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Symposium 2013

Proposal - Stimulating the entrepreneurs’ economy with private (impactful) equity

The Challenge

Social investing refers to the investment of private capital in organizations that create a direct, intended and measurable social impact while also generating a financial return. Social investors are ...

Social investing refers to the investment of private capital in organizations that create a direct, intended and measurable social impact while also generating a financial return. Social investors are to date primarily focused on social enterprises working towards the delivery of many essential services in developing countries (e.g. health, sanitation, education, access to financial services). Investment opportunities in developed market economies are relatively limited in comparison. Recent innovative financial instruments such as the "Social Impact Bonds" that were first launched in the UK in 2010 have, however, opened up new and exciting possibilities for investing in a broader range of social purpose organizations. These instruments are constructed as public-private partnerships and can help to raise additional finance to tackle social challenges ranging from youth unemployment to catering to the needs of an ageing population. They are evidence of an increasingly diverse mix of social investment opportunities available to investors. With policymakers, investors and social purpose organizations becoming ever more interested in exploring the potential of social investment there is need for a better understanding of the specific financing gaps that social investments can fill and the implications for existing financing steams in the social sector.

The most direct and scalable impact investment is through private equity and private debt, and should join the arsenal of alternative investments as a portfolio diversifier.

Less than $40 billion in capital has been committed to impact investments globally, according to a World Economic Forum report published in late September[1]. In a world awash with capital, this seems disproportionately small. So what is the solution to growing this sector and reaching the optimistic market projections of impact investing reaching $500b-$1 trillion by 2020 (keeping in mind this is just 1% of global managed assets)? By identifying impact investing as the latest alternative investment, highlighting its potential as a low-correlated portfolio diversifier and developing it into a recognised asset class, impact can be both monetised and commoditised. Specifically, focusing on private equity and private debt opportunities will stimulate the entrepreneurs’ economy, generating the most direct and scalable investments with the greatest impact.

According to Bain & Company, today’s financial flows are creating unsustainable pockets of excess capital in certain regions while simultaneously cutting off access in others where risk premiums are prohibitively high[2] (i.e. investing in BoP SMEs). This has been caused by the rapid increase in the global volume of financial assets without a parallel increase in the global output of goods and services, which has slowed over recent decades. Nowhere is this mismatch more clear, and more imperative to be addressed than in social enterprises—social mission driven organizations which apply market-based strategies to achieve a social purpose. The abundance of capital can be realigned with the impact investing sector by channelling private equity, private debt, and venture capital funds directly into growing these businesses and championing companies finding profitable, scalable solutions around health, energy, and sustainable development at home and abroad. Indeed as the Bain report points out, the most attractive growth opportunities this decade will require patient capital, a certain degree of risk appetite, and a proximity to and familiarity with the generators of the winning ideas.

How do we get there? Asset allocations have shifted from the early days of 60-40 equity-fixed income split that comprised the bulk of portfolios. Today’s portfolios use more sophisticated instruments with both strategic and tactical allocations. Fixed income and cash allocations remain elevated in portfolios today around 30-40%, but private equity, hedge funds, commodities and real estate now join listed equities in developed and emerging markets to offer investors more attractive, inflation-protected, less volatile returns across different horizons. Impact investing should be flagged as a relevant alternative asset or sub-asset class with the same portfolio benefits. To increase flows into the sector it should be understood first by wealth managers, then marketed as such. According to the WEF report, while 80% of US-based pension fund managers are familiar with impact investing, only 9% felt that it is a viable investment approach[3].

While most of the efforts of impact investing have been focused on emerging markets and least developed countries, Europe is awash with opportunity as loan growth to both households and corporates on the continent is still at low levels compared to pre-recession levels. Providing credit to SMEs at home addresses the most pressing needs in our backyard, and tapping the PE opportunities in sectors targeted for growth—like domestically focused companies in manufacturing, health care, financials, and housing. Correlations are coming down again after elevated levels since 2008—this bodes positively for active managers and for flows into equities, public and private.

And indeed, following largely flat and directionless years in private equity since 2010, the market is taking a turn. Credit markets have rebounded, the debt market has been strong, and mergers and acquisitions have picked up. 2013 looks like it will finish with stronger than expected PE returns which is perfect for young asset owners: entrepreneur crowdfunding platform iCrowd surveyed investors with over $1 million in investable assets or individual annual income exceeding $200,000 and found that private equity is key in the 18-29 year olds’ portfolios, significantly more than for older investors[4]. Young accredited investors allocate less than 30% of their portfolio to public equities (versus 48% for baby boomers); 49% is in private placements and angel investing, compared with 21% for 45-60 year olds. 18-29 year olds have allocated 7% to both private equity and hedge funds, in comparison with their senior counterparts, who have allocated only 4% and 2% respectively to the same asset classes[5]. These trends are promising and indicate that a fundamental shift in thinking is under way.

So, if the most direct and scalable impact investment is through private equity and private debt, the global financial system should be equipped to transfer capital to startups and SMEs enabling solutions to social and environmental problems. Equipping the market with the right tools like sectoral research, platforms connecting buy and sell side, legal frameworks is a good start.  Relationship managers and financial advisors must be equipped with this knowledge as well: and, in a survey conducted for more than 4,000 US-based HNWs, 50% claimed that their advisers did not recommend impact investment products even though 48% of respondents claimed that they are interested in these opportunities[6].

Embedding impact-driven financial investing as an asset class available to mainstream investors and in global portfolios will stimulate the entrepreneurs’ economy. The financial system that can identify and fund these opportunities will change the global shape of capital markets. It will identify and endow the winning enterprises, dedicated to social capital markets, and nurture the impact economy. Bain suggests that the larger financial institutions, like pensions, endowments, and sovereign wealth funds could use their resources and networks to act as idea or portfolio incubators, using the example of pharmaceutical companies who foster drug development[7].

The expectation by many is that the investment supply-demand balance is shifting and will continue to shift to address these mismatches. In a capital-abundant world, “investors’ success will be determined less by how much money they command than by their ability to spot an investment’s true value creation potential and act on it nimbly[8].” So well-networked, well-marketed, well-thought-out, and certainly well-positioned social enterprises will have the leg up in this environment, with ideas worth funding. The winners will have the luxury to pick and choose among investors that can add the greatest value, keen to enable the entrepreneurs’ economy.



[1] http://www3.weforum.org/docs/WEF_II_FromMarginsMainstream_Report_2013.pdf

[2] http://www.bain.com/publications/articles/a-world-awash-in-money.aspx

[3] http://www3.weforum.org/docs/WEF_II_FromMarginsMainstream_Report_2013.pdf

[4] http://www.reuters.com/article/2013/08/21/ny-icrowd-survey-idUSnPNNY67151+1e0+PRN20130821

[5] Ibid.

[6] http://www.hopeconsulting.us/work/money-for-good

[7] www.bain.com/publications/business-insights/eight-great-macro-trends.aspx

[8] http://www.bain.com/publications/articles/a-world-awash-in-money.aspx

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