There is a growing consensus that capitalism needs to be re-imagined. In the hunt for profits with purpose, impact investing is starting to gain traction globally and in South Africa.
Is it possible to create a measurable societal benefit that yields not just brownie points, but financial returns too? Yes, say a growing number of impact investors. Sustainable investing is on the rise, with companies seeking to create a positive impact, while still generating a healthy financial return. Underlying this philosophy is the belief that private capital is critical to tackling the world’s most pressing problems – poverty, climate change, social injustice, and more.
The global mindset of millennials is a huge factor, according to a report by the Economist’s Intelligence Unit titled ‘Motivated by impact: a new generation seek to make their mark’. According to the report, 87% of millennials believe that business success should be measured by more than just financial performance and 93% believe that social impact is key to their investing decisions. In their entrepreneurial and philanthropic pursuits, they are seeking to marry profit with purpose, and they are motivated by the size of their impact and their ability to measure it.
More than two-thirds of existing impact investments have been made into emerging markets such as South Africa and India. One example of how this works is Prodigy Finance, a UK-South African company that offers loans to postgraduate students who struggle to get funding for high-priced MBAs in the world’s top business schools. Students pay the loan back at 7%, plus a 2% fee; three-quarters of the students are from developing countries. Investors get financial returns of around 5,5% that compensate for the risk, as well as the satisfaction of knowing that they helped fund the next generation of leaders.
The International Finance Corporation (IFC) defines impact investing as ‘investing with the intent to contribute to measurable positive social, economic and environmental impact alongside financial returns’.
‘This is different to socially responsible (SR) and environmental, social and governance (ESG) investing which only applies screening criteria to investments, such as not investing in tobacco products, for example,’ says Lize Lubbe, principal at Phatisa, a sector-specific fund manager operating across sub-Saharan Africa. ‘The key differentiator with impact investment is the active intent to generate a positive impact.’
South Africa is one of the most unequal nations in the world, she says, pointing out that the public sector and donor community can no longer be solely responsible for solving this problem. ‘Private sector companies should also start rolling up their sleeves and become more involved. Impact investing can be a tool to unlock private capital for social and environmental change. Additionally, South Africa has also woken up to the devastating impact of climate change, especially on our agricultural sector. It is starting to become impossible to ignore these issues and not change our investment philosophies.’
Elias Masilela, chairman of Impact Investing South Africa (IISA), says interest in impact investing in South Africa is being fuelled by growing socio-economic imbalances, poor economic growth, high rates of unemployment, deepening poverty and gaping inequalities. ‘Impact investing is the private sector’s response to these challenges. In addition, growing uncertainty about policy response and implementation is also a contributing factor. In its desperateness to offer a solution, the ruling party, the ANC, presented asset prescription, which was met with wide scepticism and discomfort by capital owners and allocators – in particular, pension funds. The institution driving impact investing, Impact Investing South Africa (IISA), has offered this initiative as an alternative to asset prescription.’
Masilela believes impact investing will gain better traction as it is private sector driven and will most likely yield better returns. ‘Impact investing aims to conscientise the private sector about its role in leading investing to drive development and close social gaps. This echoes the principles underlying global social development goals – inequality being the biggest risk for capital and the existence of government as we know them today.’
Why is it great for South Africa?
Impact investing is directed at solving the world’s main social and environmental challenges. The UN’s global social development goals for 2030, an ambitious blueprint for a world without poverty or inequality, have become a guideline to initiate, drive and measure impact. There is, however, still a $2,5 trillion annual funding gap to achieve these goals, which can be bridged through partnerships between public, private and donor funders. ‘South Africa has a myriad of social and environmental issues that can be solved through impact investing into the SDGs,’ says Lubbe.
How does impact investing work?
