This article originally appeared in the Trialogue Annual Sustainability Review, a copy of which is available here.
Impact investing is an increasingly effective driver of socio-economic development in South Africa. It draws on the power of capital to advance business models and entrepreneurs that intentionally create and combine social, environmental and financial value. The question is: in a country where corporate social investment and BBBEE take up much of the impact spotlight, what is the role and future of impact investing?
Are you interested in impact investing and wondering what the sector looks like in South Africa? Google ‘impact investing in South Africa’ and you’ll find that only a few relevant funds and sources come up. Now search ‘Impact investing in Kenya’. Titles such as ‘Impact Investors in Africa are looking East’ and ‘East Africa emerges as a global hub for impact investing’ appear; painting a picture of a booming, if still nascent, industry.
Does the scarcity of resources and hype reflect a non-existent impact investing industry in South Africa? No. However, it does depict a market that differs significantly from the rest of the African continent. These very differences hold significant opportunities for growth.
The perception of South Africa undersells the reality
According to the Global Impact Investing Network (GIIN), SA is the regional powerhouse for impact investing in Southern Africa. The GIIN recently published a comprehensive map of the impact investing landscape in East, West and Southern Africa, revealing that South Africa is the single-largest market for impact capital in Southern Africa. Nearly three-quarters (74%) of all impact capital disbursed in the region has been placed in South Africa, amounting to $4.9 billion, excluding investments from local and international development finance institutions. In comparison, the equivalent number for Kenya is $1.4 billion.
Why the discrepancy between perceived reality and the hard numbers? One explanation is that the term ‘impact investing’ is not widely adopted in South Africa.
In the past two decades, as the country sought to rebuild and transform its economy, the impact spotlight has been on mandated BBBEE spend in the areas of socio-economic development (SED), corporate social investment (CSI), and enterprise development (ED). That spotlight, as well as a strong traditional divide between the non-profit and commercial space, to some extent has hindered the uptake of the terms ‘impact investing’ and ‘social enterprise/inclusive business’. From both sides of the aisle, there is discomfort in blending social impact with business.
Sectors such as education, health and financial inclusion are key to impact investors in countries like Kenya. In South Africa, these sectors are largely serviced by the public sector. Where this is not the case, non-profit service providers fill the breach, often subsidised by international donor funding and local giving. Ultimately, this creates a less obvious market opportunity than related activity in countries such as Tanzania and Kenya. Nonetheless, with South Africa being one of the most unequal societies worldwide, this doesn’t mean that impact investors don’t have a role to play; rather, it means they have to be more creative in their approach.
Innovative models emerging in South Africa
Local investors don’t easily identify with the term impact investing. Some SA investors who not only state and track their social impact, but even remunerate their employees based on impact performance, do not consider themselves impact investors. However, whether or not they identify with the concept, many trailblazing investors and fund managers have committed to investing in companies that blend commercial and social viability.
Examples of such investors include Futuregrowth, Mergence Capital, Ashburton Investments, Goodwell Investments, Knife Capital and Edge Growth. Some, such as Edge Growth, make strategic use of corporate funding released as a result of compliance with the enterprise development section of the dti’s BBBEE Codes to invest in early stage enterprises focused on job creation and the creation of social and environmental value. Others, such as Knife Capital, leverage investments from high net-worth individuals in order to pursue their mandate.
The impact investing spotlight in South Africa often highlights the very early stage, seed capital space. This is increasingly populated by angel investors and foundations, and awarded at pitch competitions. A social entrepreneur with a good idea and the right access will not struggle to find R1 million in funding from such sources. The struggle comes when the business is ready to scale and grow. That is where the new investor trailblazers have a role to play.
Mergence, for instance, specialises in South African equity funds, absolute return funds and socially responsible impact funds. The group’s impact investing began in 2006 with the launch of its first private real estate equity fund, focusing investing primarily in previously underserved township communities. This fund grew into what is now the Dipula Income Fund, which was listed on the Johannesburg Stock Exchange in 2011. In 2010, Mergence launched its own impact investment product offering with its ESG Equity, High Impact Debt and SRI Funds. Mergence’s High Impact Debt Fund is recognised as a Global Impact Investing Rating System (GIIRS) Pioneer Fund. Another example is Goodwell Investments, which provides early stage capital and technical support to companies primarily operating in the financial services and technology industries and targets companies that serve the Bottom of the Pyramid (BOP) emerging consumer segment. To date, Goodwell has invested in 20 financial inclusion businesses, providing more than $1.5 billion in financial services to over nine million families.
South Africa’s impact investors are partnering with emerging social enterprises such as Nomanini, a South African-based enterprise payments platform provider that enables transactions in the cash-based informal retail sector. Other examples include AllLife Insurance and Zoona. More mature businesses are benefiting too, both in the for-profit as well as the not-for-profit space. Examples of these include TUHF, the Kuyasa Fund and CareCross (recently acquired by MMI). One of the attractive features of South Africa for impact investors is the greater opportunity for exits, largely due to more developed financial markets and the growing private equity industry.
