Social Impact Investing

Impact Investments:
An emerging asset class
Global Research
29 November 2010
Appendix I: Managing impact investments
One of the most challenging aspects of participating in impact investments is
managing the risk. It is an asset class where we find peculiar financial behavior – as
evidenced by the flat yield curve from the Calvert Foundation database as analysed
in Appendix V: Additional Returns data – and many investments will be made in
countries where even hedging currency moves can be a challenge. Still, the risk
management is not unlike that required for venture capital or high yield debt
investments, particularly in emerging markets.
The risks for impact investments are similar to those for venture capital or high
yield debt investments, with heightened reputational risk
A venture capital or high yield debt investment can be characterized by the earlystage
nature of the business in which the investment is made. Many impact
investments are similarly early-stage private companies that often operate on small
scales. These kinds of investments involve several different types of risk typical in
traditional investments, including: company risk, country risk, and currency risk.
Further, and particular to impact investments, are certain legal and reputational risks
that arise especially when operating in emerging markets and with vulnerable
populations. We start by discussing these impact investment-specific risks, and then
return to the more general financial risks that investors will need to understand.
Legal and reputational risks
When setting up a new business, there are always legal and regulatory hurdles that
will take some resources and time to accommodate. This can be amplified for impact
investments, particularly when operating in emerging markets. We will focus on
those cases in this section, and acknowledge that some of the same will be true in
developed markets, but (hopefully) to a lesser extent.
Legal and regulatory infrastructure in local markets can be onerous
In his book The Mystery of Capital, Hernando de Soto puts forward the theory of
“dead capital”: That in too many countries the barriers to legal ownership result in
informal ownership that then inhibits the owner from later being able to realize the
value of assets. De Soto points out that many transactions in emerging markets are
not legally enforceable transactions. The "obstacles to legality" include the sheer wall
of bureaucracy that can face business or asset owners, and the cost of legal
registration. For example, in Peru, he cites that it took his team 289 days of working
six days a week to fully register a garment workshop, which then cost them $1,231 –
31x the minimum wage. According to de Soto, 4.7 million people in Egypt chose to
build their dwellings illegally rather than face the 77 bureaucratic procedures that
could take anywhere from five to 14 years 99 . Particularly if the scale of the business
is small, the time and resources required to obtain approvals and secure legitimacy
for the business can be very onerous. Water Health International, a business that sells
purified water to BoP customers cites the ability to get all the necessary paperwork
completed as one of the main hurdles to successfully building scale in their business.
In addition to legal and regulatory challenges upon inception of the business, there
may also be changes to legal and regulatory regimes over time, or challenges to
99 The Mystery of Capital, Hernando de Soto, 2000
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