ImpactAlpha, June 13 – Failure is good. That’s the party line – of successful people, at least – in Silicon Valley.
Mathematically, it’s actually true for venture capitalists, where failures come with the risks of betting on unicorns. (Less so for entrepreneurs who put all their time into a single company.)
There’s no reason at least some impact investors shouldn’t like the same odds as Sand Hill Road as they hunt for social unicorns – scaled-up solutions that can reach a billion or more people with high-quality, low-cost health care, abundant clean energy and resilient food supplies.
Yet failure is still not a universally accepted positive among impact investors. Go figure.
The latest object lesson is the likely liquidation of the Abraaj Group, which not long ago was a high-flying $14 billion private equity fund investing in the “growth markets” of the Middle East, South Asia and sub-Saharan Africa. Its CEO, Arif Naqvi, was one of the most visible proponents of the investment opportunities represented by the 2030 Sustainable Development Goals, calling such impact investments not a tradeoff, but “a tradeon.”
The $1 billion Abraaj Growth Markets Health Fund was to be a catalyst for scaling up investments in SDG No. 3, “ensure healthy lives and promote wellbeing for all at all ages.” The investment needed to fulfill that goal is not just $1 billion, but $140 billion in additional investment in health infrastructure every year through 2030.
Instrumental
The Bill & Melinda Gates Foundation seeded the health fund with a $100 million program-related investment and helped recruit other investors, including International Finance Corp., the U.K.’s CDC Group and the Overseas Private Investment Corp. By targeting lower-middle and middle-class customers rather than the poorest of the poor, the health fund aimed to crack the code for providing 21st-century health care to the rising billions in emerging megacities like Lagos, Kolkata and Karachi.
“Bill was instrumental in that vision,” Naqvi said on a panel in Davos early this year. “It all started with a discussion with him, that you can tackle the base of the pyramid, but there are so many measures that have to be dealt with. ‘Let’s come up with an innovative solution.’”
>>MORE: What we know about Abraaj’s $1B health fund — and the mystery of the firm’s finances
The Gates Foundation, along with several other foundations, also helped trigger the spate of investigations into Abraaj’s finances, calling in auditors to resolve questions about Abraaj’s use of funds in the Growth Markets Health Fund. Since then, the cascade of inquiries into other areas of the firm has led Abraaj’s holding company to file for liquidation in the Cayman Islands this week. A Gates Foundation spokeswoman declined to comment.
The problems certainly went beyond the health fund. The Wall Street Journal reported Abraaj told investors in May that it used money from one of its funds for general corporate purposes. Abraaj developed sloppy financial habits in its early years, Axios reported. “Most notable was its belief that investor commitments were fungible, whereas private-equity firms are supposed to put tight fences around specific funds.”
Cerberus Capital Management has offered to buy out Abraaj’s fund-management unit. A Kuwaiti pension fund is seeking to put Abraaj’s Cayman Islands holding company into insolvency over a $100 million loan. Abraaj has suspended fundraising and released investors from their commitments to what was supposed to be a new $6 billion growth-markets fund. The limited partners in the health fund are reportedly talking to other private equity firms, including TPG’s Rise Fund, about taking over the fund.
Studiously quiet
The Gates Foundation has been studiously quiet about what went wrong. As yet, we don’t know what might have been missed in its initial due-diligence of Abraaj and what impact the debacle may have on the broader goal of reshaping health systems around emerging challenges. Bill Gates has flagged in particular the rise in the developing world of chronic diseases such as heart disease, diabetes and cancer.
The Abraaj health fund is not the foundation’s first, but rather its second, attempt to reshape health-delivery systems. The foundation invested $7 million in Africa Health Fund, which also included capital from International Finance Corp. and the African Development Bank, among other partners, to invest in clinics, individual companies and other organizations to upgrade health delivery for low-income patients. The $105 million fund, which closed its fundraising in 2009, was managed by Aureos Capital, a spinoff from the British foreign aid agency now known as CDC Group. In 2012, Abraaj purchased London-based Aureos to expand its footprint, inheriting the earlier health fund.
ImpactAlpha a couple years ago worked with the Gates Foundation to produce a special report, Making Markets Work for the Poor, that profiled a number of the foundation’s “program-related investments.” Julie Sunderland, who managed a $1.5 billion carveout from the foundation’s huge balance sheet until 2016, was keen to take a close look at what had gone wrong, as well as right.
Of the eight case-study stories in the report we produced in collaboration with Stanford’s Paul Brest, two were acknowledged failures. Sunderland thought other investors, particularly foundations deploying charitable funds for impact investments, could learn from a low-cost blood-test biotech startup that failed to bring a product to market, or a college social network pulled off-strategy by the foundation’s mission-driven directives.
(Note: The Gates Foundation paid ImpactAlpha to produce the report, and the Stanford Social Innovation Review to publish it. The project included a non-disclosure agreement that requires approval to share confidential information, which I have respected.)
Due diligence
Foundation officials have yet to comment on the impact of the controversy around Abraaj on the foundation’s own portfolio performance, or on the larger mobilization of capital to meet the 2030 global goals. As recently as last fall, Abraaj officials claimed to be on track toward treating 14 million patients a year by 2020 and employing more than 50,000. The networks of health services in urban clusters promised to drive both better health and lower costs through large-scale investments. Where does that strategy stand now?
And the Gates Foundation’s efforts at due diligence are of more than passing interest to foundation practitioners of the arcane category of program-related investments. Such investments, coming as they do from tax-advantaged funds designated for charitable purposes, face heightened legal, as well as public, scrutiny. Couple that with widespread skepticism about the entrance into impact investing of big commercial private-equity players, such as TPG, Bain Capital and KKR, and the Abraaj case-study presents a potentially combustible mix.
>>MORE: Big new private-equity funds are on the hook to deliver impact outperformance
It seems incumbent on the Gates Foundation to explain how the outcome of its investment in the Abraaj health fund does or does not affect the future of both SDG- and program-related investing.
James Napper, a trustee of the Teachers Retirement System of Louisiana, which has been released from its commitments to Abraaj’s new fund, told The Wall Street Journal that unresolved questions would keep him from investing in another Abraaj fund. “If the fund has had some kind of prior problem that I don’t fully understand, no I wouldn’t,” he said.
That understandable caution, taken more broadly, could chill private-equity SDG investing before it even takes off. If the Gates Foundation wants to avert that outcome, it should follow its own instincts to share its setbacks as well as successes. Failure can only be good if we learn the right lessons.
This is the latest column in David Bank’s weekly series, The Impact Alpha. Catch up on all of David’s columns here.
