The impact investing world is an exciting place to be. Investors’ hopes of doing good and doing well are alive and well. As impact investing matures, veterans in the field are asking how to focus resources. Should we seek high returns in order to attract mainstream investors, or maintain a clear social bottom line, even if returns fall below the market average? Which direction should our unique blend of development and capitalism take?

Two recent articles attempt to answer this question: one is a <a href="https://ssir.org/articles/entry/almost_everything_you_know_about_impact_investing_is_wrong">longer essay in Stanford Social Innovation Review</a> – by <a href="https://www.poverty-action.org/people/wendy-abt">Wendy Abt</a> – the other an <a href="https://www.ft.com/content/b6c893d4-f48e-11e8-9623-d7f9881e729f">interview with Elizabeth Littlefield in the Financial Times</a>. Both these accomplished women are well positioned to reflect on and shape the future of impact investing.

Abt is the founder of <a href="https://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=51828662">WPA, Inc.</a>, an investment advisory firm, and former deputy assistant of USAID. Littlefield was the director of CGAP before becoming president of the Overseas Private Investment Corporation, which has shaped her current role as Senior Counselor of the <a href="https://www.albrightstonebridge.com/team/elizabeth-l-littlefield">Albright Stonebridge Group</a>.

There is a lot to agree on in both articles, but I have some reservations about them as well.
<h2>Abt: Market Returns, Better Measurement, Bigger Players, and a Different Investment Paradigm</h2>
Abt is right that greater clarity is needed regarding impact investing’s key principles and practices.

She contrasts two investing paradigms that come from mainstream investing but are often applied in impact investing. The first is venture capital (and incubators), an approach that prioritizes rapid growth and a clear exit strategy for investors. The problem here is that fast growth and clear exits can be incompatible with attention to social impact. Abt prefers an approach that more closely resembles project finance. While the analogy may not be exactly appropriate, project finance takes a longer-term perspective and considers complementary investments by other players.

She also points out that too many impact investors surrender to concessionary business models before they even join the fight for market returns. They offer a plethora of rationales to justify concessionary returns, arguing, for example, that subsidies are necessary because impact-oriented businesses take a long time to become financially self-sustaining. Many social enterprise business models need to start off with concessionary funding (subsidies) because the timeline for revenue generation is unclear: these are, after all, new operating models tackling social problems that big business has not taken on. Often however, this concessionary capital becomes “permanent” because the goal of moving towards financial sustainability takes a back seat to other priorities. So I agree that impact investors should expect their investees to move towards sustainability and profitability, and that requires clearly negotiated timelines and diligent oversight.

However, Abt makes some assertions that I disagree with.

Abt insists that the purpose of impact investing is to solve major social problems – like income inequality or global warming – by attracting non-concessionary capital into a competitive marketplace. I’m not on board with several parts of that claim. Impact investors should not have to carry the weight of building more competitive markets, and do not have to aim exclusively at non-concessionary capital sources. These are grand aims, but often they are too much to ask of investors wishing to use their own capital in socially positive ways.

As a result of her focus on non-concessionary capital, the only source of below-market capital Abt is willing to entertain is government, on the grounds that if impact investors do not anchor themselves to market returns, they risk serious misallocation of resources. I disagree. In fact, many impact investors, especially foundations, prioritize social return over market returns especially if their money can be used in a catalytic way to create a business with a social good. Why should they not be considered legitimate investors?
<blockquote>Many impact investors prioritize social return over market returns, especially if their money can be used in a catalytic way to create a business with a social good.</blockquote>
Because Abt’s vision is all about major social problems, she defers to the biggest corporations in a way I find a bit troubling. She asserts that only large regional and global companies, not small ventures, can make a difference in the complex sectors most critical to the poor, namely infrastructure, health, agriculture and logistics. She states, “impact investors are noticing the advantages that global and large regional firms have over smaller firms in low-income and fragile countries.” She cites successes of Carlos Slim in Mexico, Aliko Dangote in Nigeria, and Jack Ma in China.