A 2017 global investor survey by Schroders found that 81% of South African investors reported sustainable investment growing in importance to them in recent years. Financial returns for impact investing can be in line with traditional investing, differentiating it from philanthropy. It includes a wide spectrum of returns, from more patient to risk-adjusted market-related returns. Instruments cover the full continuum, including grants, debt and equity, and everything in between, also referred to as ‘blended capital’. Investments can be made into businesses ranging from very early to later, more established stages.
Rushil Vallabh, managing director of Secha Capital, which provides patient capital for African SMEs, says more conversations are happening about purposeful, impact investing. ‘At Secha Capital, our impact lens is job creation and that determines our approach, as well as the measurement metrics we use to report. We have designed our investing process and principles to balance job creation and financial returns. Secha is built on a holding company model, a permanent capital vehicle, focusing on SMEs (the largest job creators) with hands-on operational support for each SME, ensuring skills transfer and long-term business sustainability.’
For South Africa in particular, impact investing can be used as a tool to systemise the process around addressing the country’s social challenges, while proving to investors that you don’t have to sacrifice financial returns for social good. ‘It changes the narrative around grants, aid and CSI funding, making it more purposeful, rather than simply being a corporate box-ticking exercise,’ says Vallabh. ‘South Africa also has well-developed financial markets and governance processes. We have a relatively good ease of doing business score and so, having more impact investing opportunities allows foreign investment to flow in alongside local capital.’
He stresses that South Africa needs to address historical biases as well as current inequality gaps that exist and hinder economic growth. ‘Having a purposeful, mission-driven investing objective helps tackle those challenges. At Secha, most of our capital has gone to black and/or female entrepreneurs. It helps to have a diverse team that can bring in diverse ideas, and the group effort helps us understand markets that each of us individually may not necessarily be able to tap into.’
Who should get involved?
Impact investing is here to stay. Everyone can participate in this movement to bring about positive social and environmental change, bequeathing to future generations a legacy of investors who are driven by values that are impact-centred and who work towards a greater good.
‘Those in charge of capital, whether it is public, private or donor funding, can catalyse the change by developing themselves and unlocking capital,’ says Lubbe. ‘Those involved in investment management can develop fund managers to include impact as part of their DNA. Those that form part of the great ecosystem, whether it be universities or industry bodies, can work to build sufficient capacity to support this model.’
The impact movement under IISA is open to all private sector participants, institutional and individual asset owners and allocators. ‘Government, as policy setter, participates to ensure that the requisite investment environment is provided and guaranteed,’ Masilela says. ‘It is essential that the broadest participation is realised to achieve the scale required to have impact on the economy. IISA is actively engaged to conscientise and publicise the important role of impact and broad participation.’
Lubbe’s vision is to create large-scale impact investments on the African continent through the work she does every day. Phatisa subscribes to the pursuit of the UN’s sustainable development goals of no poverty, zero hunger, gender equality and decent work and economic growth. Its African Agriculture Fund (AAF) has invested more than R3,5 billion in entrepreneurs across the continent and has created large-scale impact in food and agriculture. Lubbe has played a key role in the African Agriculture Fund, which has delivered 2,6 million tons of food and food-related products and supports more than 9 000 permanent jobs and more than 78 000 small-scale farmers and entrepreneurs in rural communities from investment to date.
At home, in a previous role, she led the innovation and implementation of South Africa’s first Uber owner-driver financing scheme. ‘We worked with one of South Africa’s big four banks to reinvent their credit scoring system to be based on the Uber driver data and not their credit history. We leveraged the Uber technology to enable drivers who did not have a sufficient credit record to qualify for affordable vehicle finance. Consequently, drivers could create their own micro-enterprise through ownership. The project had the capacity to create 1 000 jobs and increase the income of these drivers by up to 300% to 400%.’
