Responsible Investing (part III) : what really make a difference ?

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Responsible Investing is a process in which the Environmental, Social and Governance (ESG) criteria are taken into account along with the usual financial criteria.

Part I deals with listed RI (SRI funds and stocks) : Is it still a credible alternative against the mainstream ?

Part II deals with microfinance.

Part III deals with impact investing, as direct investment in not-listed companies

The author, Xavier Heude has been entirely dedicated to the development of Responsible Finance by the mean of promoting Impact Investing, mainly. He is convinced that Private and Institutional investors are growingly interested in putting some part of their money in business activities or projects where they can themselves follow up the financial performance, and last but not least, the social and environmental outcomes generated.
He is Co-founder of meso IMPACT Finance, a Luxembourg-based holding company aimed at taking stakes in SMEs that generate a social and environmental (measurable) impact. MIF helps them develop through a financial and extra-financial support (i.e. technical assistance).
He is also Délégué Général of SAKURA Initiative, a Luxembourg-based not-for-profit organisation promoting social and responsible practices in the economic and financial sector, through various means such as conferences and communication.

Xavier Heude founded also the “PEERS Direct Investment” – registered trademark in 2011, after having stated for many years, that there are still quite few incentives and operational frameworks and guidelines allowing and encouraging a large public to invest in socially responsible business activities or to support valuable social initiatives.
A network is being built, in order to contribute to expand the mark and get it known worldwide.

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Responsible Investing (part III) : what really make a difference ?

