> Posted by Emily Kunz, Financial Inclusion Analyst, CFI
The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.
Impact investing is becoming increasingly alluring. However, anyone who has tried to put their finger on the pulse of this trendy subject has likely been inundated with dense reports focusing on industry minutiae that would take weeks to read. Who has time for this? Not too many it would seem considering that the World Bank recently revealed that a third of the reports it produces have never been downloaded – not even once!
Accordingly, we challenged a team of Credit Suisse Virtual Volunteers (Credit Suisse staff members David Samach, Anne Levonen, and Surender Gounder) to research the world of impact investing – reading industry reports, talking with many of the relevant players, running the numbers – and synthesize this information into a brief and user-friendly overview of the current impact investing landscape.
Too many definitions fuel industry confusion. If you have trouble comfortably committing to one definition for impact investing, you’re not alone. While researching, the Virtual Volunteers identified a fundamental industry issue: there is no universally agreed-upon definition for impact investing. Competing definitions, as well as models and reports that aren’t aligned, continue to fuel misunderstandings about and within the sector. Ultimately though, the Virtual Volunteers proposed defining impact investing as “an investment approach that intentionally seeks to create both financial return and a positive social or environmental impact that is actively measured.”
Most of the money comes from a few players. A wide range of actors currently provide capital for impact investing, from retail investors to pension funds, endowments and foundations to development finance institutions. However, the 2014 GIIN/ J.P. Morgan Spotlight on the Market reported that over 80 percent of impact investments are owned by development finance institutions (managing 42 percent) and fund managers (managing 39 percent). It is interesting to note that, according to the World Economic Forum, development finance institutions only hold a small share of the global capital relative to other sources of capital (e.g. insurance companies and pension fund investor types). This fact indicates tremendous potential for growth if other investors become interested in the sector.
Banks help sustain the industry by providing intermediary services. The Virtual Volunteers identified four key roles played by banks in the sector. First, banks create liquidity; they maintain a constant flow of capital and help match the needs of issuers and investors in terms of maturity, risk, and other factors. Second, banks reduce risk by bearing risk on behalf of investors, transforming risk by spreading and pooling, and allocating assets effectively. Third, banks lower transactional and information costs. And lastly, banks provide payment mechanisms to facilitate settlement of exchanges and to facilitate easy exchange of assets.
To further illustrate this point, the Virtual Volunteers examined Credit Suisse’s impact investment work over the past 10 years. Credit Suisse helped over 4,000 clients allocate over $2 billion dollars to impact investing through various investment vehicles, including responsAbility’s Global Microfinance Fund, the first Fair Trade Fund, and their Capacity Building Initiative.
Debt instruments currently dominate. According to Spotlight on the Market, sixty-two percent of the total capital managed by impact investors is structured as debt (44 percent private debt, 9 percent public debt, 9 percent equity-like debt). Only 24 percent is invested in private equity. It is likely that this balance will shift, however, as existing equity funds reach maturity and standards for the sector become more settled.
Target IRRs vary widely. One of the biggest differences among impact investing funds is their target rate of return. Target rates span a range from near zero to over 20 percent, with a large group, 35 percent of funds, targeting internal rates of return above 20 percent.
Investors indicate increasing interest in areas beyond financial services. To date, impact investment funds have largely focused on financial inclusion, which may not be surprising given microfinance’s established history. At present, 42 percent of all investments are in financial services (more details can be found here). However, the latest GIIN/ J.P. Morgan report indicates that a significant number of funds intend to further increase their investments in other areas in 2014, with the greatest interest in food/agriculture and healthcare (currently at 8 percent and 6 percent respectively).
Taken together, these numbers indicate that the impact investing landscape is likely to change significantly in the next few years. Do you have any predictions on where the industry is heading?
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