Mainstreaming Impact Investing 2015

Summary of Impact Investing Sessions at the World Economic Forum Annual Meeting 2015
Davos-Klosters, Switzerland

Background

The Forum’s Mainstreaming Impact Investing Initiative is a multi-year project focusing on sustainable and impact investing. The initiative’s primary objective is to identify how impact investing may be a feasible strategy for traditional and mainstream investors and to investigate requirements to accelerate the flow of capital into impact investments.

To accomplish this objective, the World Economic Forum team:

- Brings together experts from the impact investing sector to collaborate and share insights

- Works with traditional investors (e.g. institutional investors), policy-makers and others who are less familiar with impact investing to evaluate challenges and potential solutions

At the World Economic Forum Annual Meeting 2015, leading practitioners from the investment industry gathered to discuss and consider:

- Relationships between social/environmental impact and financial returns, including circumstances in which impact and financial returns are mutually-reinforcing

- Potential roles of hands-on impact investors in starting successful and profitable social enterprises

This was done in the format of an interactive game.

Why a Game?

- The structure of the game and the nature of the decisions required teams to perform potentially unfamiliar tasks that are often the subject of debate within the sector. Teams needed to:
- Define their financial and impact return objectives
- Discuss the relationship between impact and financial returns
- Make business operations decisions to achieve their objectives by considering real and perceived trade-offs between impact and financial returns

- The interactive nature of the game increased participant engagement in group discussions

- The competition between teams spurred participants to overcome preconceived notions about impact investing in order to engage with the subject matter

Who Participated?

How Did the Game Work?

Game set-up

- Participants gathered in teams and were placed in the roles of impact investors, actively involved in designing and launching impact enterprises

- In each of two rounds, the teams received information on a fictional country and business ‒this information is available in two hand-outs, available for download on this page

- In each round, teams were tasked with setting up a new enterprise that met market needs and created a positive impact ‒ they did so by choosing from pre-defined aspects of a business model to implement

Rules

- The simulation had time constraints – 30 minutes for the first round and 25 minutes for the second round

- No details were available outside of what was provided in Round 1 and Round 2 hand-outs

- Choosing certain options in the game closed off other courses of action ‒ teams were encouraged to consider and discuss trade-offs

- All teams started from the same point in Round 1. The teams that created the highest levels of economic development impact at the end of Round 1 received more investment support from the government in Round 2 ‒ as a result, they were given more investment resources to allocate in Round 2

Assumptions

- The game scenarios are based on real-world investments

- To make the game dynamic and fast-paced, liberties were taken to “gamify” decision-making:
- A point-based system was used in place of currency to represent investment resources and financial returns
- Information on the fund’s strategy and investors was excluded
- Information on the investment characteristics (e.g. asset class, size, expected investment horizon) was excluded

-Teams were free to make assumptions in order to progress with decision-making

Performance
The winner was determined based on generated financial returns and positive impact ‒ results were calculated by an Excel model, available to download on this page

What did we learn?

- As one participant stated, in the 19th century investors focused on returns, in the 20th century investors focused on risks and returns and, in the 21st century, the conversation has shifted to risk, return and impact. As we get better at measuring impact, we are seeing that there does not necessarily need to be a trade-off between an investment’s risk/return characteristics and its impact. The two businesses in the game only became successful if players considered factors such as the financial strength of workers, the physical health of customers and the level of crime. As participants learned at the end of the game, those businesses were based on real investments ‒ investments that have been successful in large part because the investor didn’t treat an impact as separate from financial returns. Rather, impact was factored into decision-making to create successful businesses.

- Businesses that target positive social/environmental impact have tremendous potential in developing markets and many feel that impact investing scale will be seen here first. Corporate forms that embed social missions in companies (such as Benefit Corporations in the US) have a role to play in this. These models will help attract more impact investing capital and, at the same time, prove that companies can simultaneously achieve social/environmental and financial returns.

- Tremendous market forces are driving investors to become serious about impact investing. Investors want to do more than create financial returns ‒ investors representing $46 trillion in capital have signed on to the United Nations Principles for Responsible Investing (UN PRI). Additionally, the millennial generation is expressing a widespread desire to do more with their investing activity than just make money.

- In the current investment climate, with government bond yields near zero, large pools of institutional and pension capital are forced to seek other means of investment. At the same time, there is a need for infrastructure projects in both the developed and developing world. Many investors have successfully deployed capital into such projects while mitigating political issues and risks through public-private partnerships.

- Despite popular perceptions to the contrary, determined institutional investors are making impact investments and reaching the necessary scale, deploying billions of dollars. They have found scale in a variety of investments including in private equity funds, funds of funds and infrastructure project finance. Some of these investments take more time/effort to source and set up, but many investors insist that they are out there.

