Investing for Multiple Bottom-lines in the Developing World

Development experts have almost always agreed that investment by the advanced industrial economies in developing countries is a key element in ending economic hardship for billions of people. But the consensus about how to spend the money has changed in recent years.

Two decades ago, the answer would probably have been through the financing of huge factories or hydroelectric dams. Today, according to many of the scholars, analysts, business executives, and representatives of non-governmental development agencies who gathered at the United Nations Global Compact Academic Conference titled, “Bridging the Gap: Sustainable Environment,” which was held recently at Wharton, some leading development agencies and institutional investors are trying to invest with an eye toward a “triple bottom line” – shorthand for an investment policy that considers not only profits but also the environmental and social impact of various projects.

The conference was jointly organized by Wharton and Turkey‘s Sabanci University in collaboration with the United Nations. The Wharton Risk Management and Decision Processes Center and the Social Impact Management groups took the lead in organizing the gathering. Earlier in the year, a similar meeting was held in Turkey.

It sounds good, but how is it done? At the global level, selecting the most socially and environmentally responsible companies is apparently getting easier for investors. Innovest Strategic Value Advisors, for example, issues ratings on the corporate, social, and environmental performance of 2100 companies around the world, most of them large cap. The New York-based agency rates companies on a AAA to CCC scale, somewhat like the conventional credit agencies. Although that might not sound like a service Wall Street would be interested in, the firm’s 25 analysts have attracted the attention of dozens of the world’s biggest asset management companies. State Street, the world’s largest institutional investor, even has an investment in the firm. 

Investors who use Innovest’s ratings are apparently able to earn more than better karma. Hewson Baltzell, president of Innovest, told conference attendees that some large institutional investors have had positive results with model portfolios where position weightings – not choices of stocks– were influenced by the companies’ Innovest ratings. Baltzell said that State Street Global Advisors, for example, back-tested a portfolio of top companies with strong sustainability scores from 1998 through the first two months of 2004 and found that the core environmental portfolio would have outperformed by a huge margin – 41.52% total compounded returns compared to 0.70% for the S&P 500.

Nice guys finishing first to this extent might sound counter-intuitive, but Baltzell made a case that Innovest’s ratings can serve as an early indication of how the company might perform later on, “because we’re looking at a broader set of issues than purely financial sector metrics,” he explained.

Despite Innovest’s track record, Baltzell is skeptical about the depth of the major investment houses’ commitment to sustainable investment. “Notwithstanding the fact that we as a firm have made a lot of progress and our client list has gotten to be pretty impressive, I still think there is a lot of BS out there … a lot of talk and no action,” he said.

For example, one major Wall Street asset management firm claims its analysts are using sustainability guidelines in all their research but Baltzell says this isn’t actually the case. “I’m sorry but that’s not true,” he said. “Sometimes some of [their analysts] are looking but a lot of them aren’t. The vast majority will have no idea what we’re talking about.”

Triple Winners

Picking such triple-winners appears to be an even more difficult proposition in emerging markets, for a variety of reasons. For one thing, it’s a road few investors choose. Although private sector capital is making substantial investments in some developing countries, the harder-to-reach places are overlooked, said Louis Boorstin, manager of the environmental finance group of the DC-based International Finance Corporation, who spoke on the same panel as Baltzell. “A lot of people say the private sector in the last 10-15 years has become the major source of capital for the developing world. That’s true if you happen to live in about a dozen countries. But if you don’t live in Brazil or China or one of those other 10 or 12 countries where most of the money flows, you’re not necessarily [seeing] much private sector capital.”

Another problem may be the private equity model itself, an important funding mechanism for risky ventures in the developed world. Does the European-American model for private equity work in developing markets? asked Stephen M. Sammut, a venture partner at Burrill & Company and senior fellow at Wharton who teaches a class on private equity in emerging markets. “The answer is, actually, nyahhh! It simply does not work. And the reason is the capital market structures differ, the entrepreneurial talent is different, the nature of the technology and the context in which it must be developed and produced are entirely different,” he said.

According to Boorstin, his group at IFC also had experienced some difficulties in making investments in private equity funds work. “These have been very challenging for us,” he said. “I think the real problem is that we ended up with a smaller-than-expected pool of potential investments and most of the candidates were small and medium enterprises that were not really easy to work with,” said Boorstin, whose environmental group manages $250 million of investments directed towards companies that can contribute to the environmental quality of the developing world. However, despite his difficulty, he noted that this division of the World Bank now runs its investments in private equity through a specialized office, a policy that seems to be more successful.

Public Sector Investments

Nor is direct investment by the public sector much easier. Boorstin recalled a team that came to him with the idea of supporting the distribution of a new strain of feed in Africa. These would-be backers wanted to “invest in a bunch of small companies in Africa that do this.'”

Boorstin looked at them and said, “Based on our experience in other areas, you’re nuts. That’s the wrong way to do it. Go in and find out who these distributors are today, find out who finances the sale of those things, work with the local institutions, provide them with an incentive to target what you’re trying to do,” he told the investor. “And for God’s sake, don’t put your money into a bunch of small companies in the rural areas of Africa because you’ll lose all your money and you’re not going to meet your public goal.”

Perhaps to sidestep those difficulties, IFC invests about a third of its portfolio in local banks and financial institutions. “Sitting in Washington, even now that we have a lot of people based in the field – and I think 70 or 80 field offices – we still realize that one of the best ways to help development is developing institutions in the developing countries,” Boorstin said.

As a direct investor, IFC always tries to find company. Boorstin noted that the group never contributes money unless other investors are interested in the project. “I actually think that’s a great discipline … We are a partner, we take the same risk as other investors. We have some benefits as a multilateral agency but basically we’re out there exposed. We don’t take government guarantees – the World Bank does that – we don’t get to do that,” he said.

In selecting projects, Boorstin noted that they also look for projects that will eventually be self-sustaining. “The fact is, it needs to be commercially viable, because if it’s not somebody has to subsidize it forever, and we don’t have the money to do that.”

Businesses that leverage some kind of pre-existing network tend to get a more favorable reception as well. “There’s an enormous benefit in the developing countries to having that existing network.” Cases in point: He mentioned at least two businesses in which IFC invested that have piggybacked on Bangladesh’s Grameen Bank. The two, a solar company and Grameen Phone, a mobile phone company, both work with the model microfinance project that has established a strong network in villages throughout the country.

The lack of an easy exit from such an investment presents another challenge. Sammut said the lack of an exit is one factor that prevents a great deal of investment in the developing world. Structuring a deal as self-liquidating debt-financing is one way around that, he advised.