Impact Investing: Mainstream Tomorrow?
How many active fund managers have seen the size of their funds double in the past year? One such is BlueOrchard Finance, a pioneer in the field of impact investing, which saw 99 per cent growth in its flagship fund.
BlueOrchard was developed by UNCTAD (the United Nations Conference on Trade and Development) to help grow the market for microfinance. This consists of offering small loans to people otherwise unable to obtain credit, with the aim of enabling them to rise out of poverty. Although a niche concept at the time, microfinance is now well established as a means of supporting people out of poverty while offering financial returns to investors.
When BlueOrchard was launched in 2001, ‘impact investing’ as a term had not yet been coined, but it is now an area of active interest from investors and BlueOrchard has increased its portfolio to include educational finance and climate protection finance.
Although investors are clearly interested in the concept, impact investing has a number of differences from mainstream investment that may require some education for them.
The main challenge is it is much more labour intensive than simply buying listed instruments.
“We manage our assets with 70 people,” says Pierrick Balmain, business development director at BlueOrchard. “A traditional hedge fund or fund might manage such assets with only a few people.”
It follows that these funds are expensive to run, with a much higher total expense ratio than traditional bond funds (most of BlueOrchard’s investments are debt). “But the problem is made ok for investors if they understand why it is so,” says Mr Balmain. The problem is also no doubt eased somewhat by the returns offered. In its 16-year track record, the BlueOrchard Microfinance fund has returned an average annual return of 4.3 per cent, net of fees. In addition, because the debt bought is fixed rate and the fund is hedged against duration, this return is relatively immune from changes in the global interest rate environment.
In recent years, this lack of correlation has been a rare and desirable property in investment portfolios.
It is not only the prescience and caution of having hedged the fund against interest rate changes that keeps the microfinance uncorrelated, as the industry as a whole has remained relatively unaffected by the recent historically low interest rate environment.
For many asset classes, such massive inflows would spell trouble, pushing up asset prices and even lowering the quality of instruments used. In microfinance, however, there are a number of mitigating factors.
The good thing is that we are working with institutions that have a 20 per cent organic growth rate, then there are new institutions and new opportunities on top of that.
Currently the BlueOrchard pipeline of potential deals is bigger than its funding, so provided the capital comes in fairly smoothly, Mr Balmain has no concerns about putting the money to work effectively.
Neither regulation nor impact measurement
As a relatively small and new market, impact investing and microfinance are not a huge object of regulatory activity.
Luxembourg has attempted to encourage microfinance fund managers to set up in the jurisdiction with a waiver on withholding tax for these funds, but that is as far as it goes. There is no regulation on how the social impact of the funds should be measured or reported, but this is largely because it is such a broad sector, ranging from $100 loans to women in India to bonds issued to raise capital for climate mitigation projects.
“Maybe one big step the regulators could take would be to help make the asset class mainstream,” says Mr Balmain. “At the moment, they are usually classified as alternative investment funds, which makes them more complex to sell.”
If it were possible to package impact investment as Ucits funds, retail investors could join the professional investors who are now looking at the asset class.
A new mindset
Increased interest in impact investing has been driven by a variety of factors: Mr Balmain cites the UN Climate Change Conference (organizer of COP), the Paris Agreement which came out of COP21, increasing awareness of the UN’s Sustainable Development Goals.
“But also there is a general change in mentality among investors,” he says. Investors are motivated to make the world a better place by putting their money to work with that specific goal. The outcome, he hopes, will be to drive greater innovation in developing financial instruments towards this goal.
He points to the development of “blended finance”, where public money can be used as a backstop to encourage private money into the sector. The BlueOrchard InsuResilience Investment Fund, which funds climate insurance, for example, is backed by KfW, the German development bank. However, the long term aim of these types of innovation is always to make the impact investment independently sustainable, once the structure has been sufficiently developed.