Seeking returns on your social good: a case study of co-investing with impact
Proponents of environmental, social and governance (ESG) practices have at times been accused of prioritising values over value, and concerns around the financial basis for ESG investment can become an obstacle for even the best-intentioned of businesses. Accordingly, the ability to build a business case for ESG projects will go a long way to safeguarding the durability of the ESG movement. Importantly, favourable financial returns may also be available to businesses which scrutinise the commercial viability of ESG pursuits.
Balancing priorities
Responsible investment is one method by which a business can pursue financial returns while participating in ESG activities. This article explores the possibility of balancing purpose and profit, by examining one such project - a partnership between Singapore-listed Darco Water Technologies (Darco) and InfraCo Asia Development (IAD), a commercially managed infrastructure impact investor, and their co-investment in the development of water supply infrastructure in semi-rural Vietnam (Water Supply Project). We’ll use it to help explain what impact investing is (and isn’t)!
The Water Supply Project
The Water Supply Project involved the co-development of water treatment projects that aimed to assist Vietnam meet its water supply and sanitation-related development goals, including universal access to safe drinking water by 2030. The water distribution systems developed as part of the project aim to provide 24/7 piped, treated water to approximately 500,000 individuals in Ben Tre province and Hai Phong municipality, where the populations rely heavily on the collection of rainwater to meet their daily needs. In addition to drinking water, the water is also deployed as clean industrial grade water, a much-needed resource for the push to attract foreign investment into manufacturing facilities and the overall development of the Vietnamese economy. For Darco, an engineering and construction company specialising in water treatment, the Water Supply Project represented a move across the value chain that provided the company with exposure to offshore markets, while creating an avenue for recurring revenue.
Responsible investment can take many forms. The Responsible Investment Association of Australasia (RIAA) describes responsible investment as a spectrum of investment activity, which exists between traditional profit-driven investment and philanthropy.
Avoiding harms
On one end of the spectrum, responsible investing can be simply the integration of ESG factors into the decision-making matrix underlying an investment, negative screening of certain industry sectors or companies to avoid conflicts of values, or norms-based screening which exclude investments that fail to meet minimum standards and include those that satisfy defined criteria. These kinds of investments are focussed, to varying degrees, on avoiding harms.
Contributing to solutions
Investors can go beyond avoidance of harm and seek to make positive contributions to society or the environment. This type of investment emphasises taking active steps, for example by seeking and investing in companies with demonstrated records of high levels of ESG performance or taking an active role in projects which are aimed at solving specific social or environmental problems, also known as impact investing. In impact investing, the social or environmental outcomes are a driving force for investment decisions from conception to execution. It shifts the focus of responsible investment from an 'avoidance of harm' approach to targeted initiatives where the private sector takes an active role in shaping communities and mobilising their financial influence to achieve defined goals. IAD's Water Supply Project and its broader portfolio of investments fall within this latter category.
Co-investing for successful outcomes
Partnering with an established impact investor such as IAD is an opportunity to bring about returns on impact, as well as returns on investment. For impact investors, the largely untapped pool of capital on corporate balance sheets is an opportunity to bridge a gap that cannot be met by government or development bank funding. Working with Darco, IAD was able to provide funds, leadership and experience in deal structuring, as well as supporting Darco in its feasibility studies.
Accessing high-growth emerging markets
By financing socially responsible and commercially viable early-stage infrastructure development activities, IAD is able to contribute to economic growth, social development and poverty reduction in South and South East Asia. Under the commercial guidance of IAD, funding from the UK’s Foreign, Commonwealth and Development Office; the Ministry of Foreign Affairs of the Netherlands; the Swiss State Secretariat for Economic Affairs and the Australian Department of Foreign Affairs and Trade is applied to mitigate early-stage project development risks and create a “bankable” infrastructure project attractive to private sector investors. In other words, public funding is applied to de-risk projects where the private sector is unwilling or unable to access such investment opportunities. By financing early-stage infrastructure development, IAD is able to mobilise private sector capital to invest in sustainable infrastructure projects in emerging economies.
Distinguishing impact investing from philanthropy
It is important to keep in mind that impact investment is distinct from philanthropic pursuits where financial return is not a factor. While positive social and/or environmental impact is at the heart of impact investment projects, it exists here alongside commercial viability. For the project to proceed and succeed, both aims must work in tandem. Commercial viability sustains the long-term prospects of the project, which allows investors to maximise their investment and enable the social benefits to continue well into the future.
Finding the right project
Impact investment projects, such as those undertaken by IAD, are often bespoke, leveraging the expertise of the investor to maximise impact and return on investment. Investors in this area work to strategically identify and develop projects where private capital has the capacity to not only contribute funds but lend their specific expertise, whether this be geographical or industry experience to enhance the success of the project and promote tangible benefits for the community.
For many, the opportunity to participate in impact investing is yet to present itself. Research from RIAA indicates that in Australia, impact investing is predominately the domain of numerous smaller investors along with the dedicated impact funds of a few major international investment managers. Despite this, current projects only scratch the surface of the ways in which investors might participate in impact investing. As the overall demand for responsible investing rises, investors looking to engage with impact investing should reflect on their unique strengths and look for opportunities which match these.
