This article is sponsored by Development Partners International
You’ve been working in both environmental, social and governance implementation and impact investing for some time. From your vantage point, what is the difference between the two?
Runa Alam: There is confusion in the market around these terms. Although impact and ESG are different, they bleed together. We’ve been doing both since inception – for more than 13 years. ESG is applicable to companies and funds and is meant to supplement investment or corporate work. Impact work started with funds designed to deliver social or environmental impact. ESG tends to correct practices while in impact the industry focuses on measurement as one would do in the finance world. We are investors in Africa, where development finance institutions, including our LPs, have driven the agenda around ESG and set standards based on a ‘do no harm’ principle. For us, ESG is not an aspiration; it’s in our DNA. We have a lot of experience and also historical data demonstrating what we’ve got right and wrong.
Regarding impact, we’ve reported on impact since DPI was founded. What’s changed over time is that with our current fund [African Development Partners III] we declared intentionality and formalised the way we measure outcomes. Those are key to impact investing.
Michael Hall: Broadly, ESG focuses on the management of risk around specific topics. LP expectations are very clear. Impact is about establishing what your impact outcomes will be, disclosing this at the beginning of your investment, and then developing a system to measure that impact. Managers need to demonstrate how, using investment capital or direct engagement or value-add propositions, they reached that outcome.
Through ADP I and II we have invested in growth companies employing more than 40,000 individuals. Through portfolio company expansion and acquisition we’ve helped create 18,000 new jobs. The direct impact on employees is huge, and also their families and communities, as is how our companies operate and the services they offer to their customers. Looking at that structure, we realised our ability to create impact outcomes was significant. As a result, for ADP III, we have collated the impact we already measured and reported and formalised them into a defined impact agenda.
Among the range of possible impact outcomes, where do you focus?
RA: Our overarching principle is that our work generates a positive outcome for Africans and Africa. Beyond that we thought through where we had the expertise to deliver impact, and what is important to DPI and it’s stakeholders. We chose three buckets that are organic to who we are and what we’ve done. They are gender balance, job creation and enhancement, and climate change. These correspond with UN Sustainable Development Goals five, eight and 13, respectively. When we undertake due diligence, should we identify a possible impact outside these three areas, we will include it in a fourth bucket.
For instance, we invested in Sicam, a Tunisian agri-business that supplies farmers with seeds, technical support, financing and other agricultural inputs. Through that investment we can execute initiatives with implications for climate change, for instance around water use, as well as levels of farmer income, which both sit within our target SDGs. But then there is also addressing food waste, which relates to SDG 12 around responsible consumption and production. And distributing food more efficiently serves SDG 2, zero hunger. We can address those too.
Gender equality and diversity are front of mind for many managers. Can you share with us an example of on the ground impact you’ve had?
RA: Gender equality has been one of DPI’s impact goals since the very beginning. We are a gender-balanced firm and from that foundation we’ve been able to talk about it with our companies. There’s a lot of data showing that women’s involvement in the workforce, especially in emerging markets, leads to more productivity, as well as improved health and educational outcomes. And we’ve seen that in action.
For example, we invested in Nigerian food retailer Food Concepts through Fund I and II. The business operates the well-known Chicken Republic brand – the fastest growing quick service restaurant chain in West Africa. We have worked with management to promote women at every level, including from the shop floor into managerial positions. Today, more than half of the staff is female and of the seven ex-co members, four are women.
This business is also working to build greater gender balance into its supply chain and has increased the number of women-owned and led businesses it uses. It is now focusing on increasing gender balance in really strategic areas like construction and logistics. We’re really proud of our work there.
For new funds wanting to move into impact, what are the pitfalls or challenges?
RA: To me the biggest requirement, beyond understanding impact and having a specific strategy, is that managers must have investment expertise. Whatever returns they discuss with LPs they must be able to deliver them. On the flip side, for a commercial fund wanting to invest in impact, the biggest challenge is integrating an impact approach throughout the entire firm. It requires ownership from the top down. Every firm has to find the balance between pursuing what is important in terms of impact and the time and resourcing required for successful execution of the investment thesis. That is the tricky thing.
MH: One of the major pitfalls is not having a clear investment thesis and the chosen impact measures. Launching an impact fund without a clear description of intent is an early mistake that is difficult to fix. Impact investing is hard work. It’s a complicated process that needs to be well thought out by each GP for each new fund and must be made clear to LPs.
Then the work really begins: working with the portfolio companies to achieve the impact goals, while also keeping companies sustainable through generation of returns. Many managers are quite passive, preferring to identify good opportunities and operate through the board. We have a structured approach toward engaging with our portfolio companies at different levels and in different functional areas, which involves our investment professionals, portfolio managers and ESG teams. We do at least one impact and ESG site visit a year to talk about the objectives we are trying to achieve and monitor performance.
Impact is evolving rapidly. Where’s it headed?
RA: Innovation in measurement would have enormous implications for the asset management industry. Some funds are described as impact because of the industries they invest in, and some invest specifically in impact. Finding common ground where funds can be measured against each other would allow LPs to choose GPs, and perhaps bring more capital into the industry.We invest in healthcare, pharmaceuticals, microfinance and banking, and agribusinesses which are impactful sectors tied directly to UN SDGs. We have a double impact because we choose to have intentionality through our impact agenda which we measure, and we have a triple impact because we are in Africa, where small interventions can have significant impact in the lives of Africans.
MH: I totally agree. There needs to be metric harmonisation. There are existing metrics and measurement standards like HIPSO and IRIS+ from the Global Impact Investing Network, but we need to move to an expanded set and find a common framework for impact assessment. In fact, the number of approaches out there creates confusion because there are different types of data and ways to measure and report it and some impact managers also use a bespoke process.
RA: A further step forward would be if the asset management industry recognised impact investing as a definitive asset class. There is an appetite within endowments and pension funds for riskier assets and emerging managers. Impact investment with equity return goals are not dissimilar to these buckets. Having an asset class would channel more capital into this area. This, along with clear measurement metrics, might lead to significant global change in areas such as poverty alleviation and climate change.
And finally, is it different investing in impact in Africa than in other regions?
MH: The impact work is not different, but the results are. The impact outcomes in Africa are more significant relative to the capital invested. For a European manager investing in Europe, achieving significant impact outcomes would be a more complicated proposition and require more capital.
What was DPI’s process in developing its impact management system?
MH: Based on our experience with our previous two funds, we analysed where we could have the most influence to affect change. Then, in consultation with existing LPs and others that we considered to be leaders in the impact and ESG space, as well as an internal survey, we created a new integrated ESG and impact management system.
Some of the most accomplished DFIs and pension funds interested in impact gave us significant feedback on the system, which sets out DPI’s strategy around ESG and impact and establishes the standards we work to for both.
It is designed to align with the Operating Principles for Impact Management and its methodologies, launched in April last year and to which DPI is a signatory. The Operating Principles require signatories to submit an annual public disclosure statement detailing how the principles are integrated into the investment process. That’s on our website.
There is also an emphasis on regular independent verification of the signatories’ alignment with the principles. Increasingly stakeholders require verified impact reporting assured by an independent third party and Fund III will go through this process in Q1 2021.
Additionally, our ESG and impact management system details the expectations on each of our staff at every step of the investment process. We did this to make sure that the burden on our business was as light as possible and that we were making the most of the efficiencies built into the way we work, as well as to ensure the burden on our portfolio companies was not significantly increased by our impact agenda.
By carrying out impact due diligence we can understand the investment more holistically together with its prospects within its geography. That’s really useful to our investment professionals who incorporate that information into their thinking about the business plan.