  1. 1. 1 Impact Investing Direct investment in not-listed companies : a way to address social and environmental issues ? Xavier Heude xh@peersdirectinvestment.com 2nd update - March, 2015
  2. 2. 2 1.0 - SRI negative screening (bad actors)  ban certain activities … Return OR Impact 2.0 - ESG policies positive screening (good actors)  choose the best in class … Return AND Impact 3.0 - Shared value Get positive impact being financially profitable … Return FROM Impact EVOLUTION in the Sustainable Investment case In the light of the dominance of capitalistic socio-economic models in our societies – and the lack of credible alternatives the challenges of sustainability can only be overcome if they are integrated into market logic “How the SRI industry has failed to respond to people who want to invest with conscience.” Paul Hawken (Natural Capital in 2004) « An unconventional perspective on Impact Investing » - 2011
  3. 3. 3 The scope of challenges facing society today can no longer be solved with a purely philanthropic approach : - threat of possible climate change - poverty leading to major political instability - human rights issues - supply change management (e.g. food security) - scarcity of primary resources - demographic challenges - etc … The socio-economic context Bamboo workshop (Vietnam) – copyright Xavier Heude
  4. 4. 0 5 10 15 20 25 30 35 40 Improvesociety Generateprofit Drive innovation Produce goods and services Enhance livelihoods Enable progress Drive efficiency Exchange goods and services Create wealth Primary purpose of business … according to the Millennial Generation (% of survey respondents) Source : Deloitte 2013 Nearly 7,800 participants from 28 countries across Western Europe, North America, Latin America, BRICS and Asia-Pacific about business, government and innovation
  5. 5. Interrelation of initiatives
  6. 6. 6
  7. 7. 7
  8. 8. 8 The popular assumption that impact investing involves a trade-off between financial gain and social impact is wrong … Unless this positive correlation is evident, any investment with a social goal is simply philanthropy Clean technologies have paved the way : the benefits for society and financial profitability are so closely interwoven in the business model that one cannot be separated from the other => the origin of an investment decision should be the judgement of a business model that happens to include a given social impact Financial return is not assessed in isolation from the risks taken => why assess investment performance separately from social and environmental sustainability ?? « An unconventional perspective on Impact Investing » - 2011
  9. 9. 9 True impact investing has 4 key-characteristics : - profit as an objective - a positive correlation between the intended social impact and the financial return of that investment - an intentional, pre-determined social impact - a result that produces a net positive & measurable change to society Ambition of impact investing is to justify the investment case (investment decision is based on a holistic assessment of business objectives, including their social and environmental impact) - how it could be integrated in the investment decision ? - how it could be monitored ? - the only difference between impact investing and traditional investing is in the intentional measurability of non-financial impact
  10. 10. 10 If impact investing has not yet become a genuine asset class, it is primarily because it has failed to define its industry standards, and impact metrics are these standards’ centre of gravity Attempts to come up with standardised, comparable and transparent measures have so far failed because of this lack of homogeneity in the expected purpose of metrics for various stakeholders In order to be a meaningful expression of achieved impact : - KPIs need to be closely tied to the activity’s characteristics - Individuality, however, defies comparability of KPIs, which is the expectation of investors who seek to compare impact-related investment performance => it is more important for impact to be measurable than how impact measurement is actually done
  11. 11. 11 Social Business (Yunus’s definition) - business model that does not strive to maximize profits … - … but rather to serve humanity’s most pressive needs - aims at solving social problems with products and services at affordable prices (education, health, technology access, environment)  company’s dividend behaviour is not a feature that determines whether or not a business is an impact business  flexibility of different share classes (privileged dividend rights vs. waive of rights) - only original investments are paid back - all profits are reinvested (no dividends) - workforce is professional and paid according to market wages - losses must not incur, in order to be sustainable
  12. 12. 12 Impact investing (Wikipedia’s definition) - practice of assessing not only the financial return on investment - … but also the social and environmental impacts of the investment that happen in the course of the operations of the business and the consumption of the product or service which the business creates - take an active role mentoring or leading the growth of the company - similar to the way a venture capital firm assists in the growth of an early-stage company (Monitor Institute’s definition) - actively placing capital in businesses and funds that generate social and/or environmental good and at least return nominal principal to the investor - equity, debt, working capital lines of credit, and loan guarantees Forms of Impact Investing microfinance, community development finance, clean technology investments … (IESE Business School’s definition) Any profit-seeking investment activity that intentionally generates measurable benefits for the society