It may be true that behemoths have advantages, but it’s simplistic and unrealistic to apply that thinking wholesale. It sends a message that impact investing is all about co-investing with or exiting to Alibaba or Dangote, who were themselves small disruptors at one time. But do the behemoths value social impact? What should happen in countries where big companies don’t invest? It’s true that the goal of many a small innovator is to sell to a global company – and that proves my point: impact investing is needed precisely for these smaller firms to innovate and test their ideas before large multinationals will give them a second glance.
<h2>Littlefield: Market Returns Not Necessary?</h2>
I put myself more in Littlefield’s camp, agreeing with her assertion that the impact investment sector should accommodate all investors, whether large or small, institutional or individual, philanthropic or commercial. Millennials are demanding investment opportunities, and not all are looking for above market rates of return. The “investment experience” is important along with social and financial returns. Research suggests that the demand for sustainability is <a href="https://www.inc.com/melanie-curtin/73-percent-of-millennials-are-willing-to-spend-more-money-on-this-1-type-of-product.html">firmly entrenched in mainstream millennial attitudes toward money</a>. As these millennials gain seniority in the business world, they won’t hesitate to advocate investment decisions that promote sustainability above traditional market returns, and data-driven decision making will help shape these investment decisions, even if it means their money grows more slowly. Many millennial investors are willing to experiment and refine. Time, of course, is on their side.

Moreover, a below-market return doesn’t mean a loss. Investors who prioritize social returns are also looking for the investee to grow and become profitable. With this in mind, I agree with Littlefield that the universe of impact investors has to be broadened, which is why I appreciate her wider definition of “impact investor” vis a vis Abt. There is no one type of impact investor, so there is no single approach or type of funding that will ensure success.
<blockquote>the universe of impact investors has to be broadened.</blockquote>
Abt’s search for a big business fix is not realistic. Yes, there is a lot to say for economies of scale, access to cheap capital and the big data that big players bring, but can we trust these companies to care for small impact investment projects, especially in cases of global economic headwinds? Will they let them fall by the wayside when they need to make revenue projections for a particular quarter? To succeed, the impact investment sector will need a broad and diverse community of investors. As we move forward, millennials will drive this diversification.

If you’ve read this article, chances are you have a lot on your mind regarding the impact investing and how it affects financial inclusion. We’d like to hear from you! Please write your opinions in the comments below and let the world know what you think.

The Future of Impact Investing: CFI’s Take on Dueling Views

North America

Equity Investing

Impact Investing

Responsible Investing

Social Impact Metrics

Blog Post

This virtual dialogue provides an opportunity for the <a href="/about/what-we-do/africa-board-fellowship-program/">Africa Board Fellowship</a> (ABF) network and <a href="/about/what-we-do/fiec/">Financial Inclusion Equity Council</a> (FIEC) members to discuss the role disruptive technologies play in advancing financial inclusion. This dialogue will also provide opportunities for peer exchange on investment evaluation and which technology solutions have the potential to be the most disruptive.

Discussion Topics:
<ul>
 	<li>The theme of financial inclusion week is “getting inclusion right”. What role do disruptive technologies have in advancing that agenda?</li>
 	<li>What are the most innovative and disruptive technologies that you are seeing in the FI sector?</li>
 	<li>Are there technologies from other sector that we should be watching/following?</li>
 	<li>How can investors evaluate different technologies for financial inclusion? What criteria to you use to assess which technology solutions have the potential to be the most disruptive?</li>
</ul>
Featuring:
<ul>
 	<li>Wayne Hennessy-Barrett, CEO, 4G Capital, ABF Fellow</li>
 	<li>Ami Dalal, Managing Director, FINCA Ventures, FIEC Member</li>
</ul>
Moderator:
<ul>
 	<li><a href="/bio/danielle-piskadlo">Danielle Piskadlo</a>, Director, Investing in Inclusive Finance, CFI</li>
</ul>
&nbsp;

&nbsp;

Webinar: Disruptive Technologies Advancing Financial Inclusion

Africa Board Fellowship Program

Financial Inclusion Equity Council

Financial Inclusion Week

Challenges and Crises

Enabling Environment

Financial Service Providers

Financial Technology

Trends

Webinar

The words “offshore” and “tax-haven” are often taboo rhetoric within the investment space. In this paper, the Financial Inclusion Equity Council (FIEC), with support from CFI, explores why and how equity impact investors use offshore vehicles. Our findings reveal that offshore vehicles offer key operational, legal, tax and reputational advantages and are a key part of the impact investment landscape.

