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Six questions about impact investing

June 05, 2012

Mitchell L. Strauss, Special Advisor Socially Responsible FinanceBy: Mitchell L. Strauss, Special Advisor Socially Responsible Finance

Investors are increasingly talking about “Impact Investing,” but the practice is not new to OPIC, which has a 40-year history of transforming private capital into solutions for common social and environmental challenges around the world. This Q&A explains the concept of Impact Investing, and why it offers the potential for such strong financial returns.

Last fall, OPIC announced a “historic commitment” to impact investing when it approved $285 million in funding for six impact investing funds: Explain the concept of impact investing.

Impact investing is the practice of targeting and delivering social and environmental impact to emerging markets while also generating a financial return.Six Young Children Smiling

OPIC catalyzes support for impact investing through financing and insurance to companies that invest in developing nations. Our projects help address some of the world’s toughest problems such as access to education, finance, housing, water and sanitation and health care, as well as climate change.

OPIC has a 40-year history of investing with impact, and today, OPIC is continuing to innovate with new products and services to support impact investing. We have so far committed to six investment funds approving $285 million of financing which will catalyze $875 million in investments. The historic funding commitment we announced last fall was the result of an unprecedented response to our call. Some 83 groups – including 63 funds, seven funds-of-funds, and 18 debt and microfinance vehicles – submitted proposals in response. We are working on more proposals which we will announce soon.

Ultimately, the goal is to see the industry provide risk-adjusted returns that will attract greater numbers of commercial investors. An Impact Investment needs to be able to stand on its own in the market, so impact fund managers need to keep refining their proposals until they get a foot in the door of established investment houses.

This sounds a little bit like socially responsible investing. What is the difference?

Impact investing builds on the foundation of socially responsible investing (SRI), but it goes much further in attempting to achieve social benefits. SRI focuses on channeling investments into publicly-traded assets that are screened for corporate governance, human and worker rights, and environmental standards. Impact investing seeks to place capital in projects that not only are screened for these standards but are designed to deliver social or environmental benefits along with financial return. It is basically a more proactive form of SRI.

Increasingly, investors are holding their investments to a higher standard: in addition to ensuring that they do no harm, they want to see that they are making a positive social contribution. SRI still represents only a small fraction of worldwide capital but more and more investors and entrepreneurs are finding ways to transform their capital into answers for our common social challenges.

Offer one or two examples of an impact investing project that OPIC has backed and explain how the project was designed to create a profit for investors.

One example would be OPIC’s loan to Husk Power (pictured), a small startup company in India that is building a series of small power plants that generate power from discarded rice husks. These plants are providing light and electricity to remote villages located off the electricity grid, using a byproduct of a food that is a staple of the Indian diet. Husk, a company started by two Indian-American entrepreneurs, says that these power plants have had numerous positive impacts, from providing the light for children to do their homework to providing the electricity to support other entrepreneurial activity.

OPIC has also provided three loans to Living Water International, a nonprofit devoted to implementing community-based clean water drilling projects throughout the developing world. Nearly 90% of all diseases in the world are cause by unsafe drinking water and inadequate sanitation, resulting in more than 2.2 million deaths each year. The OPIC loan helped Living Water to drill about 150 wells in Kenya, more than 200 wells in Ghana.

This type of work sounds like the sort that is often addressed through aid rather than investment. Besides the obvious financial advantages of profit-focused investments, are there other benefits of addressing some tough world development challenges through an impact investment framework?

We know that access to capital for businesses and pressing human needs worldwide is a huge challenge. We also know that development dollars available worldwide are very small in relation to the trillions in global financial markets. Investing has the potential to have a much greater impact than aid dollars can.

The key is to develop investment pools with qualified managers who see the opportunity in all of these sectors and are willing to engage businesses at all levels of the pyramid. We will find sustainable solutions when the international community assists local banks, small and large investors, and businesses to create jobs fueled by domestic and international capital. This can go much further than non-sustainable aid funding in raising people up and decreasing conflict.

How risky are such investments and how can OPIC help mitigate the risk?

OPIC provides risk mitigation with political risk insurance as well as regulatory risk products. OPIC can also provide a full loan guaranty on portions of larger financing vehicles.

OPIC provides these after a full analysis of project risks. Generally OPIC has found that when project participants are capable; structures, financial and social/environmental returns are sound; and the risk is appropriately shared by qualified parties, then the overall risk to the investor is less. After reviewing the insurance and guarantee descriptions on the OPIC website, a call to OPIC is the best way to determine how OPIC can tailor a custom solution to risk mitigation.

The financial engineering of risks and returns in impact investing is becoming more sophisticated. If an investor or fund manager is serious about a long term commitment to impact investing, he/she needs to think strategically about how to use a full range of instruments – insurance, guarantees, and derivatives — to mitigate risks.

What do you see for the future of the impact sector?

Corporations will increasingly look for ways to improve supply chains and reach the billions of people at the bottom of the pyramid as customers. International financial institutions will work together to support impact sector financing vehicles to make financing available for the missing middle, between the commercial banks and microfinance.

Capable, honest managers will develop long-term investment capital funds. The funds will receive a wide range of investments from individuals to pension plans and will provide local currency capital for portfolios of investments to help solve the world’s critical social infrastructure problems. These funds will make debt and equity investments in local businesses and in some cases will be evergreen in addition to being sustainable.

With the mobilization of capital and the diversification of risk across the world, investors will be more able to address some of our most urgent needs in the developing world, from infrastructure to impact sectors like education, healthcare, housing, sanitation and water.


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