, government and innovation

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Discover how to invest with difference on :

www.mesoimpactfinance.com

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http://www.mesoimpactfinance.co/


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The popular assumption that impact investing involves a trade-off between financial gain and social impact is wrong …

Unless this positive correlation is evident, any investment with a social goal is simply philanthropy

Clean technologies have paved the way : the benefits for society and financial profitability are so closely interwoven in the business model that one cannot be separated from the other

=> the origin of an investment decision should be the judgement of a business model that happens to include a given social impact

Financial return is not assessed in isolation from the risks taken => why assess investment performance separately from social and environmental sustainability ??

« An unconventional perspective on Impact Investing » - 2011

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True impact investing has 4 key-characteristics : - profit as an objective - a positive correlation between the intended social impact and the financial return of that investment - an intentional, pre-determined social impact - a result that produces a net positive & measurable change to society

Ambition of impact investing is to justify the investment case (investment decision is based on a holistic assessment of business objectives, including their social and environmental impact)

- how it could be integrated in the investment decision ? - how it could be monitored ? - the only difference between impact investing and traditional investing is in the

intentional measurability of non-financial impact

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If impact investing has not yet become a genuine asset class, it is primarily because it has failed to define its industry standards, and impact metrics are these standards’ centre of gravity

Attempts to come up with standardised, comparable and transparent measures have so far failed because of this lack of homogeneity in the expected purpose of metrics for various stakeholders In order to be a meaningful expression of achieved impact : - KPIs need to be closely tied to the activity’s characteristics - Individuality, however, defies comparability of KPIs, which is the expectation of investors who seek to compare impact-related investment performance

=> it is more important for impact to be measurable than how impact measurement is actually done

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Social Business (Yunus’s definition) - business model that does not strive to maximize profits … - … but rather to serve humanity’s most pressive needs - aims at solving social problems with products and services at affordable prices (education, health, technology access, environment)

company’s dividend behaviour is not a feature that determines whether or not a business is an impact business

flexibility of different share classes (privileged dividend rights vs. waive of rights)

- only original investments are paid back - all profits are reinvested (no dividends) - workforce is professional and paid according to market wages - losses must not incur, in order to be sustainable

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Impact investing (Wikipedia’s definition) - practice of assessing not only the financial return on investment - … but also the social and environmental impacts of the investment that happen in the

course of the operations of the business and the consumption of the product or service which the business creates

- take an active role mentoring or leading the growth of the company - similar to the way a venture capital firm assists in the growth of an early-stage company

(Monitor Institute’s definition) - actively placing capital in businesses and funds that generate social and/or environmental

good and at least return nominal principal to the investor - equity, debt, working capital lines of credit, and loan guarantees

Forms of Impact Investing microfinance, community development finance, clean technology investments …

(IESE Business School’s definition) Any profit-seeking investment activity that intentionally generates measurable benefits for the society

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Impact investors can be broadly classified into 2 groups based on their primary objective :

• Impact first investors, who seek to optimize social or environmental impact

with a floor for financial returns - primarily aim is to generate social or environmental good - investors are often willing to give up some financial return if they have to

• Financial first investors, who seek to optimize financial returns with a floor

for social or environmental impact - typically commercial investors who seek out subsectors that offer market-rate returns while achieving some social or environmental good

13 Derived from Monitor Institute

Rational behavior

Emotional behavior

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Moving beyond Socially Responsible Investment

The market should be driven by : • Prominent family offices : executing investments to address a range of challenges (climate

change, poverty …)

• Clients of leading private banks : calling on their investment managers to provide them with more choices than just traditional investment and pure philanthropy

• Private foundations : making investments in areas related to their social mission

• Private equity funds : aiming to provide growth capital profitably to businesses

• Mutual funds : dedicating a portion of their assets to emerging companies committed to

generating social and environmental value

• Pension funds and sovereign wealth funds : using their substantial resources to deploy capital in ways that benefit the communities they serve

• Corporations : finding ways to materially improve the lives of the poor while creating products and services that generate a profit

• Governments : investing in funds that support economic development in poor areas

Source : Monitor Institute

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• the pull of more values driven consumer behavior, combined with the push of current and expected regulatory incentives and mandates

• A steadily developing track-record with early successes in community development, microfinance, and clean-tech attracting broader interest

• A flock of talent interested in careers in this space, creating a next generation of leaders

Opportunities

• Lack of efficient intermediation (high search and transaction costs caused by fragmented demand & supply ; complex deals ; lack of understanding of risk) lack of impact investing opportunities into which large amounts of capital can be placed at investors’ required rates of return

• Market being still organised around a clear divide between philanthropy (for impact) and investment (for returns)