Secha Capital is concluding the pilot phase of an impact investing model specific to the African continent. ‘We have raised a small “fund” to test a new model for private equity in Africa,’ says Vallabh. Our dual mandate is to create jobs and have private equity-like financial returns. Thus, we invest in SMEs looking to scale their businesses but get stuck in the “missing middle”, too big for start-up funding, but too small for debt/private equity funding. We have built our model to solve the top three pain points of SMEs: access to finance (we provide unrestricted growth capital); management talent (we support entrepreneurs on a day-to-day basis and second interns to work with the management teams); and market access (we leverage the Secha “fly-wheel” to open up channels across the portfolio).’
To date, Secha has invested in six SMEs and created more than 50 sustainable jobs. Each of the companies is growing revenue and increasing profit margin, proving the company’s ability to balance financial and social return. ‘We are in the process of raising Fund 2, which will build on the pilot phase and be able to implement this model at scale. Fund 2 will invest in 40 SMEs and will bring in younger investment professionals to help scale these enterprises. Our investment partner, Caleo Capital, has seen the success of the model and is committing to following on their support and investment into Fund 2.’
Vallabh cites Rush Nutrition, a health food business, as one of the successes. ‘We worked daily for nine months with the founder, Lara Maré, to help scale the business, creating jobs at the factory and in sales, while increasing access to healthy nutrition products for people,’ he says. ‘Our investors understand the impact model and are willing to provide patient capital to create positive impact outcomes alongside financial returns. Thus far, we have invested in six companies, all creating jobs and growing steadily.’
Urbika, an estate developed by Similan, a specialist residential property developer focused on residential developments for the middle-income market, is a development that showcases the ethos of ‘green’ impact investing. The eclectic demographics of its tenants is testament to the company’s success in developing inclusive communities of residents. A key feature of the estate, aside from the urban design and landscaping, is the sustained 100% collections on all rentals.
Urbika’s EDGE certification makes it a future-proofed investment which will not only see average energy cost savings of between 30% to 50% but currently exceeds the requirements for South African National Standards (SANS).
‘Even though we face widely publicised challenges with regards to the various levels of government who are responsible for creating a healthy environment for viable development impact funding, we are considered one of the most progressive countries in terms of legislation, especially where construction, banking and housing are concerned,’ says Harold Spies, CEO of Similan.
While it’s still early days for the IISA, Masilela says it is instructive to record the relationship built with the Presidential Investment Summit, which has acknowledged the importance of impact investing. ‘This partnership has had immense impact in informing private sector expectations and behaviour,’ he says. ‘This is critical for long-term behavioural change. Further, South Africa has been tasked with the driving the continental initiative and has representation at the Global GSG Board. More importantly, we will be hosting the 2020 GSG Impact Summit in Johannesburg from 9 to 11 September. The summit is an annual, impact investment conference that convenes stakeholders with the objective of increasing global awareness and realising a tipping point for the impact investing within the host’s geography. South Africa will be the fifth country to host the event.
With Millennials expressing the explicit intent to solve pressing social and environmental problems, impact investing could have real-world impact and bring big financial returns. As it becomes more mainstream, the focus will be on setting higher standards. However, the success of this type of financial innovation might just make our shared future a more positive one.
What are the current challenges?
- Unlocking the capital – Capital providers do not yet understand impact investing fully and are not yet allocating sufficient capital to this asset class and to catalyse the right change.
- Investing for impact – A new generation of asset managers, with impact investing as part of their DNA as well as a solid foundation to invest in the right impact opportunities, needs to be developed.
- Creating a conducive ecosystem – The investment ecosystem needs much investment and support from stakeholders – such as government, industry bodies, universities and service providers – to build sufficient capacity to support an impact investing framework.
- Systemising and measuring impact – There are various frameworks and reporting measures being used, but no global standard. How, as an investor, can you compare investment opportunities on an apples-to-apples basis?
- Education – There is insufficient education around impact investing and where it fits within the investment landscape. Does it fall more towards the pure financial markets or more towards the CSI market? The breadth of impact investing models makes it difficult to bucket it into one or the other. However, new models are being developed and it set to soon become its own asset class.