Blended finance enables social impact and financial returns
Another attractive feature, which has not been explored sufficiently to date at the southern tip of the continent, is the global trend towards blended finance. In essence, blended finance makes use of public and philanthropic capital to lower the risk for investors pursuing a market-rate return.
One of the most enduring misconceptions about impact investment has been the perception that financial returns are sacrificed in favour of social return. Although the subset of impact funding data we have is small compared to the overall market, we are beginning to have access to enough data points to suggest that impact investments do not necessarily underperform the market and that investors do not expect them to do so.
According to the 2015 Cambridge Associates and GIIN Report ‘Introducing the impact investing benchmark”’, small impact investing funds (under $100 million), started between 1998 and 2004, returned a net internal rate of return (IRR) of 9.5% to investors, handily outperforming similar-sized funds in the mainstream comparative universe (4.5%). These data reinforce investor sentiment towards social impact. In 2015, a JP Morgan report found that approximately 27% of survey respondents said the social impact of their investment had outperformed their expectations. While their impact investments had not beaten their financial expectations, only 9% of respondents were disappointed with the financial returns. Although these are not definitive findings, they point towards a general trend of positive financial and social returns.
Blended finance – the potential for South Africa
By its very nature, impact investors, especially in early stage investing, are to varying degrees, comfortable taking on more risk than mainstream investing. The impact investing category spans different types of capital providers; from early stage seed funders providing high risk capital over a long time horizon, to investors expecting more market-rate returns over a shorter term. Increasingly, these investors come in at different stages and complement each other in setting up funds as well as the structuring of deals.
One of the most significant trends in impact investing is the blending of public and private funds in order to limit the risk exposure of investors and drive more capital towards social and environmental outcomes. Earlier this year, the global blended finance platform, Convergence, was launched to help connect the impact investing family and “magnify the impact of public and philanthropic investors’ funding by attracting additional private capital towards investments that deliver social, economic, and environmental impact”. Another example, USAID, has two catalytic programmes for blended finance: the Development Credit Authority, which provides guarantees to local financiers in emerging markets; and the Partnering to Accelerate Entrepreneurship (PACE) Initiative. PACE aims to catalyse private-sector investment into early stage enterprises and identify innovative models that help entrepreneurs to bridge the pioneer gap, which occurs between the early stages in an enterprise’s growth, when it is not considered investable by many impact investors.
The ASISA ESD Fund, managed by Edge Growth, is the first South African awardee of the PACE Initiative. The recent investment aims to enhance the existing support provided to early stage SMEs through the fund as well as crowd in additional private sector capital. It is an interesting example of how donor money – which is by nature public – ED funding and private sector capital is blended to fund early stage enterprises in South Africa.
The aggregated BBBEE spend for corporate SA equals about R8 billion for CSI and R50 billion for ED. Thus a combination of the public capital committed to social outcomes and the mandated corporate CSI and ED spend can increasingly be used to encourage private investment. Combined, this could unlock significant sums to fund inclusive businesses that not only create jobs, but also work to create social impact.
In the UK, which has one of the most developed social investment sectors worldwide, key policy enablers and strong intermediaries have largely driven the development of the industry. In the midst of these strong intermediaries in the UK is Big Society Capital, a fund of funds that invests in social investment intermediaries. The Bertha Centre and partners are currently exploring whether a similar structure could be adopted in South Africa; using public funds to reduce the risk impact investing funds face by providing outcome payments linked to metrics that might include job creation, health and education for early stage investors. This would ultimately also serve to increase the co-ordination between capital committed to impact by creating hand-over mechanisms between early stage and growth capital providers. Creating these linkages is key to the development of the impact investing industry, as it would contribute towards building a pipeline of investable social enterprises, a vital need if the industry is to continue on its growth path.
In addition to providing seed funding, policymakers can pave the way for an attractive impact investing market for private capital; for instance, through applying tax credits and/or regulatory mandates, as has been done in the UK, US and elsewhere.
In 2014, the G8 Social Investment Task Force published a comprehensive set of policy recommendations for social investment. Many developing countries have started to investigate and implement these ideas. As South Africa has started developing a social investment market, it is currently being groomed to participate in the G20 Social Investment Task Force. In 2011, changes to Regulation 28 of the Pension Fund Act increased to 10% the proportion of a pension fund’s portfolio that could be invested in alternative asset classes, many of which, including unlisted equity, are favoured by impact investors. Although pension funds’ typically conservative investment mandates have so far limited the extent of investment in these asset classes, the revisions to Regulation 28 are an example of how policy can be used to encourage more investment towards social outcomes.
Value-creation for the many
Policymakers, fund managers and entrepreneurs are increasingly coming together to build an impact investing industry in South Africa – though it might not be coined as such. Building on the existing infrastructure and committed capital, the country stands poised to be an impact investing powerhouse on the African continent. Innovative financiers, high net-worth individuals, corporates, foundations, fund managers, asset managers and financial portfolio managers can seize the opportunity to participate in the impact investment market. By partnering with and leveraging existing CSI and BBBEE capital to advance business models and entrepreneurs that also create social impact, these providers of capital can create value for both shareholders and the wider South African community.