One-third of all those who moved out of poverty in Latin America over the past decade will likely slide back. That’s 30 million people. Another 200 million are considered vulnerable.
Traditional solutions to address societal challenges – led by governments, international organizations and non-profits – are important, but by themselves they won’t be enough, especially if we are to meet the ambitious Sustainable Development Goals (SDGs).
So who or what can bridge the gap? The private sector.
Doing well by doing good
The private sector has always played a small part in tackling the region’s challenges, but not at enough scale. This is likely to change as more asset owners, asset managers and corporations in the region embrace impact investing – investments made into companies, organizations and funds with the intention of generating social and environmental impact as well as a financial return.
Impact investors work in sectors such as sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services including housing, healthcare, and education. These investments are being made in both emerging and developed markets, and are targeting a wide range of returns – from market rate (or above) to below market rate, depending on the investors’ strategic goals. A 2016 survey reported over $77 billion in impact investment assets under management, with the intention to increase annual capital committed by 16% in the following year.
Of course, as worthy as these goals sound, what most decisions-makers in the C-suite want to know is: does it make financial sense? The data we have so far suggests it does.
For example, in 2015, GIIN and Cambridge Associates launched the industry’s first private equity benchmark, which has shown performance largely in line with conventional private equity funds.
More recently, GIIN’s 2016 Annual Impact Investing Survey found that 89% of respondents achieved financial performance in line with or better than their expectations, and that six in ten principally target risk-adjusted, market rate returns.
Two steps forward, one step back in Latin America
Latin America has made significant progress over the past decade. For example, according to a recent study by the Brussels-based think-tank Bruegel, region-wide income inequality has declined significantly.
But the region is still saddled with deeply-rooted pockets of poverty. According to the OECD, 175 million people in the region still live in poverty, and 64% of young Latin Americans come from poor or vulnerable households.
And things don’t look like they’ll improve any time soon. In fact, it is estimated that GDP growth will have been negative for the second consecutive year in 2016, a contraction the region has not seen since the early 1980s.
Bridging the gap
But that’s just part of the story. Because at the same time as economic growth has been going into reverse, assets under management (AUM) have actually been rising – from $800 billion in 2007 to $1.9 trillion in 2015. Private wealth is also on the up. In 2015, it grew by 7% to $5 trillion, and it’s expected it will continue to grow by between 9% and 11% each year through to 2020.
Impact investing is very well placed to act as a bridge between this capital offer and societal needs in the region. In fact, over the past decade, that’s what has slowly been happening.
This trend looks set to continue. In the 2016 edition of the GIIN’s Impact Investor survey, 44% of respondents said Latin America was an area of focus for them, and the region accounted for $7 billion of investment out of the $77 billion total AUM.
The challenges ahead
That’s the good news. But there is still much work to be done if impact investments are to have more of a positive impact in the region. Here are four ways of making that happen.
Sustainable Development Goals
The region needs a thorough study, ideally produced in collaboration with the UN, on the correlations between societal needs and capital offering in the context of the SDGs.
A comprehensive guide to the sectors that should be prioritized would help institutional investors and fund managers decide where to channel their capital. Currently, fund managers often select their priority areas based on internal expertise or on expected returns rather than specific societal need.
But GIIN research shows that impact investors see the SDGs as a valuable unifying framework that could help ensure that individual deals add up to something bigger. A comprehensive study would help them achieve this.
Impact investors still operate with insufficient support from some governments and regulators.
The Brazilian National Development Bank (BNDES) and the Interamerican Development Bank (IADB) have made significant contributions to irrigate the market with capital and credibility, but other top-tier financial institutions such as CAF, IFC, the largest pension funds and commercial banks could make their presence more visible to decrease uncertainty and legal/regulatory risk.
International organizations, such as the Organization of Ibero-American States, along with large governments could also create regional-wide or national policies on sustainable finance, as is presently being done in places such as the UK and Australia.
Several fund managers in the region go to great lengths to find companies that are financially robust, have the potential to scale, and have products and services whose impact can be properly measured. For example, Mov, a leading impact investor in Brazil, assesses about 100 opportunities for each investment.
This is the rule, not the exception.
Many funds end up competing over high-caliber opportunities, fostering a culture of watchfulness rather than of cooperation. The consolidation of the impact investing ecosystem in the region should go hand in hand with investments in incubators, accelerators, training for companies, and in the organization of events that intentionally connect capital and enterprises. The World Economic Forum organizes regular events that promote cross-mentoring exchanges between investors and social enterprises (called ScaleShops). Others should join in.
For impact investing to grow in Latin America, capital allocations from mature markets to the region need to be expanded. But fundraising is still cumbersome for a range of reasons.
First, as impact investing in the region is still in its early stages, fund managers have no track record of successful exits and therefore their financial credentials cannot yet be properly encapsulated.
Second, most are first-time managers. Impact investing has attracted social entrepreneurs, millennials, very wealthy individuals (UHNWIs) and former multinational professionals with little or no background in asset management apart from experience in venture capital. Of the funds in GIIN’s searchable database, 40% have been in operation for at least three years, but in Latin America that figure stands at just 8%.
Third, the region is facing a “middle-income trap” – on the one hand, institutional investors still consider it too risky, and would therefore rather invest in less volatile markets; on the other, it is already above the poverty threshold established by some development finance institutions to guide their investments. Even if some countries in Latin America have lower GDP per capita than some African nations, global financial institutions tend to follow regional strategies, not national or local.
Research consistently identifies the supply of “professionals with relevant skill sets” as one of the ongoing challenges to the growth of impact investing, which is why greater access to fund manager training around impact investing is needed.
Big investors need to tackle the big issues
Institutional investors will be critical to scaling impact investing in the region. To that end, we need more data across asset classes to prove that impact investing does not require a financial sacrifice and can be compatible with fiduciary requirements. Doing so will help people see that impact investing is in the long-term interests of asset owners.
If that is to happen, local investment managers need to show a more consistent track record and the size of impact funds needs to grow. Globally, nearly 20% of funds in the GIIN database have a target AUM greater than $100 million; in Latin America, the figure is just 6%. If Brazil’s Securities and Exchange Commission and Mexico’s Banking and Securities Commission, along with other local regulators and associations, provide better guidance on how fiduciary boundaries could include impact investments, that would be a game-changer.
The future of impact investing in the region
Collaboration will be a critical element of success for impact investing in Latin America.
Experts need to help structure and design investment products to ensure they are suitable for the challenges at hand. Community groups need to identify opportunities where investments could have a real impact. Government bodies must put in place a regulatory environment that encourages investment. Researchers will have to develop market intelligence. And of course, investors will be needed to provide the capital.
It’s going to take all types of players working together to ensure impact investing reaches its full potential.