• Lack of reliable social metrics makes the suspected trade-off between financial and social

benefits even harder to address

Challenges

Source : Monitor Institute

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168 funds identified

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Microfinance Impact funds

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Raising opportunities of long-term value creation

for investors

and beneficiaries in rural areas

For reasons of confidentiality, the identity of some business-cases may not released

Rural finance gap and the missing middle

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Investment targets

Microfinance

Medium to large companies

SMEs

Profile : - startups - going concerns

Investment needs : 200.000 to 2.000.000 €

Mesofinance (the missing middle)

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The approach …

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Business-case : Empowerment of the rural communities in the Philippines, with developing a competitive national milk industry,

Key-success factors in this project : 1) Animal sourcing and crossbreeding : the capacity to set up a scalable livestock 2) Training, monitoring and coaching of the farmers (= microfinance techniques) 3) Export sales

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Small-hold farmer (Aug. 2012, Philippines)

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Dairy plant Philippines

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major NEGATIVE weighting major POSITIVE weighting

LEGAL Corp. management Strong management / business skills

Mission statement Clear written mission statementStakeholders relation Strong relations with local actorsStakeholders adherence Slow process of knowledge acquisition with

the small-hold farmers

OPERATINGProduction capacity Flexible, scalable

MODELOrganisational structure Proven procedures manual, monitoring tools, MIS

Innovation & Dvlpt Good command of technology

HR management Jobs creation (SH farmers) an assistance

Training, internal communication, incentives …

MARKET Customers Customers diversification

Clear payment policy

& COMPETITIONQuality / Reputation Good products quality and diversification

Strong products & services advantages and few

shortcomings

Market and climate Unsecured breeding during monsoon season

(?)

Large-sized market with steady growth

Competition Promotion and advertisement to intensify (?) Weak competition so far (not concentrated market)

FINANCE Financial statements Sound financial projections

Insurance Livestock not insured so far (no competitive

offer vs. mortality rate)

SOCIAL & ENVIRONMENTAL INITIATIVESLocal development Good to high social / environmental impact along the

supply-chainLobbying and awards Local dialogue, intense networking

Unofficial recognition

PROJECT’S SCORING

Score : 3,11 / 4

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Financing & technical assistance to saving/credit cooperatives, rural banks, NGOs, SMEs 1,7 mio. end-beneficiaries around

Business-case : Finance company in the Philippines, serving loans to socially responsible driven MFIs

End-beneficiaries (Aug. 2012, Philippines)

major NEGATIVE weighting major POSITIVE weighting

LEGAL Corp. management Strong management / business skills

Mission statement Clear written mission statementStakeholders Strong relations with local actors

OPERATINGOrganisational structure Proven procedures manual, monitoring tools, MIS

MODELInnovation & Dvlpt Good command of technology

HR management Jobs creation

Training, annual assessment, incentives …

Internal communication, code of conduct …

MARKET Customer Customers diversification

Clear payment policy

& COMPETITIONQuality / Reputation Good products quality and diversification

Strong products & services advantages vs. medium

shortcomings

Market Medium-sized market with steady growth

Competition Interest rates being under pressure due

to the growing competition

Good sales (and promotion ?) strategy

FINANCE Financial statements Sound financial projections

Insurance Culture of risk

External factors Government support to the microfinance sector

SOCIAL & ENVIRONMENTAL INITIATIVESInternal / external initiatives Good to high social / environmental impact

Local dialogue, social / environmental lobbying

Score : 3,60 / 4

PROJECT’S SCORING

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Philippines

NPFC, Manilla (2011) - Credit to around 300 SMEs in 2014 - Finance company - Investment : 350 K€ in shares – lock-up 5 years

Yield : 10% gross / year

Investment

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NPFC’s philosophy

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In the Philippines, upper-range loan in microfinance is around 50.000 PHP (less than 1.000 €) NPFC grant loans in a range from 50.000 PHP to 2.500.000 PHP (less than 50.000 €)

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NPFC clients (March 2014)

Manufacturing of spare parts for the automotive industry

Studio of massages performed by blinded masseurs

Manufacturing of hand-crafted decorative items

Score : 3,44 / 4 major NEGATIVE weighting major POSITIVE weighting

LEGAL Company's history 3 years only …

Corp. management Strong management & business skills

Mission statement Clear written mission statement

Stakeholders relation Good (still to expand)

OPERATINGOperational capacity Flexible, scalable

MODEL Organisational structure Policies, risk management (still to reinforce),

reporting, full integrated MIS expected soon …

Innovation & Dvlpt NPFC's strength

HR management Several employees with a banking background ,

training and incentives

MARKET Customers Customers diversification, clients' rights

& COMPETITION Quality / Reputation High-valuable products & client monitoring

Market Medium market's size that could expand with

economic growth ; good sales & promotion strategy

Competition Competition might loom up on the long term

(?)