Through interviews with Financial Inclusion Equity Council (FIEC) members, we sought to better understand the scope of offshore usage in financial inclusion and the factors at play when impact investors select a fund domicile. Convenience, transparency and reputational advantages are among the strongest drivers for choosing to offshore. However, divergent views exist among FIEC members regarding the tax implications of offshore vehicles.
<h3>Major Findings</h3>
<ul>
 	<li>Impact investors have legitimate reasons for using offshore financial centers (OFCs)—and tax status is not the driving factor. The main factors for choosing OFCs include:
<ul>
 	<li>Administrative Efficiency: OFCs have the legal, financial and administrative infrastructure in place to facilitate investment.</li>
 	<li>Human Capital: Accordingly, OFCs have specialized staff on hand to manage investments, such as lawyers, accountants and auditors.</li>
 	<li>Reputation: OFCs are reputable vehicles in international investing, which helps to validate their use for financial inclusion.</li>
 	<li>Convenience: OFCs may serve as a neutral base for multiple investors. Favorable time zones, shared language and currency also add to their accessibility.</li>
</ul>
</li>
 	<li>Two divergent perspectives exist between North American and European investors regarding the tax implications of OFCs. The North American perspective prioritizes tax minimization for shareholders/investors, while the European perspective prioritizes paying their fair share of taxes to the offshore country.</li>
</ul>
Challenge your assumptions about offshore funds and learn more about how these financial instruments contribute to financial inclusion.


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&nbsp;

Offshore Financial Centers for Financial Inclusion

Report

As the microfinance industry matures, a question that has come into sharper focus is how social investors committed to advancing responsible finance practices should “exit responsibly” from the microfinance institutions (MFIs) in which they have invested over the years. As they prepare to sell their stakes, what options do development-minded investors have to help ensure responsible behavior by their partner MFI into the future and healthy development of the broader market?

In this paper the Center for Financial Inclusion at Accion (CFI) and the Consultative Group to Assist the Poor (CGAP) seek to spark discussion among the stakeholders working to advance financial inclusion and in particular the investor community that will result in greater clarity around the goal of responsible exits and the policies and practices that would support it.

The Art of the Responsible Exit in Microfinance Equity Sales

CGAP

Responsible Exit

The <a href="http://www.centerforfinancialinclusion.org/programs-a-projects/investing-in-inclusive-finance" target="_blank" rel="noopener">Investing in Inclusive Finance</a> program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

When you think about responsible investing, what comes to mind? Finding investment prospects that can deliver social returns? Perhaps diligent monitoring, with an eye to effective governance? How about when you sell an investment? How can investors remain committed to balanced social and financial goals when passing the baton to someone else?

This last question is the focus of a joint project by the Center for Financial Inclusion and CGAP. With several microfinance equity funds approaching maturity, the issue of equity sales is becoming more relevant, and as part of the project, the team has been interviewing many equity investors to understand how they perceive the question of what, exactly, is a responsible exit? A paper detailing the findings of these interviews, The Art of the Responsible Exit in Microfinance Equity Sales, will be released in the coming weeks.

In the course of these interviews, many respondents used the analogy of children growing up. As early-stage or founding investors, they reach a certain point where they have fulfilled their "parental" mission and are no longer best-positioned to provide the MFI what it needs, be it capital, expertise, or market access. From the investor's perspective, the analogy works. But selling an MFI is less an act of entrusting your child's future to his or her own good sense, along with whatever wisdom you've been able to impart – you are handing the MFI over to somebody else.

Indeed, the better analogy might be that of an arranged marriage: you hire a matchmaker (M&amp;A specialist) to help find a suitor (buyer); you meet with the suitor to find out who he is and what he has done in the past (due diligence); maybe if you're a responsible parent (investor), you ask your daughter (MFI management) for her opinion. All along, you are nagged by one important question – is this a suitable match for my daughter?