  13. 13. 13 Impact investors can be broadly classified into 2 groups based on their primary objective : • Impact first investors, who seek to optimize social or environmental impact with a floor for financial returns - primarily aim is to generate social or environmental good - investors are often willing to give up some financial return if they have to • Financial first investors, who seek to optimize financial returns with a floor for social or environmental impact - typically commercial investors who seek out subsectors that offer market-rate returns while achieving some social or environmental good
  14. 14. 14Derivedfrom Monitor Institute Rational behavior Emotional behavior
  15. 15. ... and a Range of Asset Classes Range of Return Expectations... Impact investments generate returns that range from below market to risk-adjusted market rate
  16. 16. 17 Moving beyond Socially Responsible Investment The market should be driven by : • Prominent family offices : executing investments to address a range of challenges (climate change, poverty …) • Clients of leading private banks : calling on their investment managers to provide them with more choices than just traditional investment and pure philanthropy • Private foundations : making investments in areas related to their social mission • Private equity funds : aiming to provide growth capital profitably to businesses • Mutual funds : dedicating a portion of their assets to emerging companies committed to generating social and environmental value • Pension funds and sovereign wealth funds : using their substantial resources to deploy capital in ways that benefit the communities they serve • Corporations : finding ways to materially improve the lives of the poor while creating products and services that generate a profit • Governments : investing in funds that support economic development in poor areas Source : Monitor Institute
  17. 17. 18 • the pull of more values driven consumer behavior, combined with the push of current and expected regulatory incentives and mandates • A steadily developing track-record with early successes in community development, microfinance, and clean-tech attracting broader interest • A flock of talent interested in careers in this space, creating a next generation of leaders Opportunities • Lack of efficient intermediation (high search and transaction costs caused by fragmented demand & supply ; complex deals ; lack of understanding of risk)  lack of impact investing opportunities into which large amounts of capital can be placed at investors’ required rates of return • Market being still organised around a clear divide between philanthropy (for impact) and investment (for returns) • Lack of reliable social metrics makes the suspected trade-off between financial and social benefits even harder to address Challenges Source : Monitor Institute
  18. 18. 20
  19. 19. 21 21 Raising opportunities of long-term value creation for investors and beneficiaries in rural areas For reasons of confidentiality, the identity of some business-cases may not released
  20. 20. Rural finance gap and the missing middle
  21. 21. 23 Investment targets Microfinance Medium to large companies SMEs Profile : - startups - going concerns Investment needs : 200.000 to 2.000.000 € Mesofinance (the missing middle) 23 The approach …
  22. 22. 24 Business-case : Empowerment of the rural communities in the Philippines, with developing a competitive national milk industry, Key-success factors in this project : 1) Animal sourcing and crossbreeding : the capacity to set up a scalable livestock 2) Training, monitoring and coaching of the farmers (= microfinance techniques) 3) Export sales
  23. 23. 25 Small-hold farmer (Aug. 2012, Philippines)
  24. 24. 26 Dairy plant Philippines
  25. 25. 27
  26. 26. major NEGATIVE weighting major POSITIVE weighting LEGAL Corp. management Strong management / business skills Mission statement Clear written mission statement Stakeholders relation Strong relations with local actors Stakeholders adherence Slow process of knowledge acquisition with the small-hold farmers OPERATING Production capacity Flexible, scalable MODEL Organisational structure Proven procedures manual, monitoring tools, MIS Innovation & Dvlpt Good command of technology HR management Jobs creation (SH farmers) an assistance Training, internal communication, incentives … MARKET Customers Customers diversification Clear payment policy & COMPETITION Quality / Reputation Good products quality and diversification Strong products & services advantages and few shortcomings Market and climate Unsecured breeding during monsoon season (?) Large-sized market with steady growth Competition Promotion and advertisement to intensify (?) Weak competition so far (not concentrated market) FINANCE Financial statements Sound financial projections Insurance Livestock not insured so far (no competitive offer vs. mortality rate) SOCIAL & ENVIRONMENTAL INITIATIVES Local development Good to high social / environmental impact along the supply-chain Lobbying and awards Local dialogue, intense networking Unofficial recognition PROJECT’S SCORING Score : 3,11 / 4
