Q&A: IDB Invest on the future of impact investing after the pandemic

WASHINGTON — Impact investing will be essential to Latin America and the Caribbean’s recovery from COVID-19, according to IDB Invest Development Effectiveness Chief Alessandro Maffioli. IDB Invest, the private sector arm of the Inter-American Development Bank, works directly with the private sector in a variety of industries such as infrastructure, finance, and agribusiness to maximize investments for development effectiveness. The long-standing inequality of the region, plus the expected 9.1% decrease in economic output in 2020 because of the pandemic, is endangering progress on the Sustainable Development Goals, Maffioli said. “Everything that we do is meant to have a contribution to the SDGs, and the contribution to the SDGs … is measured through having a specific indicator that is rated to one specific target of the SDGs that we can track over time,” Maffioli said. “It’s not just a line, just saying, ‘This transaction may have to do with climate change.’ No, it’s setting a specific indicator that will allow me to say, ‘This transaction will allow me to reduce emissions by XYZ amount.’” Maffioli sat down with Devex to talk about how IDB Invest evaluates opportunities for impact investing in Latin America and what role this will play in recovery. This conversation has been edited for length and clarity. Why is private sector investment key to growth in Latin America and the Caribbean? Particularly in developing countries, where sometimes the fiscal space of the public sector is constrained, the contribution that private sector investment — being local or international — can have on development goals, such as those established by the SDGs, is absolutely fundamental. Think about what can be done in terms of infrastructure investment and project finance, where the public sector and private sector work together. Job creation, the strengthening of value chains, the development of agribusiness sectors, food security, provisional services — there’s a lot of services and goods that now are provided by the private sector. There’s an agreement that this is a fundamental part of development finance at this point. What role does impact investing play in helping the region meet the SDGs? Everybody agrees, from multilaterals and government, the SDGs cannot be achieved without an all-hands-on-deck approach. Everybody needs to contribute — that is clear. The need to mobilize private investment for this purpose is clear. And there is, at this point, a great consensus even by mainstream investors that this is good and is necessary. The big question now is not why we need this and do we need this. The big question is: How do we do this? And this is where we’re trying to focus the most at this stage. How do you identify investments that can really bear positive return for economies and society? How do you promote the use of this kind of approach? How do you measure effects? Many things are done in finance in terms of how do we learn what works, what doesn’t work, how we can get the highest return in what condition. This is what is happening now with impact investing: “How do we select, measure, monitor, manage, and learn from this investment?” Why has it taken so long for private investors to commit to an approach that focuses on the actual impact that investments have on development outcomes? Traditionally, there was a conceptual division between the private sector’s job — just to maximize profit and shareholder value — then there should be the public sector, taking care of the distribution of benefits and making sure that society is developing in a relatively equal way. There’s no seeing that trade-off anymore. It’s clear that having a stakeholder approach, looking at the broader base of who is benefiting from your activities, is perfectly coherent and consistent with healthy financial return. “The contribution that private sector investment … can have on development goals, such as those established by the SDGs, is absolutely fundamental.” --— Alessandro Maffioli, development effectiveness chief, IDB Invest For private sector investment, this is something that had to grow. The first step was the environmental, social, and corporate government approach: “Do no harm. Let's invest and try to avoid negative externalities for the society.” But then increase that, and you can have an intentional approach: “I don't just want to avoid negative effects for others with my investment. I can actually focus my investment so it can benefit a larger group of stakeholders.” Looking at our clients in the region, we see an increased interest for that. Davivienda in Colombia is issuing a “gender bond” to focus their portfolio in providing access for women entrepreneurs. Something that is good for them is good for the businesses, contributing to close a gap that is an obstacle for the proper development of society and an efficient economic system. How does IDB Invest go about evaluating impact on development outcomes? If you believe you want to achieve impact, you have to manage your investment for impact. You evaluate it and measure it at the end to see if actually you achieved in the kind of investment you selected. You analyze why they achieved or why didn’t achieve their results, so you can learn and be better making those choices. We have an impact rating system — the Development Effectiveness Learning, Tracking [and] Assessment Tool, DELTA — that we apply throughout the life cycle. The DELTA is basically a tool that we use to estimate what is the potential return of the investment for the society. It’s not only the financial return, but the possible return for society, which means not only looking at the financial part of it, but also all the economic positive and negative additional effects or externalities that the investment can have. In addition to that, we perform a stakeholder analysis. So the question there is: Who is benefiting from this? And how does DELTA help you determine that? We produce a rating. This rating is used to take decisions where we have defined, below certain ratings, we won’t finance this transaction. We get to define what is our development appetite. We calibrated the tool in a way that, below this threshold, we don’t feel it is something within our mandate, and above it, we feel it is. And at a certain point, we say, “This is really an exceptional transaction,” and we compare that also to how much the transaction is contributing to our financial sustainability. What we try to achieve is to have an impact with our entire portfolio. We build a portfolio to help us maximize our impact as an organization and, at the same time, being healthy from the financial point of view. This, we believe, is exactly what every single impact investor needs to do. When we ask our team to look for transactions, we start to steer their effort towards the deepest development gaps of the country we’re working in. For that, we have a tool that ranks indicators in different sectors for different countries, and then we see where the countries are lagging behind the most and we need to invest the most. We use those as incentives in our rating system to guide the origination effort. What role does impact investing play in COVID-19 recovery? This is at the center of our concern. The region has been disproportionately affected by COVID- 19. This is probably due to the fact that the population is very concentrated in big cities or mega cities, so this is producing additional problems, compared to other emerging regions. It’s also very concerning because there’s a lot of informality in Latin America — 40% of GDP [gross domestic product] is coming from the informal sector. You have a lot of people that are not included in the social safety net, and it is unfortunately a very unequal region still. We know that the effects disproportionately focused on the most vulnerable people in the region. When you think about recovery, it’s clear that the public sector itself cannot do it all. There is no way that it can meet all the needs of short-term and long-term investment that the region is facing. The need to mobilize private sector resources towards Latin America is clear — even more acute than before. The only good news is there was an increasing interest from the region for impact investing before and that we hope now to be able to increase the mobilization of private resources. There’s no doubt that private investment, impact investment will be critical in the recovery. It will be mandatory for the future if you want to have a decent recovery and not have a new, prolonged crisis for the region.