2023 emerging market opportunities are locally-rooted, gender-smart and climate-friendly

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ImpactAlpha Editor

Jessica Pothering

ImpactAlpha, December 20 – Impact investing’s early advocates imagined a trillion-dollar industry. This year, by one estimate, the industry surpassed that target. Big commitments have poured into public impact, climate finance and private equity. 

Not so for impact investing in emerging markets. More fund managers are emphasizing impact in their investment strategies, but struggle to raise funds. There are more deals, but deal sizes are still relatively small. Catalytic capital in the form of credit enhancements, first-loss reserves and other guarantees is still needed, even in established markets and sectors, much less new ones

Perceptions – or misperceptions – of risk remain deeply rooted among institutional investors, including development finance institutions that specialize in investments in Africa, Asia and Latin America. 

Firms in emerging markets manage only about 5% of all impact capital. Meanwhile, economically-crucial small businesses face a $5 trillion annual financing gap, effective climate adaptation requires up to $340 billion in additional capital annually, and investments in women’s equality face a persistent shortfall of capital. 

It’s time for the narrative around risk and opportunity in emerging markets to change, says Elevar Equity’s Jyotsna Krishnan. The impact investment firm focuses on businesses that deliver high-quality, low-cost goods and services for low- and moderate income consumers in India and Latin America. “We confuse ‘impact’ with ‘niceness.’ Impact investing requires ruthless execution.”

Last year’s pandemic-inspired digitalization wave, which saw a flood of private capital back startups serving and banking offline shops and gig workers, has exposed the small business investment opportunity. Not all models have been successful. But some, like South Africa’s Nomanini, have leveraged data to unlock commercial bank finance—a previously inaccessible stream of capital for informal and micro-enterprises in particular. 

“Demand for our services is only going up,” says Nomanini’s Vahid Monadjem. 

Local talent and capital

Local fund managers, entrepreneurs and political leaders are not waiting on international development finance institutions from wealthy countries to plug the financing gap. Instead, they’re rallying local investors, building local ecosystems and crafting local policies for  long-term sustainable economic development. 

Local investors, including pension funds, insurance companies and individuals are key backers of first-time fund managers at firms like Senegal’s small business-focused Teranga Capital, Nigeria’s gender-focused Aruwa Capital, and tech-focused funds like Mexico’s Amplifica Capital and Palestine’s Ibtikar Fund.

Local government, community and business leaders “should be the ones who feel the greatest sense of urgency” to invest in local fund managers, says Lilian Mramba of Grassroots Business Fund. “We’re trying to make changes in our communities. We shouldn’t only look at trying to change the mindset of capital coming outside.” 

Much of their effort focuses on strengthening small businesses, the backbone of local economies.

In Zambia, Ghana and other countries, “national advisory boards” for impact investing are educating domestic institutional investors, setting up funds, and building deal pipelines to usher more capital to small and growing businesses. 

The Collaborative for Frontier Finance, 2X Ignite and other ecosystem builders are catalyzing resources and networks for first-time and local fund managers. 2X Ignite is fundraising to provide emerging women-led and women-focused funds with working capital, a deal-warehousing facility and support services. 

The collaborative supported this year’s launch of Nyala Ventures, a fund of funds seeded by FSDAi that invests in first-time fund managers. Nyala this month inked its first deal, investing in Nigerian gender-lens firm Aruwa Capital’s first fund.

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Gender smart

Assets in purpose-built gender-lens investment funds remains woefully small at just $20 billion annually. But in a noticeable shift, investors now expect an embedded gender-lens in nearly all emerging markets investment strategies. 

Credit goes to ecosystem initiatives like GenderSmart’s Suzanne Biegel and 2X Collaborative’s Jessica Espinoza. The two organizations are merging to become 2XGlobal. An initiative of a number of development finance institutions, the 2X Challenge has catalyzed $7 billion in gender-focused investing since 2018—more than twice its initial goal.