Unsurprisingly, buyer selection is a major part of social investors' focus during the process and is seen as the most important way to assure continued attention to the double bottom line. However, investors have a few additional options at their disposal to insure that buyers will stick to their promises and will not lead the MFI away from its primary mission. The most common among these is simply selling a minority stake, relying on other like-minded investors to provide continuity of governance. In one case, a seller included one year employment contracts for key MFI management as part of the sale agreement, thus assuring at least temporary continuity in MFI operations. Several investors incorporated specific commitments to the MFI's social mission and to client protection principles in the shareholder agreement, thus binding the buyer to some degree. Yet another investor was seeking to structure a minority stake with veto power over key institutional decisions, as a means of retaining post-sale control.

Each of these is an interesting exercise in insuring at least some level of continuity or control, even if the suitor turns out to be a dud. However, one institution figured out a way to bypass the process altogether. From the start, it was built on an unusual evergreen governance structure that assured that this commercial enterprise would stick to its social mission. Its initial charter insured that no single investor would have a controlling stake, and gave its board – composed of majority independent directors – veto power over any acquisition that would give a single investor a controlling stake. In effect, the structure gives a purchasing investor a share of the company's assets and earnings, while leaving governance largely outside investor hands. And thus far, this MFI has been highly successful. In effect, the institution rendered the arranged marriage – or any marriage – unnecessary, by choosing to remain single and independent.

Which MFI is this, and how exactly does its governance structure function? And what are the other relevant lessons to investors seeking to sell their equity responsibly? Stay tuned for The Art of the Responsible Exit in Microfinance Equity Sales.

Have you read?

<a href="http://cfi-blog.org/2013/09/23/a-204-million-leap-for-financial-inclusion/" target="_blank" rel="noopener">A $204 Million Leap for Financial Inclusion</a>

<a href="http://cfi-blog.org/2013/03/29/six-to-dos-now-for-responsible-investors/" target="_blank" rel="noopener">Six To-Dos Now for Responsible Investors</a>

<a href="http://cfi-blog.org/2013/07/23/a-journey-to-understanding-risk-as-a-new-board-director-in-governing-banks-mfi-edition/" target="_blank" rel="noopener">A Journey to Understanding Risk as a New Board Director in "Governing Banks: MFI Edition"</a>

&nbsp;

&gt; Posted by Danielle Piskadlo, Senior Program Specialist, CFI

<a href="http://cfi-blog.org/category/investing-in-inclusive-finance/" target="_blank" rel="attachment wp-att-9676"><img class="alignright" style="border:0" alt="" src="http://centerforfinancialinclusionblog.files.wordpress.com/2013/02/untitled2.jpg" width="310" height="54" /></a>The <a href="http://www.centerforfinancialinclusion.org/programs-a-projects/investing-in-inclusive-finance" target="_blank">Investing in Inclusive Finance</a> program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

In 2003, the Council of Microfinance Equity Funds (<a href="http://www.centerforfinancialinclusion.org/programs-a-projects/investing-in-inclusive-finance/financial-inclusion-equity-council" target="_blank">CMEF</a>) was formed by a handful of equity investors in microfinance with the goal of sharing, developing, and disseminating industry best practices in equity investing.

I recently had the pleasure of catching up with Jim Kaddaras, who was Vice President of Special Projects at Accion from 2001-2003. He was instrumental in launching the CMEF in 2003, and also led the charge on the creation of Accion Investments. Jim is now a Partner at Developing World Markets, and is still a Council member.

Q: What did the landscape of microfinance equity investing look like in 2003?  

Jim Kaddaras: It wasn’t much of a landscape – it was more of a scatter shot.

Accion owned stakes in some of their Latin American affiliates and Accion Investments was just launching in 2003. Procredit was a player (they were called IPC back then and their banks had separate names). FINCA had some equity investments and ShoreBank had a smattering of equity holdings.

