(January 27, 2014) — Five risks are deterring investors from embracing impact investment, but the good news is all of them can be mitigated, according to Bridges Ventures.
The specialist asset manager worked alongside Bank of America Merrill Lynch to find resolutions to the most common barriers cited by investors.
These: capital risk, exit risk, being able to prove that diverting funds from other opportunities is worthwhile, transaction costs, and the perceived black box attitude to impact investments.
These complications have led to the two financial institutions producing a de-risking toolkit to encourage more institutions to invest in this sector.
For the five risks, some seven techniques were found by interviewing investors who were already investing in impact assets from around the world.
The first thing to do is to select the right form of downside protection, the report said. For some investors, that could mean using a “capital stack”, where they hold junior equities for the first layer of protection, preferred equity or mezzanine debt for the second, and senior debt the third. Each layer’s potential financial returns from the underlying investment are commensurate with the risk they are taking.
For lower risk investors, synthetically building forms of downside protection, through collateralisation for example, could be a better fit, the report said. Bundling products was also advocated to negate capital risk, as well as lessening transaction costs.
Selecting liquid impact assets mitigates against exit risk, while garnering a robust understanding of the placement and distribution of the assets, their track record, and deploying technical assistance—such as staff training and improving corporate governance—can help lesson the unknown risks, the report said.
Finally, the report called on investors to challenge managers to produce more robust impact evidence. This should consist of a clear strategy defined by stakeholders and managers, good primary research, and analysis of their cost effectiveness to help investors benchmark the returns appropriately.
“A product with strong impact evidence focuses not just on its target outcomes but also on its wider stakeholder impacts, in order to spot and manage any negative unintended consequences or externalities and, ideally, turn these into value creation opportunities,” the report continued.
Clara Barby, head of impact at Bridges Ventures, said investors might be tempted to wait until impact strategies had proved themselves, but some of the societal challenges that impact investments can address are “too urgent”.
“By clarifying some of the key risks and exploring features that will mitigate them, we hope that more investors can participate in the market and more impact-driven organisations can access the capital they need,” she added.
Andrea Sullivan, head of corporate responsibility for EMEA and Latin America at Bank of America Merrill Lynch, said the development of a robust market for impact investment was an “important progression in creating a healthy economy”.
She added: “Impact investment is currently still a niche activity and, in order to broaden the market, it’s essential to clarify and mitigate the associated risks so that we can connect more capital with need.”
The full report can be found here.
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