Frameworks, like IIX’s “orange bond” principles for gender-focused bonds, are setting standards and building accountability for investors claiming a gender edge and impact in their portfolios. 

Where efforts fall short: getting money into the hands of female investment managers. Investors claim their lack of track record makes them too high-risk. But without investors who will step up to cut first checks, women will never prove their investment chops, much less raise second, third or fourth funds.

“We are overtrained and over-mentored and underfunded,” says Lelemba Phiri of Africa Trust Group. “Just write the check,” adds Anna Raptis of Amplifica Capital in Mexico City, which invests in women in tech.

With little investor support, first-time female fund managers are bulldozing their way into the male-dominant investment sector by supporting each other. Africa Trust Group is paying first-time fund managers a commission for investable deals, and helping the new managers build their track records in the process. 

Firms like Womvest, a debt provider, revenue-based financing firm Linea Capital and equity investor Five35 Ventures are working with each other and other women-focused capital providers to provide founders with multiple types of capital. 

To an investor community claiming commitment to women’s equality, Biegel says, “be a first mover.” Help new female fund managers “in every way that you can to succeed.” 

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Financing climate adaptation

The vast majority of global climate finance has gone to efforts to reduce emissions. At COP26, world leaders pledged to double funding for adaptation to about $40 billion a year by 2025. 

But adaptation needs in emerging markets could reach $340 billion a year by 2030. The 20 most climate-vulnerable countries have lost a total of $525 billion to climate impacts since 2000, amounting to roughly 20% of their GDP.

Low-and middle income countries have been calling for help to recover from the devastating floods, droughts and storms that are becoming more frequent and intense because of global warming. At this year’s COP27 summit in Egypt, countries agreed to hammer out details of a proposed “loss and damages” fund to aid nations’ recovery from climate-related damages they had little hand in creating.

Private capital is starting to flow into adaptation. Bill Gates’ Breakthrough Energy last month said it will expand its focus on decarbonization to include adaptation. Nuveen and the Shell Foundation are investing $100 million to build climate resilience in emerging markets. 

Private-sector players are deploying creative natural-capital instruments to protect marine ecosystems and biodiversity, boost smallholder farmers’ resilience, empower Indigenous communities, and support a just energy transition

The risk of inertia? Waves of displacement, setbacks of progress against poverty and hunger and the accelerated loss of climate-critical ecosystems and biodiversity. 

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Catalytic development capital

The big international actors in economic development are largely letting smaller fish do the heavy lifting. 

A report this year from Convergence found that DFIs insist on standard commercial terms in three-quarters of the blended-finance deals in which they participate. “There’s definitely scope to take on more risk,” says Convergence’s Ayesha Bery. 

Multilateral banks and development finance institutions are facing pressure from Barbados Prime Minister Mia Mottley to U.S. climate envoy John Kerry to U.S. Treasury Secretary Janet Yellen to take on the role of capital mobilizers, not just capital providers. Often DFIs hide behind their investment mandates, which require them to deploy capital for a commercial return. 

“To really move the dial in what we’re trying to do with expanding the flow of capital to local capital providers, we need to really look at mandates and ensure they are fit for purpose,” Courageous Capital’s Laurie Spengler tells ImpactAlpha

Some DFIs are pushing the boundaries of their risk appetites in pursuit of impact. British International Investment (formerly CDC Group) has deployed more than $1 billion in catalytic capital and recently launched a new vehicle, its “kinetic fund,” with a higher tolerance for risk. The Dutch government-backed Dutch Good Growth Fund has seeded a number of first-time fund managers. “We need more of this,” says Spengler.

In 2023, watch for intensifying pressure and transparency initiatives that expose DFI leaders and laggards, like Publish What You Fund’s new DFI Transparency Index.

“Maybe business as usual can’t continue,” says Josh Bicknell of small business loan fund, Balloon Ventures. “There will be things that can make returns, but if you want to do really, really hard stuff, maybe all of us have to sometimes accept less.”

He asks: “Are we all willing to accept that and walk that walk?”