Since philanthropy blogger Lucy Bernholz pronounced “impact investing” a buzzword of 2009, the idea that investment capital can be used to generate both a financial profit and a social benefit has drawn the attention of more and more institutional investors. Without a doubt, whether impact investments are a new asset class or simply a new source of philanthropic capital in the face of shrinking government coffers, they are gaining recognition as a legitimate use for at least some of investors’ money.
Of course, the impact investment industry is still young; there is much to be learned and the universe of active funds is still relatively small. But recent surveys have begun to reveal details about the industry, including where investment capital comes from, how investments are identified and how investments are ultimately used. According to one report, the majority of institutional asset owners’ investments go through fund intermediaries – funds skilled at selecting assets capable of returning blended value.1
According to the results of several other surveys, it appears that a large portion of North America’s impact investments remain inside the continent. That is, available data suggest that impact investments are unevenly distributed as compared with need, and that assets are disproportionately directed to domestic organizations and companies.
Impact investments stay on the continent
In 2011, GIIN and J.P. Morgan conducted a landmark survey in which they analyzed more than 2,200 impact investment transactions. The respondents to the survey were organizations, funds and banks, at least 75% of whom were based in the U.S. or Canada. When asked for the destinations of their past investments, the respondents reported that $2.1 billion USD – 51% of their total impact investment dollars – had gone to projects in the U.S. or Canada. Forty-four percent had gone to projects in emerging markets.
Other data echo the finding that U.S. and Canadian impact investments tend to stay disproportionately within the continent. For example, a study by FSG Social Impact Advisors found that United States-based foundations engaged in mission investing place more than 95% of these investments in U.S.-based investees.2 A project by the Center for Financial Inclusion at ACCION found that the U.S. is significantly behind European counterparts Switzerland, Luxembourg and the Netherlands in making international impact investments.3
As one Canadian impact investor I spoke with confirmed, “There aren’t many institutional investors from Canada investing in emerging and frontier markets.” He explained that some are dabbling in the BRIC countries, “but they are not engaging more widely.”
Perhaps the tendency for U.S. and Canadian impact investors to keep their money close to home is not surprising. And, it may not depend entirely on the investors – after all, many rely on intermediaries to facilitate deals. But investment capital that stays close to home may be falling short of its full potential to generate the maximum profit while making the maximum impact.
Maximizing profit, maximizing impact
Most of the world’s poor – the people who live on less than $2 a day – live in low- and middle-income countries such as India, China, Pakistan, Nigeria and Indonesia.4 It is in these countries, where the economy is still developing, that the greatest number of people at the “bottom of the pyramid” reside. Accordingly, these countries house the opportunity to make the greatest impact on social challenges associated with poverty.
Developing economies may also be home to the best financial opportunities. Some experts have opined that organizations and companies working in developing countries are better at returning blended value than organizations and companies in advanced industrial nations such as the U.S. and Canada. According to a 2011 Responsible Research report, “emerging and frontier markets (EFM) often show higher and more stable GDP growth projections than developed countries.”5
Over the three years preceding that report, emerging and frontier markets in Asia and Africa performed more strongly than developed economies. Researchers reported that “it is in the countries where there is growing urgency to find sustainable solutions to poverty and the lack of basic services such as healthcare and education, environmental degradation and other areas of social and environmental need that the opportunities exist for impact investors.”
According to a 2010 report by J.P. Morgan, the capital needs of base-of-the-pyramid investors in the areas of urban housing, clean water for rural communities, maternal health and primary education over the next ten years are at least $224 billion USD. The minimum anticipated profit from investing in just those four issue areas? Over $182 billion USD.6
Why investors are afraid to go abroad
Given the increased interest in impact investing among North American institutions, the need for social impact and the potential profit in developing economies, why aren’t more of North America’s impact investing dollars going to projects in India, China and other developing countries? While research on this question does not provide all the answers, a few themes have become apparent.
Transaction costs are greater in emerging markets
One obvious challenge lies in the simple fact of geography. If an intermediary’s management team is located in New York or Vancouver, it is naturally more expensive for that team to find, vet and monitor an investee working in Vietnam than an investee in North America. Distance, language, culture, and regulatory differences all drive up the transaction costs for each deal that takes place across national borders. In addition, according to the Ease of Doing Business Index, it is more difficult to do business in emerging and frontier markets than it is in the U.S. or Canada. This further raises both transaction costs and risk.7 Add the legal and regulatory issues associated with investing abroad, and it is easy to see why some investors see staying home as an attractive option.
Investors want the big deals
It is the institutional investors – such as pension funds, endowments and insurance companies – that control most of the world’s investment capital. Because these investors are generally handling enormous amounts of capital, they are also looking for places to invest large amount of that capital. As the CIO of Acumen Fund has explained, “For most funds, the transaction costs of any [investment] less than $500,000 become hard to justify.”8 Larger markets that can support larger deals may therefore be more attractive to institutions, particularly as compared with smaller frontier markets.
Investors perceive developing economies as riskier
Finally, regardless of whether it is true, the belief that emerging and frontier markets carry increased risk deters investments in them. As Serge LeVert-Chiasson, Senior Partner and the COO of Canadian impact investing firm Sarona Asset Management, explained in a recent interview, “institutional investors perceive emerging and frontier markets to be risky. Many institutional investors have never set foot outside of North America and Europe, so when they look at Africa they see poverty-stricken economies. In fact, nothing could be further from the truth. Most economists will tell you that seven out of the ten fastest-growing economies in the next decade will be in Africa.”
Are investors missing out?
While impact investors’ concerns about emerging and frontier markets are understandable, it may be unwise to neglect these opportunities for long. Doing so means leaving both money and impact on the table… and what impact investor wants to do that?
Anne Andrews Juntunen is a legal strategy consultant and 2011 LGT Venture Philanthropy Fellow currently based in Toronto, Canada.