By guest bloggers Wouter Deelder and Nicolas TheopoldImpact investments, or investments that generate financial and social returns, have grown rapidly over the past few years as investors have begun focusing their assets in areas such as microfinance, SME finance and carbon finance. However, the downturn in financial markets may negatively affect this trend, and presents a risk to the growth of this emerging asset class.
Professional investors, such as pension funds and private wealth managers, have historically allocated few funds to impact investment opportunities. The investments they made were driven in part by corporate social responsibility (CSR), partly to find “alpha” in new areas, and partly by low correlation with traditional assets. Each of these factors has been affected by the current financial crisis.
Furthermore, the diversification benefit of some forms of impact investment has been overstated. Microfinance has been hit by crises in recent years, linked to the global economic downturn.Climate change mitigation is no longer as high on the global priority list as before, and carbon prices have spiralled down as a result. On the upside professional investors may give impact investment another look, seeing the disappointing returns of other alternative assets in the market downturn, such as regular private equity, and the need to find new sources of alpha. However, investors will increasingly concentrate on those top-quartile impact asset managers that have shown they can continue to deliver steady, uncorrelated results in times of crisis.
The appeal of impact assessment for private retail investors also has changed. Although sustainable investment benefits from the general contempt for traditional Wall Street finance, the larger trend is that disillusion with financial assets will push investors back towards traditional charity. Impact investment managers will thus have to increase efforts to prove the greater social impact of investing over donating.
The upcoming few years will be critical for impact investment. The asset class needs to grow to reach critical mass and investors have become more critical and demanding. The foundations and development banks that have incubated this asset class should expect, and maybe even stimulate, a shake-out of non-performing funds. At the same time, they should support well-performing funds, especially in the areas of risk management and social impact measurement, to strengthen performance and accommodate further growth.
Wouter Deelder is a partner in Geneva and the head of Dalberg’s Access to Finance practice. Nicolas Theopold is a Project Manager in Geneva.