Weak competition so far

FINANCE Financial statements Sound financial statements & projections

Insurance No public liability insurance policy (not

required by law in the Philippines)

SOCIAL & ENVIRONMENTAL INITIATIVESLocal development Good to high social / environmental impact

Supply chain Social / environmental specifications along the supply-

chain

External factors Favourable regulations from the government for

SMEs

PROJECT’S SCORING

NPFC offices August 2013, Philippines

NPFC Shareholders’ meeting - March 2014

NPFC Capacity Building session - March 2014

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Overview and principles

A methodology applicable whatever : • the location (worldwide) • the activity (industry – agriculture – services) • the business development’s step (start-up – going concern)

Appraisal process :

1. a conventional Due Diligence-process (101 questions) 2. a scoring system 3. a risk-management audit framework (30 to 60 questions)

Impact Investment processing :

4 steps

Monitoring process :

• social-environmental KPIs (Key Performance Indicators) • a technical assistance plan (applicable on a case by case basis)

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1. A conventional

Due Diligence approach

Corporate overview Operating Model

Market - Competition

Financial statements

Social – Environmental Initiatives

An in-depth analysis … (101 questions)

Financial return

Social- environmental

return

Check … tracking risk (4 categories)

Operational

Reputation

Financial

Legal

Operational

Reputation

Financial

Legal

Operational

Reputation Financial

Legal

Operational

Reputation

Financial

Legal Clear strategic

vision

50 50

Value analysis in Impact Investing

(extract from the Due .Dil. check-list)

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2. A scoring system Ranking of notes

Weighting system : 3 scales of notation

Weighted notes Risk’s intensity

Feature of the case / situation

appraised

Scales of notes

N (negative) Average

to High

Case / asset / situation making neither compromise nor significant advantage, whatever it occurs. Negative to neutral impact (at best)

- 5 1 2 = should be the case to reach

D (double sided)

High to Low

Case / asset / situation having negative or positive advantage, depending on the action taken

- 5 1 2 3 4

P (positive) Average

to Low

Case / asset / situation having neutral to positive advantage (can never be negative)

3 4 = minimum requirement to

reach

1 2 3 4

Poor Very good Satisfactory Below

standard

Neutral

- 5

Significant warning !

(average note)

3. Closing of analysis

• A risk-management audit Findings are classified below under 5 parts : - governance risk - operational risk - IT and physical risk - credit risk - ALM (asset & liability management)

• A validation by the Investment Committee Covenants … ?

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4. Investment set-up

• Private placement memorandum (private bond) Private investors from Retail (mini. 5000 €) to “sophisticated” investors (+50.000 €) Institutional investors Investment companies, family-offices … Foundations

• Portfolio of +1 million € invested in 3 to 4 projects (2014) Philippines sector-based diversification : finance, agri-business, energy … Target net return 5% per annum

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• JEREMIE (Joint European Resources for Micro to Medium Enterprises) : EU Structural Funds to finance small and medium-sized enterprises (SMEs) by means of equity, loans or guarantees. It operates through selected financial intermediaries

Set up in 1994 to help small businesses :

European Venture Philanthropy Association. Established in 2004 Network of venture philanthropy organisations and others committed to promoting high-engagement philanthropy in Europe Diverse membership (+150 members from 19 countries) : - venture philanthropy funds - grant-making foundations - private equity firms and professional service firms - philanthropy advisors - business schools

74 European organisations specifically identified as impact investors (EUROSIF)

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Vocation to support SMEs and microfinance institutions • Series of financial instruments designed to expand already existing

organisations or to help companies to set up in business : - Equity and quasi-equity stake - Long-term loans - Guarantees • Capacity Building Fund : BIO provides grants to co-finance feasibility

studies and technical assistance programmes • Support of technical assistance programmes upon request of the

investee companies in order to improve performance

Germany's leading development bank , with the Federal Ministry for Economic Cooperation and Development (BMZ), as a main client. Funds allocated from the federal budget, for the promotion of developing countries + additional resources raised on the capital markets Finance programmes and projects : - purely from federal budget funds (grants and loans) - mixture of federal budget funds and KfW funds (development loans) - loans at near-market conditions from pure KfW funds

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Founded in 1980 (USA) Named, created and pioneered the global field of social entrepreneurship

Philosophy : founded on the premise that the most effective way to promote positive social change is to invest in social entrepreneurs with innovative solutions that are sustainable and replicable, both nationally and globally

Established programs in over 60 countries and supports the work of nearly 3000 Fellows

Support Social Entrepreneurs - identifying / investing in leading social entrepreneurs and helping them

achieve maximum social impact

Promote Group Entrepreneurship - facilitating collaborations and knowledge sharing

Build Sector Infrastructure - helping close the historical gap between the business and civil society - creating important avenues for integration and synergy between both

communities

Global Impact Investing Ratings System

Comprehensive and transparent system for assessing the social and environmental impact of companies and funds Ratings and analytics approach analogous to Morningstar investment ranking

