South African pension funds have directed capital into impact funds for more than two decades. This is evidenced through Futuregrowth’s track record in managing impact investments for more than 25 years on behalf of our clients, with approximately R48 billion invested in infrastructure and developmental sectors. These have been held across a variety of debt and equity asset classes and have delivered risk-adjusted returns, in addition to tangible social and developmental impact over the years.
In considering the complexities of impact investing, we have to remind ourselves of our role as institutional investors. When we have a mandate from pension funds to deploy funds into impact investments, we also have a fiduciary duty to the pension fund beneficiaries to create commercial risk-adjusted returns, in addition to creating impact. Therefore, we should report equally and diligently on both – yet as an industry we continue to fall short in evidencing the impact of our investments.
Show me the impact
Why is impact measurement and reporting such a challenge for investors? After all, we have the necessary frameworks, tools and metrics to support the process. Could this be a function of the fact that in some instances, the effect cannot easily be captured into a metric and that the inherent human element that inevitably brings subjectivity into the process?
There is a wide divergence of opinions on what is meant by meaningful impact and where priorities should be placed. One investor might place a bigger preference on affordable housing to address the backlog in the country, whereas another might prefer to address the infrastructure backlog, believing that this achieves impact on a broader scale. How does one rate the social value of one project over another?
In our experience, a combination of all of the above needs to be taken into consideration when measuring and reporting on the impact of any investment. Having a credible foundation, then planning, reviewing and adjusting our approach in response to new insights can assist in overcoming the above challenges.
Where do investors start if we want to make a measurable impact?
Creating an impact measurement pathway
A good place to start is to see if we can align our broader impact goals and outcomes to SA’s National Development Plan (NDP). As an emerging economy, the government has outlined several areas that are intended to promote economic, social and environmental impact and stimulate the economy in order to eliminate poverty and reduce inequality by 2030.
The next step in creating an impact measurement pathway is to identify the areas or sectors of focus that align with our impact goals and objectives. We then need to identify investable opportunities (through debt or equity or a combination of both) to deploy capital.
Moving from impact goals to intent and measurement
The impact goal and intent is what differentiates impact investors from so-called ordinary investors.
A clear intent outlines what we expect to achieve by investing in a specific sector or company. This means that social outputs and outcomes can then be defined up front. Specific indicators and metrics can then be used to measure the “success” of the investment, and reported to beneficiaries and stakeholders as evidence of the outcome and impact achieved.
A framework for incorporating impact considerations into all stages of the investment process will ensure that there is cohesion and integration throughout the life cycle of the investment. The International Finance Corporation (IFC) Operating Principles for Impact Management outlines this process across four pillars:
Applying the theory
A case study may help to illustrate how the steps set out above might play out in practice. This is a study of Futuregrowth’s investment in Retail Capital, a merchant cash advance business that focuses on funding the South African SME market.
Alignment with the NDP and United Nations Sustainable Development Goals (SDGs)
Access to working capital is considered the biggest challenge faced by SMEs in South Africa. This exclusion has consequences for a country’s economic growth and transformation. Accordingly, the South African Government has prioritised the acceleration of financial inclusion in the NDP, with plans to increase financial inclusion by 90% by 2030. Some progress has been made towards achieving this goal. In 2006 South Africa was 1% away from attaining this goal but financial systems remain under-developed when compared with other developing economies (Banking Association of South Africa, 2015).
In addition, the research paper ‘Achieving the Sustainable Development Goals. The Role of Financial Inclusion published by CGAP and the UNSGSA, emphasises how including small to medium-sized businesses in the financial system can play a major role in achieving many of the Sustainable Development Goals with the aim of “ending poverty, improving health and education, reducing inequality, and spurring economic growth.”
Impact goals and intent
Both studies prompted Futuregrowth to consider a broad impact goal to “promote inclusive growth and financial inclusion” with the strategic intent to “seek opportunities to close the existing gaps in access to finance for SMEs in South Africa”.
Such an opportunity arose in 2017, when Futuregrowth, on behalf of its clients, took a non-controlling stake in the shareholding of Retail Capital, a merchant cash advance business that focuses on funding the South African SME market.
“Retail Capital partners with you through innovative funding solutions, where flexible repayment options are determined by your business performance. Since 2011, we have provided businesses with innovative, flexible and convenient alternatives to traditional business loans. Business owners still identify access to working capital as the single biggest challenge that they are faced with. With small to medium-sized businesses (SMEs) responsible for 50% of the country’s GDP and contributing to over 65% of employment, we are devoted to partnering with entrepreneurs to grow the South African economy. We are proud to have partnered with over 22,000 SMEs in providing funding of over R3bn to date.” - Retail Capital
Metrics and impact measurement
Futuregrowth used a range of metrics and indicators to assess the outcomes and impact of its investment in Retail Capital.
Table 1: Measuring impact
In addition, the impact was monitored against predetermined metrics to assess whether the desired outcome and impact was achieved, as illustrated below. This process was refined over time, to ensure its integrity and that it remained relevant.
Risk management: but not at the expense of impact
As indicated in the backdrop to this article, risk-adjusted returns are a vital part of impact investing.
Any number of financial and non-financial risks could impact the long term sustainability of such an investment. In addition to understanding the impact of an investment, it is prudent to understand the risks (these include financial and non-financial risks e.g. environmental, social and governance), since these could affect the long-term sustainability of the business. This element should form part of the investment life cycle and be embedded as part of the investment process.
The potential risks associated with the Retail Capital business were researched, debated and deliberated at length prior to investment and priced for accordingly, based on the materiality of the risks. In this way, a level of comfort was achieved that the fiduciary responsibility in the use of our clients’ funds was honoured.
Each investment is likely to be unique, with its own idiosyncrasies and metrics, which will vary from sector to sector. As indicated above, impact investing is an evolving process, with ongoing improvements based on the lessons learned as we go along. Clearly defining our intent, objectives and measurements up front, so that there is alignment between investors, investee organisations and beneficiaries can go a long way to making this a meaningful and sustainable process.