Download the Game Model here.

Game material - Round 1

ROUND 1 CONTEXT
Note: The information on this page has just been reviewed in the presentation but is included here for your reference

Investment Context:

- It is the year 2000 – we survived Y2K and many investors are excited about growth potential in the BRIC countries

- You have closed on a US$ 150 million private equity and debt fund focused on growth sectors at the Base of the Pyramid in emerging markets. The achievement of social impact was a core principle of the fund raising process and your investors expect you to pursue it along with financial returns

- Your team has scoured the international landscape to find the diamonds in the rough and so rather than following the herd to the invest in the BRICs, you’re exploring opportunities in Morosania, a country in Africa

Morosania:

The country of Morosania, a former European colony in Sub-Saharan Africa, emerged from a bloody civil war two years ago and has successfully transitioned to peace

- Foreign aid has flowed in and the new stable bi-partisan government—with a President often described as possessing the business acumen of Lee Kuan Yew and the personality of Nelson Mandela—is encouraging of private investment

- Morosania was once the breadbasket of the region, possessing fertile soil and currently dormant processing factories

- As to be expected in a post-conflict society, unemployment and crime are problems but are slowly improving

- The government has ownership over most natural resources and has created a small sovereign wealth fund with the goal of co-investing with private investors to bring half of the 19 million people living below the poverty line (on less than US$ 2/day) into middle income by 2010—that means bringing 10 million people to an income of at least US$ 10/day

- Critical to this plan is to attract foreign investors and to create stable employment, affordable housing, food security, reliable public utilities and accessible education systems

ROUND 1 INVESTMENT INFORMATION

Proposed Investment – Kudya Nova:

- After tapping your networks and conducting preliminary due diligence on a number of potential investments, one high-potential opportunity in Morosania’s agricultural sector stands out above the rest – Kudya Nova

- Kudya Nova’s management team possesses agribusiness experience in Africa and is looking for capital to set up a series of “agro-industrial” centres. These centres would support communities of farmers by providing agricultural inputs as well as by distributing agricultural products

- Plans call for ten agro-industrial centres to serve a region called New Davos containing, 1) nine small cities with an average population of 30,000 people each and, 2) 150 villages populated by 90,000 families

- After extensive due diligence on the financial and impact projections, you’re satisfied that Kudya Nova is a viable enterprise that can meet a market need and develop a sustainable food source—you’re willing to make an investment. But before you do, you want your team to have input on critical aspects of the business model—aspects which could dictate success or failure in the stabilized but still risky country of Morosania

Business Model Overview – Kudya Nova:

- For simplification purposes, this simulation focuses on a single agricultural product – eggs

- Kudya Nova’s management team has proposed a basic business model in which farmers will enter into a contract with Kudya Nova to buy egg-producing inputs (i.e., young chickens, feed) and to sell eggs back to Kudya Nova. Kudya Nova will then sell the eggs to end-retailers through distribution centres as well as direct to consumers in larger markets. This value chain is summarized in the following diagram:

- Kudya Nova’s agro-industrial centres will enable the production of high-quality import substitutes for local markets. As such, the enterprise is seen by the government as an important component in in re-integrating former soldiers, former rebels and displaced farmers—providing them with adequate housing and productive livelihoods, developing local industry and commerce, and contributing to the overall development of the Morosanian economy.

Economic and Social Factors:

- Though all of Morosania was affected by the civil war, New Davos—the region targeted by Kudya Nova—was arguably affected the most. 75% of the men aged 20-45 were killed and many women now serve as heads of households not only to their children but to extended families

- The land was once a large producer of eggs, dairy and chicken but few skilled farmers remain to begin farming again. Among those that do remain, fewer still have levels of personal savings which would allow them to start farming again

- Your internal experts calculate that if you do a turn-around of the egg and poultry business, you can get the cost of production for the eggs and chicken 30% below the prices of the dumped products

- The President is encouraged by your interest and has secured commitments from the IFC and World Bank to rebuild the electricity grids and begin the process of building a public sanitation system (but this is expected to take years)

ROUND 1 DECISIONS

Business Model Design Choices:
With the right business model, you see tremendous potential for Kudya Nova to generate financial return and positive impact. Because of this and because you believe the business model might be scaled up within Morosania and used in other countries, you’re willing to work with Kudya Nova’s management team to ensure success. And who knows, if you make the right decisions and create enough of a positive impact, you might find your fund positioned with the relationships and on-the-ground experience to make other attractive investments in Morosania.

