NEW DELHI — As the impact investing industry gains steam, questions are emerging about the role of development finance institutions in mobilizing capital toward development goals as more mainstream investors get involved.
“The impact investing community has done a great job of building a brand because everybody's heard of this thing and it’s one of these things nobody can argue against. It's done a far less effective job of moving money.”— Nick O’Donohoe, CEO, CDC
CDC, the United Kingdom development finance institution, was given a mandate in the past two years to focus on the most challenging countries to invest in. It can look to past examples, including India, where CDC has been and continues to be a critical player in helping to build the private equity industry.
Devex spoke with CDC CEO Nick O’Donohoe at the Global Steering Group for Impact Investing Impact Summit in New Delhi, India, last month, to get his take on the impact investing market, how CDC’s role is changing in India, and to ask his advice for the new United States development finance institution.
The conversation has been edited for length and clarity.
There is quite some hype about impact investing and the potential for broader financial markets to help finance the Sustainable Development Goals. Do you think we’ll get to a point where 20 percent of financial markets are investing for impact? What do you see as realistic?
It is realistic to hope that consideration of the impact of your capital investment decisions will be something that every organization will think carefully about, and I think that's happening already.
There is not an investment manager in the world at the boardroom level who isn't thinking about this question. It's become top of mind and that is a very encouraging development. I think ultimately that will raise the cost of capital for companies that are creating negative externalities — tobacco companies [for example] — and it will lower the cost of capital for other companies where the positive benefits and impact of what they do is clear.
The greatest challenge is how do we persuade capital to go and address problems in Africa, where really, the amount of capital is falling, not rising.
Impact investment does talk about being on a spectrum. We're doing an increasingly good job at attracting capital at that end of the spectrum, where the return is commercial. It's much harder to attract it toward the more impact-oriented end of the spectrum.
More on impact investing:
The impact investing community has done a great job of building a brand because everybody's heard of this thing and it’s one of these things nobody can argue against. It's done a far less effective job of moving money. It's definitely more hype than money moved, but a lot more money is moving now than moved three or four years ago. So, we are moving in the right direction.
This year the GSG Impact Summit is in India. CDC has played a key role in building India’s private equity market. At what point do you stop investing in Indian private equity because private commercial investors are now interested?
To some extent, we're stepping back in the market already.
Our role in the mid-1990s was to almost cornerstone or invest in anything because we saw building that investment ecosystem as being part of our role. But very clearly, now, we're stepping back from large generalist funds that attract lots of foreign capital and we're focusing our attention on funds that are focused regionally.
So, [for example], the northern states of India have 50 percent of the population and 5 percent of the investment capital — so we’re focusing on funds that are very specifically trying to get capital to Uttar Pradesh.
The other thing is being focused on specific sector-oriented funds, particularly in infrastructure, in agriculture, in affordable housing, health care. Those are areas that are investable, you can build scale, but there's still a significant developmental impact.
How do you balance the need, particularly in the political environment, to make money for the British government with the push to invest in riskier or more challenging environments?
In the last year, we've got a separate pool of money, about a billion dollars, which is more risk-oriented, more impact-oriented, and allows us to do things where there is a significant probability of not getting our capital returned. It's allowed us to do more in places like Afghanistan and Myanmar.
“The idea of having some bifurcation in your portfolio, … identifying a tranche of money where the pressure ... is not to earn a return, and identifying strategies and areas of market failure where you think by investing now, you can build great markets, [works].”—
In our traditional portfolio, which is consistent with other DFIs, we've earned a consistently positive return over our 70-year history. With the traditional portfolio, we think it is possible to earn a return. Most people would look at what we invest in, the risk we take, [and say], “that’s not a risk-adjusted return.” It probably isn't, but it’s still a positive return.
I think the idea of having some bifurcation in your portfolio, clearly identifying a tranche of money where the pressure on the people is not to earn a return, and identifying strategies and areas of market failure where you think by investing now, you can build great markets, [works].
It's early days for us in that portfolio, but I think that it has helped us do a lot of difficult things we never would have invested in.
Another issue that comes up a lot in conversations is leverage ratios and how DFIs and multilateral development banks can mobilize more capital. But there is a tension between that and investing in the hardest markets. How do you handle that pressure?
There is a key priority for CDC, as well as from its shareholders, to mobilize more capital.
We can do a number of things to help mobilize capital — some of that is just about sharing our experience and our data, helping people better understand what the risks are. Because, you know, the default rate on power in Africa is lower than it is in Europe. So there are some misconceptions about risk.
We've begun to take a higher profile in terms of being willing to talk about our experience, share our data, which historically DFIs have not been willing to do. We're also prepared to be the cornerstone investor often in new impact funds.
“From a risk perspective, we need equity more than we need debt.”—
Some of the DFIs are trying to do more in terms of blended finance, where they're providing more concessionary capital to try and leverage in more commercial capital. We've done a limited amount of that, partly because we're more focused on trying to, as I said earlier, identify and invest in areas that are subcommercial today and hopefully demonstrate that they can become commercial.
The U.S. is about to get a new development finance institution, with double the spending cap. CDC has also fairly recently gotten a huge influx of capital. What advice do you have for the new corporation?
The role of a development finance institution, in my view, is to take greater levels of risk and go to more difficult countries and places. I think a lot of the development finance money today is spent in easier countries doing easier things. And one of the great things about the CDC — and this was a DFID [the U.K. Department for International Development] decision, not a CDC decision — was to focus our investment in 2012 in sub-Saharan Africa and South Asia.
That makes our job of earning return much more difficult, and finding investable transactions much more difficult, but that is the role of a development finance institution.
My advice to them would be, from a risk perspective, we need equity more than we need debt. From a geographic perspective, we need Africa more than we need Southeast Asia. In the fund business, we need support for smaller, emerging impact-oriented funds, more than we need support for TPG [one of the largest private equity investment firms globally]. The role of a DFI is to fill those difficult gaps. That's my advice.
Editor’s note: The Global Steering Group for Impact Investment facilitated Devex's travel for this reporting. However, Devex maintains full editorial control of the content.