  27. 27. 29 Financing & technical assistance to saving/credit cooperatives, rural banks, NGOs, SMEs 1,7 mio. end-beneficiaries around Business-case : Finance company in the Philippines, serving loans to socially responsible driven MFIs End-beneficiaries (Aug. 2012, Philippines)
  28. 28. major NEGATIVE weighting major POSITIVE weighting LEGAL Corp. management Strong management / business skills Mission statement Clear written mission statement Stakeholders Strong relations with local actors OPERATING Organisational structure Proven procedures manual, monitoring tools, MIS MODEL Innovation & Dvlpt Good command of technology HR management Jobs creation Training, annual assessment, incentives … Internal communication, code of conduct … MARKET Customer Customers diversification Clear payment policy & COMPETITION Quality / Reputation Good products quality and diversification Strong products & services advantages vs. medium shortcomings Market Medium-sized market with steady growth Competition Interest rates being under pressure due to the growing competition Good sales (and promotion ?) strategy FINANCE Financial statements Sound financial projections Insurance Culture of risk External factors Government support to the microfinance sector SOCIAL & ENVIRONMENTAL INITIATIVES Internal / external initiatives Good to high social / environmental impact Local dialogue, social / environmental lobbying Score : 3,60 / 4 PROJECT’S SCORING
  29. 29. 33 Philippines NPFC, Manilla (2011) - Credit to around 300 SMEs in 2014 - Finance company - Investment : 350 K€ in shares – lock-up 5 years Yield : 10% gross / year Investment
  30. 30. 34 NPFC’s philosophy
  31. 31. 35
  32. 32. In the Philippines, upper-range loan in microfinance is around 50.000 PHP (less than 1.000 €) NPFC grant loans in a range from 50.000 PHP to 2.500.000 PHP (less than 50.000 €)
  33. 33. 39 NPFC clients (March 2014) Manufacturing of spare parts for the automotive industry Studio of massages performed by blinded masseurs
  34. 34. Manufacturing of hand- crafted decorative items
  35. 35. Score : 3,44 / 4 major NEGATIVE weighting major POSITIVE weighting LEGAL Company's history 3 years only … Corp. management Strong management & business skills Mission statement Clear written mission statement Stakeholders relation Good (still to expand) OPERATING Operational capacity Flexible, scalable MODEL Organisational structure Policies, risk management (still to reinforce), reporting, full integrated MIS expected soon … Innovation & Dvlpt NPFC's strength HR management Several employees with a banking background , training and incentives MARKET Customers Customers diversification, clients' rights & COMPETITION Quality / Reputation High-valuable products & client monitoring Market Medium market's size that could expand with economic growth ; good sales & promotion strategy Competition Competition might loom up on the long term (?) Weak competition so far FINANCE Financial statements Sound financial statements & projections Insurance No public liability insurance policy (not required by law in the Philippines) SOCIAL & ENVIRONMENTAL INITIATIVES Local development Good to high social / environmental impact Supply chain Social / environmental specifications along the supply- chain External factors Favourable regulations from the government for SMEs PROJECT’S SCORING
  36. 36. NPFC offices August 2013, Philippines
  37. 37. NPFC Shareholders’ meeting - March 2014
  38. 38. NPFC Capacity Building session - March 2014
  39. 39. 1. Social mission & vision - How does NPFC promote its mission and vision ? - Is the governance of NPFC appropriately designed ? - Is NPFC conducting social rating of their clients ? 2. Access and outreach - Does NPFC accept business start-ups ? - Does NPFC accept not duly registered companies ? - Is collateral a compulsory request for granting a loan ? 3. Customer service quality - How does NPFC ensure that the loans’ conditions and documents to be signed are fully understood by the borrowers - Are detailed procedure sin use, be it for credit application, collection, other services … - Is there a complaints mechanism for clients available and used ? - Does NPFC provide assistance services to their clients (training, capacity building …) ? - Are client satisfaction surveys processed ? 4. Human resources - Does every employee benefit a training scheme ? - What is the annual turnover in the staff ? - Is there a career scheme agreed with every employee ? - Does NPFC have a code of ethics ? SOCIAL PERFORMANCE ANALYSIS
  40. 40. 46 Overview and principles A methodology applicable whatever : • the location (worldwide) • the activity (industry – agriculture – services) • the business development’s step (start-up – going concern) Appraisal process : 1. a conventional Due Diligence-process (101 questions) 2. a scoring system 3. a risk-management audit framework (30 to 60 questions) Impact Investment processing : 4 steps Monitoring process : • social-environmental KPIs (Key Performance Indicators) • a technical assistance plan (applicable on a case by case basis)
  41. 41. 47 1. A conventional Due Diligence approach Corporate overview Operating Model Market - Competition Financial statements Social – Environmental Initiatives An in-depth analysis … (101 questions) Financial return Social- environmental return Check… tracking risk (4 categories) Operational Reputation Financial Legal    Operational Reputation Financial Legal Operational Reputation Financial Legal Operational Reputation Financial Legal Clear strategic vision
