August 23, 2016 - Foreign Investments

Impact Investing in Emerging Markets

Emerging markets remain ripe for impact investing – it is an increasingly important way to support small and growing businesses in emerging markets, thereby stimulating long-term economic growth, creating jobs and spurring social impact.

Although emerging markets are highly volatile and slowing or negative GDP growth remains a concern, the 2016 Global Limited Partners Survey conducted by Emerging Markets Private Equity Association (EMPEA), a global industry association for private capital in emerging markets, found that more than three quarters of limited partners plan to maintain or increase their emerging markets allocations over the next two years. The study also found that performance of emerging markets private equity, which can be used to provide information on impact investment performance, met or exceeded expectations for 70% of limited partners–down from 75% and 78% in 2015 and 2014, respectively. Despite this decrease, limited partners still expect emerging markets funds to outperform their developed markets counterparts. One explanation for these trends is that basic demand in emerging markets jobs, goods and services in the sanitation, health care and energy sectors is relatively unaffected by volatile economies. As such, impact investments in these sectors may allow investors to hedge against the volatile global economy.

Developing countries provide several unique opportunities for impact investing. Generally, investing in emerging markets allows for a varied portfolio through the diversity of countries and sectors with traditionally underserved markets. For example, although certain Latin American countries are currently facing political and economic turmoil, there remain significant opportunities for financial gains through impact investments. This region has strong local networks and trained human capital that is supportive of entrepreneurialism. Latin American countries also have a public sector commitment to private investment in low and middle-income services and products as well as comparatively favorable regulations governing foreign investments in local companies. Specifically, impact investment projects in both economically disadvantaged regions and regions undergoing industrial redevelopment in Latin America are usually eligible for aid from regional governments such as corporate tax exemptions, financing and low-cost or free industrial land sites. In South America, the Companies Act, No 71 of 2008, which was promulgated in 2009 and has been effective since 2011, rewrote South Africa’s business law regime. The new Act aims to align South African law with international best practices, making South African law more business friendly, simpler and less prescriptive. The result is that both foreign and domestic entities operating in South Africa can be more flexible and adaptable, making South Africa a great legal landscape for entrepreneurship and impact investment.

Under the EMPEA’s study referenced above, Southeast Asia ranks as the most attractive emerging market for general partnership investment over the next 12 months, followed by India and Sub-Saharan Africa, respectively. In each of these regions, the significant proportions of the population living below the poverty line create an opportunity to introduce market approaches to poverty reduction as well as to target new customer bases as these regions develop and grow their middle classes.

Despite these opportunities in emerging markets, there are some significant challenges to consider. Corruption, for example, remains a difficult problem in some developing countries. Nigeria, Kenya and Venezuela are numbers 136, 139 and 158 respectively on Transparency International’s Corruption Perception Index. Other emerging market countries, namely Brazil, India and Thailand, are faring better, all tied at number 76 on the index.

Another obvious challenge is political instability in several emerging market countries. Even those countries that have relatively stable governments may have dynamic currencies or economic policies that make it difficult for investors to keep track of and comply with all regulations. In a similar vein, in some emerging market countries complex tax regimes meet a high-level of noncompliance, making it difficult for investors to remain competitive if they do not structure their investments in tax-efficient ways. Various exchange controls are imposed by some countries in Latin America, for example, controls which often have tax implications for investors. Investors have begun to fund projects through a feeder fund rather than doing so directly, so as to mitigate these challenges. Finally, impact investors will need to account for the low likelihood of initial public offerings and few acquisition opportunities for selling smaller firms through third-party sales in emerging markets when structuring their investments. Debt instruments may be more appropriate than equity investments because of this limited liquidity.

Despite these concerns, small and large impact investors continue to pour into the developing world. For example, the Omidyar Network makes significant impact investments in emerging markets, supporting both for-profit businesses and nonprofit organizations. A recent report by the Omidyar Network highlighted the importance of investing in low and lower-middle-income populations. To this end, the Omidyar Network has invested in companies such as Zoona, a company that leverages mobile technology and an agent network to enable financial transactions for underserved customers in Zambia, Malawi, Mozambique, Ghana and the Democratic Republic of Congo; Anudip Foundation, which creates new-economy livelihood opportunities for impoverished youth, women and minorities in rural and semi-rural areas of India; and Suyo, a company that helps families secure property rights in Latin America by offering affordable and reliable property formalization services. Similarly, Leapfrog Investments is a fund that makes impact investments in Africa and Asia including investments in AllLife, a disruptive innovator in the life insurance industry that provides insurance to people living with HIV and diabetes in South Africa, and Reliance Capital Management, a company that provides diversified financial services to Indonesia’s growing middle class.

Ultimately, emerging markets are still an exciting space for impact investing – the potential financial gains and social impact are significant draws for investors. Impact investors who keep abreast of the challenges of investing in emerging markets, and transact with local partners to mitigate these risks when appropriate, can find great success in meeting their financial and social goals while also helping to develop the infrastructure for future impact investments in these markets.