You have 25 investment “units” to implement a variety of activities into the business model. These simplified units reflect a finite amount of investment and human capital resources. Work with your team members to:

1. Allocate your investment units to implement aspects of the business model, detailed below – assume you will not implement the unchosen measures. Note that any unallocated investment units will be put into in inflation-protected securities, retaining their value and counting in your final financial returns.

2. Articulate how your team prioritized your business model design decisions. You were likely forced to make trade-offs—did you utilize a strategy or approach to make your selections? The tables will share their perspectives on this question after the round.

* Any unallocated investment units will automatically go to inflation-protected securities

Game material - Round 2

ROUND 2 CONTEXT

Investment Context:

- It’s 2015 and fifteen years have passed since you made your initial investment in Kudya Nova

- You’ve exited some investments from that fund and your investors have been fairly happy with the overall financial and impact performance. It took you slightly longer than expected to get commitments for your new fund but in the end, you met your goal

- Now you’re focused on sourcing new investments and you turn your sights back to Morosania

Update on Morosania:

- In the five years since your investment in Kudya Nova, the business has been moderately successful
- The 150 villages in the New Davos region have seen some economic growth—average incomes have increased and health outcomes have improved
- Many households have a motorcycle, some even have cars, and most eat three meals a day and send their children to school to receive a secondary educationHowever, the overall success and growth in the region has caused a rural-urban migration
- Now, many workers spend an hour in traffic each way commuting to their jobs and children who attend school have similarly long travel times
- Electricity and water infrastructure was never upgraded in many locations—as a result, most middle income families do not have indoor plumbing, and have unreliable energy (some have power generators if they can afford them)

ROUND 2 INVESTMENT INFORMATION

Proposed Investment – Kamba Housing:

- Over the past five years, your team has developed valuable relationships in Morosanian government and industry. Your contacts see potential in the housing sector and you’re put in touch with an experienced real estate developer operating under the name of Kamba Housing

- Kamba Housing is interested in building apartments in the New Davos region and is looking to tap new sources of capital. Given your prior investment in the area, they are excited to be in touch with you with you

- Preliminary plans for the development include 35,000 affordable, high-quality homes

- As with Kudya Nova, after extensive due diligence on the financial and impact projections, you’re satisfied that Kamba Housing can be an attractive investment. But before you commit, you want your team to have input on critical aspects of the development plans—you know that in order for the project to have a sustainable, positive impact on the economy, it will need to address certain needs and issues that might not be considered by a developer only concerned with short-term profits

- Based on your investment history in the country, the government is somewhat willing to co-invest with you on this project

Business Model Overview – Kamba Housing:

- The basic plan for the development project in the New Davos region includes 35,000 apartment-style homes—analysis shows that there’s demand for this many units at multiple price points

- You’re faced with a number of development decisions which will not only affect the price and profit per unit (e.g., some development features will require you to charge higher prices) but will also help determine the nature of new urban growth in Morosania

Economic and Social Factors:

- While middle class earnings seem strong, levels of savings are still catching up. Accordingly, many individuals and families do not have enough money to buy a house or apartment outright. But given recent economic development, experts are in agreement that there is pent up middle class demand for housing

- Given Morosani’s recent history with its civil war, crime is still an issue, especially in and around worker slums

- Many competing developers are bringing migrant workers to Morosania as a source of low-cost labour

- As the middle class develops and urban migration continues, more women leave the home to work. However, this trend drops off dramatically after childbirth

ROUND 2 DECISIONS

Business Model Design Choices:
With the right model, Kamba Housing’s development in the New Davos region could be used as a template for other developments in Morosania. Because of this, you’re working closely with the Kamba Housing management team to ensure success. And once again, if you make the right decisions and create enough of a positive impact, you might find your fund positioned with the relationships and on-the-ground experience to make other attractive investments in Morosania.

Based on your performance in Round 1, you have a certain number of investment “units” to implement a variety of activities into the business model. These simplified units reflect a finite amount of investment and human capital resources. Work with your team members to:

1. Allocate your investment units to implement aspects of the business model, detailed below – assume you will not implement the unchosen measures. Note that any unallocated investment units will be put into in inflation-protected securities, retaining their value and counting in your final financial returns.

2. Articulate how your team prioritized your business model design decisions. You were likely forced to make trade-offs—did you utilize a strategy or approach to make your selections? The tables will share their perspectives on this question after the round.

Contact Information

Katherine Brown
Katherine.brown@weforum.org
Global Leadership Fellow
Practice Lead – Investors Industries
World Economic Forum

The World Economic Forum would like to recognize the contribution of the Schwab Foundation for Social Entrepreneurship, UNPRI and Yunus Social Business.