Social Impact Investing

Impact Investments:
An emerging asset class
Global Research
29 November 2010
Furthermore, if the fiscal consolidation (emergency or not) is unsuccessful, the
sovereign may be left with no choice but to restructure its debt. This could impact the
companies within that country in a few possible ways.
1. If the companies hold government debt, losses from the debt restructuring can
significantly affect their financial health. Financial institutions in particular tend
to hold government debt, so the financial services sectors – microfinance and
SME finance – of the impact investment universe could be especially at risk
should the sovereign restructure its debt. Even if the particular impact investment
does not own government debt, it will likely be affected indirectly by the increase
in bond yields of the sector in which they operate.
2. If the government debt is not held by the local companies, then there may be less
of a direct impact on their financial health. However, the indirect impact of higher
funding costs is likely to remain in place as many of these companies will be
borrowing from financial institutions that may be holders of the government debt.
With losses on the books, lending standards would be likely to tighten and
borrowing costs could increase to compensate for those losses as well.
Furthermore, foreign investors will also be likely to price in sovereign risk to the
company itself, particularly as there will likely be further uncertainty as to
sovereign policies going forward.
Hedging country risk is also possible through sovereign credit default swaps, though
liquidity will be challenging in many of the BoP markets we analyze and the required
trade size may also be too large to make sense for most impact investments. Should
the size and relevant country be accessible, the cost of hedging may be too high for
debt investments, but may make sense for equity investments where higher returns
are expected.
Currency risk
Currency risk will likely coincide with sovereign stress and uncertainty. As such, it
will be driven by investor perception of the solvency of the country, but can also be
impacted by technicals in the market. For example, Hungarian Forint, Mexican Peso
and Turkish Lira are popular currencies from which to earn carry for many investors.
The concentration of positions held by foreign investors and fears of contagion
across the emerging markets can exacerbate volatility in times of general market
stress, even if there is no particular country-specific news.
Hedging currency risk depends on whether there is liquidity available in the
currency. The most common hedging instrument is the non-deliverable forward,
which allows investors to lock in a forward exchange rate at a given time in the
future. In A Primer on Currency Risk Management for Microfinance Institutions 105 ,
we present currency hedging considerations in more detail. The document is written
with microfinance institutions in mind, but is generally applicable for hedging impact
investments more broadly.
Having seen the legal, reputational and financial risks with which an impact investor
will be faced, we can now turn to the question of measuring the social impact of
investments. After all, alongside the financial return and the financial risk, the social
impact is equally critical to the success of the impact investment. The next section
105 Published by J.P. Morgan Social Finance, 2010.
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