How impact investing feeds the engine for the sustainability era
Impact investment can stir the soul. The idea of putting your money to work with entrepreneurs who are making the world a better place is deeply appealing, but in truth this is barely half the story. Impact investment is really all about seeking financial returns by tapping into one of the grand themes of this century – it just happens to be a theme defined by our transition to a more sustainable economy.
People used to associate the sector with a glossy image as a quasi-philanthropic venture. These days it is maybe best to think of impact investment as a gateway to new sources of potential return. By building experience and relationships over time in this sector, an investor can gain privileged access to some of the most exciting opportunities on the planet.
We are at a stage where businesses are delivering innovative solutions to some of the most difficult societal problems of our age – from social mobility to the climate crisis – and the market is ready to pay for them. Over the last decade more of those companies have reached a stage where investment makes sense. That’s where we step in, and it is why the sector has shown sharp growth. According to the Global Impact Investing Network (GIIN), the market expanded to more than $500bn as of end-2018.1
So how do you make an impact investment?
First up, you need a network of relationships that can bring opportunities to your door – companies or funds that are aligned with your impact objectives, and which support one or more of the UN Sustainable Development Goals (SDGs). What we do then is drill down into the company and its leadership to stress test its commercial objectives against our target for market rate returns. The bulk of our time is spent on due diligence that establishes the financial viability of companies in addition to the impact returns – positive outcomes for people and the planet are not enough on their own.
The timing of investment is vital. We are not in this to test an idea or bet on a long shot. Impact investment is at its best when a proven idea is given wings. That might be someone selling tech tools to reduce waste in the restaurant industry. It might be a company delivering low-cost education in communities starved of such opportunities. The common thread is that these are people who have found a scalable proposition and who are seeking major investors to help achieve that scale.
One key point often overlooked about impact investment is how integrated the two outcomes are. The innovation driving returns is very often embedded in the positive impact being delivered. If you do the job right as an investor, you create a virtuous cycle, one where the financial returns are wedded to the impact rationale, which in turn drives a profitable business to scale up and deliver more of that positive impact. It is in this powerful combination that we see the most exciting pathways to return.
Take Bridge International Academies, a provider of low-cost schooling in Africa and India. Its goal is to bring affordable, quality education to places where access had been limited to the wealthy. Of course, that sounds great in theory, but sometimes we need to see things swimming to be sure they won’t sink. Part of our job is to find that sweet spot for an impact investment – when the theory becomes practice. In Bridge’s case we invested once schools had been built, when students had been attracted, and when the right technology was in place to drive the business forward. It was a moment when early funding from charities and foundations had created an investable proposition for one of the world’s major asset managers.
All about the base
Scale on the investor side helps too. AXA Investment Managers has had the support of the AXA Group to build years of experience in impact investment across a wide set of sectors and geographies. Why is that so important? Now, as we open-up our impact offering to more clients, that foundation of around 500 end-investments is a rich source of potential partnerships and co-investments. Bridge was one such opportunity that started in a fund and became a direct investment. Simply put, the opportunity set has grown, and we have grown with it.
It is worth pausing to consider why we have seen that expansion in the opportunity set. It might seem obvious that the world is moving to a new era, but without consumer-led change that supports the grand ambitions of politicians and activists, that new era might linger forever on the horizon. Instead, the world is seeing a genuine upswell in grassroots demand for products and services that are grounded in the sustainability mindset.
And it’s hard to see how this will change. Young entrepreneurs leaving college now are steeped in the idea that pathways to profit lie in the low-carbon world, in resource management, in social enterprise. Supply is racing to meet demand, and clued-in asset managers are instrumental in making that happen. The way we see it, the quality of opportunities for investors has never been higher, the ecosystem never larger, and the intellectual work to create new impact ideas is accelerating year by year.
Return and Risk
That evolution means impact investments cover a lot of ground. You might be putting money into a low-margin microfinance lender one minute, and the next, backing a tech company targeting double-digit returns as it helps communities build climate resilience. We seek market-rate returns for each individual investment and in our most recent strategy we are targeting private equity-style returns overall. There is no compromise – we are not more forgiving of an investment because it is making the world a better place. Our ethos is that financially sustainable businesses in turn drive sustainable impact outcomes.
This kind of strategy clearly brings a different risk profile than vanilla equity or bond investing. We back small companies, very often in emerging markets, across currencies and with a skew towards growth equity in private markets. That has one clear implication: the due diligence must be detailed and relentless, continuing through the investment cycle from sourcing to exit – a high-touch engagement strategy that protects value and delivers impact.
One way to mitigate risk is to diversify, and expansion of the market in recent years has made that far easier. When we started out in 2012, we were hunting down good opportunities. Now, the bar has been raised on what we can invest in, while the breadth of the market allows us to spread investment across sources of potential return. We can be agnostic on what stage a business is at – on occasion we have invested in first-time managers and first-time entrepreneurs – but the crucial point is that we can see strong, intentional and scalable impact alongside a clear path to returns.
And that is the fundamental lesson that you quickly learn in this space. Impact Investment is not an altruistic endeavour, if it ever was. It is the financial world’s direct route into the most compelling theme of the 2020s, a decade of transition where innovation and sustainability go hand in hand and where neither impact nor returns need be subject to compromise.