Globally, more and more people are beginning to recognize the role of the private sector and more specifically, innovation, in helping poor countries become prosperous. In October 2017, the world’s most preeminent development institution, The World Bank, released a report titled The Innovation Paradox, emphasizing the role of innovation and the private sector in development. The report noted, “equating innovation policy to frontier science and technology policy will lead to frustration and waste if the firm dimension is neglected . . . without a corps of capable firms to take these ideas to market, these investments will yield little in terms of growth.” In essence, we can do all the research and science we want, but if we don’t have firms that will create markets, we are likely not going to move the needle on creating prosperity in poor countries. But creating new markets in poor countries is both difficult and requires capital.
Investment vehicles, including private equity and venture capital funds, are now deploying capital to more emerging markets than ever before. Private equity flows to emerging markets more than quintupled from $93 billion in 2006 to approximately $564 billion in 2016. Likewise, venture capital funds, which were responsible for growing companies such as Hewlett-Packard and Apple, are constantly on the prowl for companies that can provide Facebook and Google type IPO successes, even in poor countries. Unfortunately, there are not enough of these types of opportunities in these regions. That’s because these investments and funds are often modeled after funds from developed and prosperous countries. In effect, they’re restricted to looking at investment opportunities with a five- to seven-year investment horizon with very specific financial return hurdles.
Such financial return expectations are understandable in wealthy countries, since businesses can typically plug into existing infrastructure straight from the start, thus enabling quicker returns. In contrast, capital deployed into poorer countries with less developed institutions, infrastructure, and capital markets has little to no choice but to be patient as these nations slowly build systems that can support future investments. Because businesses are often responsible for creating new markets that can pull in resources (roads, rail, schools, regulations, etc.) into poor countries, a traditional investment with a five-year horizon will not work for many market-creating opportunities in emerging markets. This is where impact investments, aptly referred to as patient capital, can play a pivotal role.
According to the Global Impact Investing Network (GIIN), “Impact investments are investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return. Impact investments can be made in both emerging and developed markets, and target a range of returns from below market to market rate, depending on investors’ strategic goals.” In essence, impact investments have the potential to fill a void that traditional financing is either unable or unwilling to fill. Although the size of the global impact investment market is small compared to the tens of trillions of dollars of assets under management globally, the industry is continuing to grow. In a 2017 GIIN report, the amount of assets managed by impact investors topped $114 billion.
Impact investing: Impacting healthcare in Brazil
The size of the global impact investment industry might still be small compared with traditional investments, but impact investments can serve as binoculars that help traditional investors see opportunities they would ordinarily disregard. For example, consider LGT Impact Ventures’ investment in Dr. Consulta, a chain of health clinics in Brazil. More than half of Brazil’s 200 million citizens don’t have access to quality healthcare, and thus have to use the public system, which is inefficient and often underfunded. To help mitigate this disparity, LGT Impact Ventures (LGT) invested $10 million in Dr. Consulta in 2014.
To fully appreciate LGT’s investment and why such an opportunity would have initially been unattractive to the typical investor, consider that Dr. Consulta provides services to those who “belong to the base of the socioeconomic pyramid.” In addition, approximately 30% of Brazilian municipalities don’t have hospitals and a quarter have no doctors. This means that Dr. Consulta couldn’t simply plug and play into existing systems and improve them. The organization had to create them.
Dr. Consulta today employs more than 1,300 doctors and treats more than 100,000 patients monthly. Since its founding, the hospital has grown at 300% year over year. This chain of clinics is so efficient that it is able to provide diagnostics exams such as MRIs, blood tests, and mammograms at an affordable cost for the average Brazilian. Since receiving funding from LGT impact Ventures, Dr. Consulta has expanded and now operates 50 health management clinics across São Paulo. Dr. Consulta’s growth, largely funded by impact investments, is now likely to attract further investments from other traditional investment firms.
Because access to financing is one of the most difficult challenges that entrepreneurs in poor and middle-income countries face, impact investments can play a critical role in unlocking viable opportunities that would otherwise be missed by traditional investors.