ProFund had been around since 1995 as the first investment company focused on microfinance equity but it was winding up when the Council started. Africap was just starting, based on the ProFund model. Various other Council members, plus the development finance institutions (DFIs) and several non-profit networks, held a handful of equity investments.

Q: What was the goal of the Council when it was formed?

JK: We felt that by gathering people who had been making equity investments in a one-off way, we could help to develop and disseminate best practices in the field.

Q: Who were the Council members in the early days?  

JK: I believe the founding members were Accion, Oikocredit, Doen Foundation, ProFund, ShoreBank, and Triodos. Other early members were Africap, Andromeda Fund, Calvert Foundation, Citigroup, DID, Deutsche Bank, Open Society Institute, Opportunity, SARONA, SIDI.

Calmeadow in Toronto was also present at the creation. Its founder, Martin Connell, was a Canadian businessman who wanted to do something social and funded a lot of early studies and research.

Q: Where was the first Council meeting? What topics were discussed?

JK: An early meeting was hosted by Oikocredit at their office in Amersfoort, in the Netherlands. The first couple of meetings were focused on getting organized as a Council, discussing who else should be invited to join the Council, and building consensus around the idea of having members pay dues, which was a very controversial topic at the time.

In those early meetings we also focused on setting out the lay of the land as it currently stood so everyone was starting from the same vantage point. And we discussed what type of research and writing the Council should focus on.

Council members represented much smaller organizations back then and we faced issues of how, given our limited capacity, we would cover the world and provide help to MFIs far away. We discussed ways to provide more effective governance in an efficient manner and debated the use of head office staff vs. trusted local directors to serve on boards. We explored the potential for sharing directors among investors in joint investments, and discussed how best to execute this concept of “piggy-backing” off of like-minded investors.

<a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/93-characteristics-of-equity-investment-in-microfinance-a-report-by-the-council-of-microfinance-equity-funds"><img class="alignright wp-image-13906" style="border:1px solid black" alt="" src="http://centerforfinancialinclusionblog.files.wordpress.com/2014/02/cmef.png" width="215" /></a>Q: What were some of the early CMEF publications?

JK: The first Council publication was the <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/93-characteristics-of-equity-investment-in-microfinance-a-report-by-the-council-of-microfinance-equity-funds" target="_blank">Characteristics of Equity Investments in Microfinance</a>, which I co-authored with Beth Rhyne. This report looked at where equity investments were in microfinance by region and country, and so tried to quantify and describe the investment landscape in microfinance. The report also examined the role investors were playing at the time – were they active on boards or passive?

The report also focused on effective corporate governance. It focused on how boards should be organized, which committees were important and why, and how to strike the proper balance in terms of a relationship between governance and management—that is, how to ensure that the power wasn’t tilted too much in one direction or the other so the board was in charge of overall strategy and direction, and management was in charge of executing that strategy and managing day-to-day operations.

Q: What were some of the controversial topics when the Council started?

JK: The Council was made up of pretty like-minded investors so there weren’t too many controversial topics among members. But one of the big issues we discussed was what to do when you didn’t have like-minded investors on the board.

All of the Council members at the time were convinced that there should be a double-bottom line and everyone investing was trying to build the field, so making money was not the leading concern. Over time, it was recognized that to build the field, we had to draw other investors in, and to do that, we had to be able to offer a reasonable return. It seems now that some investors feel the social mission can be subordinated to financial returns, but that didn’t exist back then.

We, as equity investors, were also concerned about the role of NGOs in institutions that had transformed from an NGO into a for-profit entity. Often, the non-profit entity would get most of the shares of the for-profit entity in exchange for the microfinance operations it had previously housed, and we struggled with the issue of an NGO keeping up with the capital needs of a growing MFI. Sometimes the original NGO can act as a brake on the growth of the institution, and this is especially true when a strong founder is involved. It can be hard for the founder to let go of his or her “child.” It isn’t always easy from an investor perspective for the founders to be involved. Sometimes the NGO ends up with diluted shares as a minority stakeholder but there can still be complications (i.e. the NGO requires special rights associated with its shares). An NGO refusing to let go can drag the MFI down.

Now, much more diverse shareholdings make it more challenging to have like-minded investors on the board. It used to be like a family sitting at the table and now, sometimes there are strangers.

