3 misconceptions debunked. How investing in frontier markets can improve responses to fragile contexts

Humanitarian aid was originally intended as short-term crisis relief to respond to immediate emergencies. But the 2022 State of the Humanitarian System report confirmed to us of the sobering reality: the majority of today’s humanitarian financing goes to protracted situations. And these are becoming more prevalent than ever.

There is increasing recognition that market-driven solutions can provide a sustainable and long-term response to global crises, and the private sector needs to be front and centre of this. There are many good examples of businesses and social entrepreneurs already offering solutions and delivering humanitarian impact. One example is ZIZ Energy, a social enterprise that installs decentralized power grid networks in Chad and Central Africa to break the vicious circle of underdevelopment and lack of energy access.

There are also opportunities for the private sector to work together within traditional donor models. Mrüna, a social enterprise that produces and implements decentralized wastewater treatment systems, has worked with various NGOs to implement projects funded by traditional development partners, providing sanitation infrastructure to underserved communities.

In some cases, these new players are innovating the traditional approach to deliver humanitarian impact. Mandulis Energy, a social enterprise delivering renewable energy in East Africa, has reimagined the role of vulnerable communities from being recipients of humanitarian aid to being key stakeholders in the production of high value commodities. By using the agricultural waste of smallholder farmers, they are producing biochar and bio fertilizers, and in the process generating electricity. They are now able to provide essential services such as power in humanitarian contexts at low costs or even zero priced, with the highest quality possible, by leveraging these alternative sources of revenues.

Investing in financially sustainable opportunities with a humanitarian impact is an exit strategy against aid dependency. It increases the resilience of communities and rebuilds crisis-hit economies in the long-term. It is with this idea in mind that the Humanitarian and Resilience Investing (HRI) Initiative was launched in 2019 as an approach to unlock impact investing in frontier markets with the goal to measurably benefit and increase the resilience of at-risk and crisis-hit communities.

Through its work, the HRI Initiative has discovered several prevailing misconceptions that need to be dismantled for HRI to grow and demonstrate what could be possible if humanitarian impact and financial sustainability meet.

A common challenge impact investors report is finding a “quality pipeline”. This means an adequate supply of potential investment opportunities that meet certain impact, liquidity, projected risk vs. return, and size criteria. Add “humanitarian impact” and “fragile contexts” to the mix and this pipeline drops to close to zero. Or so it is perceived.

The reality is that impact investment opportunities in frontier markets do exist. There are different ways in which enterprises can create impact in vulnerable communities, including providing goods or services that directly address traditional humanitarian needs or help build the resilience of these communities. One example is Nazava Water Filters, a social enterprise producing affordable household water filters to empower communities to purify their water, without the need to boil or use electricity.

Social enterprises in frontier markets can also amplify humanitarian impact driven by organizations and institutions targeting the most vulnerable communities. YAPU Solutions provides digital tools for financial service providers that service micro-, small- and medium-sized enterprises, enabling them to become agents of change.

They can also create employment opportunities by fairly sourcing goods and services from at-risk communities, like Humans in the Loop, who employ members of crisis-affected communities to train and improve AI systems, making them part of the workforce of the future. And Blendhub, who localize the production of personalized food products, sourcing ingredients from vulnerable communities, and reducing emissions and costs for any specific food product.

While funding is available for pilots, once innovations are proven, they often struggle to attract private capital, which prevents these innovations from scaling.

The fact is that HRI opportunities target contexts where the traditional blueprint for a successful business may not apply. The vulnerable people who live in these communities may not be its main customer group. The presence of humanitarian actors might distort “normal” market functioning. And scaling opportunities might be limited by supply chain disruptions.

However, these unique market characteristics can provide challenges that can be overcome and become a social venture’s competitive advantage. When Africa GreenTec started its operations in Mali, there was no local infrastructure available to support smallholder farming, which is a key source of livelihoods in Mali, particularly amongst women. In response, it built a fully circular solution that contains everything from solar power systems, water purification, cold storage, and internet access, to support the commercialization of smallholder production through a value chain approach and increase the livelihoods of the communities they serve.

The unique characteristics of frontier markets can also create market opportunities. For example, the founder of Nilus realized that the world’s poorest customers often pay the highest prices for their goods and services. He created a technology that aggregates individual food purchase orders and taps into food at risk of being wasted to fight this injustice and lower the cost of healthy food for low-income communities by up to 30%.

To thrive and grow in these markets, impact ventures need to find approaches and models that address the unique characteristics of the frontier markets and unlock their potential.

These approaches include new types of collaborations between organizations across sectors and a rethinking of the roles of these organizations. Humanitarian organizations and donors can, for example, help create market demand by providing innovative ventures with long-term contracts to enable them to scale. This will help them enter new markets, increase their valuation, lower their risk profile and help them on their path to profitability. These collaborations also enable impact ventures to adopt new business models, such as results-based financing approaches.

Traditional humanitarian interventions can also enable market driven solutions through interventions that a social enterprise cannot integrate into its own business model, such as skills development or financial aid, which are necessary to create the conditions for social ventures to enter these markets. For example, African Clean Energy (ACE), a social enterprise that provides renewable energy and clean cooking solutions to households in Sub Saharan Africa and Southeast Asia, was able to expand its services to a refugee settlement in Uganda which benefited from cash-based transfers.

While investors are increasingly looking to integrate social impact in their decision-making process, those looking for opportunities that come with a competitive market-rate return, a low risk profile, and high impact might find themselves in front of a trilemma.

This trilemma limits impact investors and Development Finance Organisations' ability to invest in the most impactful and innovative social ventures, or smaller but promising investment opportunities in frontier markets.

There’s an opportunity though to mitigate this through new types of collaboration across sectors. This can include de-risking HRI opportunities through catalytic capital that is patient, risk-tolerant, concessionary and flexible. Foundations are particularly well positioned to provide such capital as they have the mandate and resources for “responsible risk taking”.

For example, the IKEA Foundation’s focus is on empowering people living in vulnerable communities to improve their livelihoods, while also protecting the planet. When a crisis strikes, it threatens the hard-won gains these communities have made. By supporting the HRI Initiative, the IKEA Foundation brings together its mandate with its ability to de-risk investments in frontier communities. It believes that private sector investments can increase the long-term resilience of these communities, enabling people to withstand crises, recover from them more quickly and rebuild their lives.

However, for investors to make an impact that goes beyond financial returns, they may also need to stretch the risk appetite of their fiduciaries, revisit the time horizon of expected returns, or rethink how returns are measured. This includes challenging existing paradigms and practices of today’s financial sector.

The HRI Initiative is supporting the winners of the Humanitarian Impact and Resilience challenge (mentioned above) on the World Economic Forum’s innovation platform, UpLink (see the announcement of the winners in the video below) to help them overcome the challenges they face to scale their operations and connect them with the broader HRI ecosystem.

The initiative is also convening a new "Network for Impact Capital in Frontier Markets", a group of organizations along the spectrum of impact capital that use commercial or philanthropic finance to measurably impact the most vulnerable populations through impact investing.

In addition, the initiative will continue to work to increase the capacity of humanitarian and development organizations, donors, and DFIs to engage with each other and scale market-based solutions in frontier markets.

Ultimately, scaling HRI requires the mobilization of more partners that are ready to commit to work collectively towards creating and investing in opportunities in frontier markets.