Ensuring success means measuring for success

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(EuSEF)

Benefits of this approach Social businesses will get easier access to private finance, helping support their growth. This will benefit many ordinary citizens: creating inclusive and sustainable jobs and growth across Europe. Professional investors will find it easier to identify and choose funds that are targeting investments in social businesses (European Social Entrepreneurship Funds). Investment fund managers will find it less costly and complex to raise funds, including cross-border

A recognised EU brand for social entrepreneurship funds: Funds that market themselves using this brand would have to invest at least 70% of their money in social businesses Improved investor information Each European Social Entrepreneurship Fund would have to provide key information to investors in a standardised way Break down barriers to fundraising across Europe: European Social Entrepreneurship Funds will also act as a passport

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Peter Blom, CEO "Profit is not an objective in itself"

Stay close to the real economy; hold a direct relation to what you invest in

Reappraise the role of money and its place in the economy

Banking to make a positive impact

Services : - Banking services - Fund management - Project development - Investment management - Venture capital funds - Corporate finance - Private banking

Geographic focus : Western Europe and emerging economies

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Investment criteria

http://www.gls.de/javasc

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Principles of Ethical Finance : • ethically oriented finance is aware of non-economic consequences of economic

actions • access to finance, in all its forms, is a human right • profit produced by the ownership and exchange of money must come from

activities oriented towards common well-being and shall have to be equally distributed among all subjects which contribute to its realisation

• maximum transparency of all operations is one of the main conditions of all ethical finance activities

• the active involvement of shareholders and savers in the company's decision making process must be encouraged

//upload.wikimedia.org/wikipedia/fr/6/6f/Logo_banca_popolare_etica.gif

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rémunération annuelle de 0,70 % au lieu de 0,90 % pour un compte d’épargne traditionnel

Association sans but lucratif (1995) ayant pour objet de promouvoir des financements alternatifs et de réfléchir au développement de l’argent éthique

Over a 3-year period, SEIIF is intended to raise USD 100 million, which will be invested in debt and equity investments deemed to have relatively low-risk and high-impact.

It is not only a moral impetus that is driving socially responsible investment. The potential for financial returns has made it an attractive proposition for an increasing number of banks and corporates.

Managed by Symbiotics and advised by Oxfam GB

How does SEIIF work? Fund structure / Key terms • Registered as an open ended mutual fund in Luxembourg, in the form of a SICAV-SIF • 5-year lock up period, followed by quarterly exit opportunities, for each investor • Invests in a portfolio of debt and equity instruments • Aims at a low-risk, high-impact profile, with a target net return of 5% per annum

SEIIF targets “the missing middle” - the financing gap for small enterprises - by investing in a variety of local financial intermediaries focusing on small enterprise development

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The 4 golden rules

1st rule : Scarcity lies in the good investment opportunities, not in the investment flow

- Secure the projects sourcing, with building strong networks - Maintain strict due-diligence standards

2nd rule : Dialogue with the business owner / stakeholders never stops

- Share common values (not just check professional skills & financial projections) - Cross-check information steadily

3rd rule : Emotion is – in a certain extent – part of the decision-making process to invest

- Tell the story and report thoroughly - Get investors involved …

4th rule : But … at the end of the day, financial performance comes first

- No philanthropy 68

Lessons learned

Barriers to Impact Investing

Motivations for Impact Investing

500 wealth managers, private banks, family offices and HNWIs (between April-June 2012)

70 Source : Monitor Institute

A nascent industry … Impact Investing may have reached a transitional moment in its evolution : poised to exit its initial phase of uncoordinated innovation … ?

?

71 Source : Monitor Institute

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Socially investing : a wide offer

basic SRI funds - actions / bonds

- theme funds : water, renewable energies …

« Alternative » social investment - micro-finance/insurance -impact investing

- revenue-sharing funds (fonds de partage)

Philanthropy - contact with projects / CSOs - set up of suitable invest. vehicule

Low / medium

level of social

engagement

Medium /

high level

of social

engagement

Ultra-high level

of social

engagement

To each customer’s expectation … A SPECIFIC FINANCIAL SOLUTION

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The scope of challenges facing society today can no longer be solved with a purely philanthropic approach (capital accessible through fundraising for philanthropic activities is in no way sufficient to address all the local issues in society) : - threat of possible climate change, as well as poverty leading to major political instability,

human rights issues in supply - change management, the scarcity of primary resources, and demographic challenges

In the light of the dominance of capitalistic socio-economic models in our societies – and the lack of credible alternatives

the challenges of sustainability can only be overcome

if they are integrated into market logic

The “Missing Middle”, SME financing needs

Source : International Finance Corporation, The SME Banking Knowledge Guide”, 2010.

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Investor Relations

Responsible Investing (part III) : what really make a difference ?