  42. 42. 4848 Value analysis in Impact Investing (extract from the Due .Dil. check-list)
  43. 43. 49 2. A scoring system Ranking of notes Weighting system : 3 scales of notation Weighted notes Risk’s intensity Feature of the case / situation appraised Scales of notes N (negative) Average to High Case / asset / situation making neither compromise nor significant advantage, whatever it occurs. Negative to neutral impact (at best) - 5 1 2 = should be the case to reach D (double sided) High to Low Case / asset / situation having negative or positive advantage, depending on the action taken - 5 1 2 3 4 P (positive) Average to Low Case / asset / situation having neutral to positive advantage (can never be negative) 3 4 = minimum requirement to reach  1 2 3 4 Poor Very goodSatisfactoryBelow standard Neutral - 5 Significant warning ! (average note)
  44. 44. 3. Closing of analysis • A risk-management audit Findings are classified below under 5 parts : - governance risk - operational risk - IT and physical risk - credit risk - ALM (asset & liability management) • A validation by the Investment Committee Covenants … ?
  45. 45. The 4 golden rules 1st rule : Scarcity lies in the good investment opportunities, not in the investment flow - Secure the projects sourcing, with building strong networks - Maintain strict due-diligence standards 2nd rule : Dialogue with the business owner / stakeholders never stops - Share common values (not just check professional skills & financial projections) - Cross-check information steadily 3rd rule : Emotion is – in a certain extent – part of the decision-making process to invest - Tell the story and report thoroughly - Get investors involved … 4th rule : But … at the end of the day, financial performance comes first - No philanthropy 52 Lessons learned
  46. 46. Barriers to Impact Investing Motivations for Impact Investing 500 wealth managers, private banks, family offices and HNWIs (between April-June 2012)
  47. 47. 54 Source : Monitor Institute A nascent industry … Impact Investing may have reached a transitional moment in its evolution : poised to exit its initial phase of uncoordinated innovation … ? ?
  48. 48. 55Source : Monitor Institute
  49. 49. 56 Socially investing : a wide offer  basic SRI funds - actions / bonds - theme funds : water, renewable energies …  « Alternative » social investment - micro-finance/insurance -impact investing - revenue-sharing funds (fonds de partage)  Philanthropy - contact with projects / CSOs - set up of suitable invest. vehicule Low / medium level of social engagement Medium / high level of social engagement Ultra-high level of social engagement To each customer’s expectation … A SPECIFIC FINANCIAL SOLUTION
  50. 50. 57 The scope of challenges facing society today can no longer be solved with a purely philanthropic approach (capital accessible through fundraising for philanthropic activities is in no way sufficient to address all the local issues in society) : - threat of possible climate change, as well as poverty leading to major political instability, human rights issues in supply - change management, the scarcity of primary resources, and demographic challenges In the light of the dominance of capitalistic socio-economic models in our societies – and the lack of credible alternatives the challenges of sustainability can only be overcome if they are integrated into market logic
  51. 51. 58 What is creating this Moment ? Many challenges are standing between the promise and the reality for Impact Investors  need to be tackled for the industry’s development to accelerate Facts emerging from the global financial crisis : - growing mistrust of markets - long-lasting macroeconomic slowdown helps investments diversification - as the market has mispriced risk … the traditional capital asset pricing model (CAPM) is questioned - growing volatility of traditional financial markets
  52. 52. 59
  53. 53. The first experiment (2010) : how to reduce recidivism rates among males in England ? Partnership UK-government / a group of investors (including Social Finance and the Rockefeller Foundation) Goal : to address re-incarceration rates at the Peterborough prison Private investors provided approximately $8 million to a consortium of 6 organizations focused on rehabilitation of former prisoners through access to housing, training and employment, medical services, benefits and financial advice, and family support. Government engagement : to repay the investors if rates drop by 10 % in 4 years … or stay above 7.5 % for 6 years. 2014 : reoffender rates dropped by only 8.4 % (the project did not yield a payout in 2014) On track to pay investors in 2016 … ?
  54. 54. Rikers Island Social Impact Bond Payment Schedule First social impact bond in the U.S. (2012) : recidivism Goldman Sachs pledged $9.6 million to the Adolescent Behavioral Learning Experience (ABLE) Program Goal : reduce incarceration rates at Rikers Island in New York City through behavioral therapy. Return : capital investment returned … if the number of jail days avoided by young men is at least - 10 % in 4 years A $7.2 million grant provided by Bloomberg Philanthropies guarantees a large portion of the investment
  55. 55. SIB mechanism
  56. 56. 63 Discover how to invest with difference on : www.mesoimpactfinance.com https://www.facebook.com/mesoIMPACTfinance Follow me and express your opinion on : https://www.facebook.com/PEERSDirectInvestment

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