Social Impact Investing

Impact Investments:
An emerging asset class
Global Research
29 November 2010
Financial risk: Company, country and currency
Company risk
Company risk is the risk affiliated with the particular entity in which the investment
is made. As impact investments are often private companies, due diligence is key in
ensuring that the company applies sufficient rigor in its accounts and operations. In
this respect, impact investment is not unlike traditional venture capital where a
premium must be placed on understanding and vetting the character and capabilities
of the management team. For impact investors buying directly into a company,
visiting the premises of the company and getting to know the management can
provide some insight as to the policies and procedures by which the company abides.
For fund investors, visiting the fund headquarters as well as some of the portfolio
companies will similarly provide comfort in the management practices. Many of
these companies and funds will also be first-time operators, so investors should
expect some degree of learning from mistakes as processes are refined.
However, there will be several risks that can arise even for a diligent management
team. Fraud can be just as common in these investments as it is in other companies.
Political challenges can also crop up if the company is disrespectful of community
culture or it is seen to be competing with initiatives already attempting to deliver the
same product or service. For example, in 2008, local politicians in Pakistan were
encouraging borrowers to withhold repayments on their microfinance loans, feeding
into a more general “borrowers’ revolt” in that region 103 . A similar problem arose in
Nicaragua when a group of politically influential borrowers in one northern region
decided to forgo their payment obligations 104 . Given the sensitive nature of the
services provided, in many impact investments, businesses must recognize that they
are dealing not just with customers but with citizens who can mobilize political
opposition to collateral collection or debt payments. If the company fails to manage
these kinds of risks, the financial performance of the company and the investment
will suffer.
Hedging company risk is most commonly done with credit default swaps for larger
companies. For impact investments, it is unlikely that there will be liquidly traded
credit default swaps, and shorting bonds or equity is unlikely to be possible. The best
protection against credit risk is likely to be a thorough due diligence process both at
the time of investment and throughout the investment holding period.
Country risk
The political risks that we mentioned on a community basis can challenge an impact
investment when they occur on a national scale. Country risk is common to
investments made in emerging markets, whether impact investments or traditional.
The recent financial crisis has shown, though, that country risk can significantly
affect investments made in the developed world as well. Sovereign stress can come
in the form of heightened financial risk pushing funding costs higher, and in extreme
cases can even result in a sovereign default. If a sovereign reveals financial data that
brings investors to question its solvency, it will be faced with higher funding costs.
Its limited access to financial markets could lead to a liquidity crisis forcing
emergency fiscal consolidation that would impact the companies operating in that
country.
103 Unraveling the delinquency problem (2008/2009) in Punjab – Pakistan, H Burki, October
2009.
104 Growth and Vulnerabilities in Microfinance, G Chen, S Rasmussen, X Raille, CGAP,
February 2010
70