Q: Looking forward, what do you think will be important issues for the Council to tackle in the future?

JK: The Council has done the industry a great service in terms of supporting pioneer investors and drawing new investors into the field. Now, the Council’s most valuable contribution will be in continuing to promote the best practices in corporate governance, and in striking the optimal balance between the social mission and financial returns.

It will be important for the Council to help shape where MFIs end up at the end of the day. Is the future of MFIs to become part of the mainstream banking system, or will they continue to operate separately as specialized institutions?

The Council should also focus on keeping the social mission of the MFI. How can we ensure this social mission remains – or is our job as social equity investors in microfinance essentially now done and we should move on to other things?

Have you read?

<a href="http://cfi-blog.org/2013/09/23/a-204-million-leap-for-financial-inclusion/" target="_blank">A $204 Million Leap for Financial Inclusion</a>

<a href="http://cfi-blog.org/2013/03/29/six-to-dos-now-for-responsible-investors/" target="_blank">Six To-Dos Now for Responsible Investors</a>

<a href="http://cfi-blog.org/2013/07/23/a-journey-to-understanding-risk-as-a-new-board-director-in-governing-banks-mfi-edition/" target="_blank">A Journey to Understanding Risk as a New Board Director in "Governing Banks: MFI Edition"</a>

Microfinance Equity Investing: The Early Days of CMEF

This annual Global Microfinance Equity Valuation Survey, published jointly by CGAP and J.P. Morgan, provides benchmarks for the valuation of microfinance equity, to promote market transparency and identify industry trends. It examines the landscape of private equity (PE) deals and valuation trends in the public market for Lower Income Finance Institutions (LIFIs) in developing countries.

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Volume Growth and Valuation Contraction

Valuation

This study is the second update of the original 2004 CMEF study, Characteristics of Equity Investment in Microfinance and seeks to illustrate the changes in growth, expansion and maturity of the commercial microfinance industry between 2005 and 2008. The study quantifies the explosive organic growth, particularly in Asia, in terms of equity, assets, number of borrowers and depositors in the industry.

This study further highlights structural changes in the industry. First, there is a general trend of mean reversion of leverage. That is, as the industry matures, higher levered regions are deleveraging versus lower levered regions. Second, there is evidence that greater financial intermediation is taking place. Microfinance institutions (MFIs), especially in the African region, are clearly using deposits as a way to fund their loans. Third, using the Herfindahl equation, we were able to see concentration effects, particular in high growth regions such as India and Africa. This has clear impacts on competition and ultimately on the interest rates charged. Fourth, we developed an alternative risk ratio to better illustrate the effectiveness with which MFIs are managing their portfolio risk. We see that although Africa has traditionally had the highest PAR-30 ratios, African MFIs are managing their risk prudently from a historical perspective. Asia fares much worse with this kind of metric. Fifth, we do a simple Dupont breakdown of return on equity (ROE) in order to ascertain the main drivers of profitability between 2005 and 2008. Profit margin determined the greatest percentage of variability in return on equity between MFIs. This dependence has clear implications in terms of what type of investor will succeed in the MFI industry. Finally, we present an update on the ownership structure of characteristic MFIs. We see evidence of acceleration in transformations, an increased willingness of local capital to fund MFIs, and a continued effort by NGOs to divest their original holdings.

The Growth in Commercial Microfinance: 2005-2008

Governance

Risk Management

Deborah Drake

Vice President

Daniel Rozas

Danielle Piskadlo

Sam Mendelson

Philip M

Equity Investing

Meet the Experts

Deborah Drake

Filter

Filter

The Future of Impact Investing: CFI’s Take on Dueling Views

Webinar: Disruptive Technologies Advancing Financial Inclusion

Offshore Financial Centers for Financial Inclusion

The Art of the Responsible Exit in Microfinance Equity Sales

The Art of the Responsible Exit in Microfinance Equity Sales

Microfinance Equity Investing: The Early Days of CMEF

Volume Growth and Valuation Contraction

The Growth in Commercial Microfinance: 2005-2008