Finance as a force for good

VETERAN portfolio manager David Heng, a keen diver, is saddened by the damage that environmental degradation has wrought on marine life. "I've been a diver for 25 to 30 years. I've been to many parts of the world and I can really see the change caused by climate change and pollution. As far as the Spice Islands, there is rubbish everywhere. The coral was colourful and full of life, but there is a marked change."

The chief executive of ABC World Asia, the private equity impact investment firm backed by Temasek, sees an opportunity for financial investments to make a tangible difference.

"Impact investing isn't just ESG (environmental, social, governance) investing. We are trying to look at measurable outcomes. We want it to be evidence based. With our backers at Temasek and Temasek Trust, our reputation is key. It's important that we set a high bar.

"Impact investing enables us to look at financial and non-financial metrics consistently, using a framework. Finance has been demonised for quite a while, especially during the 2008 financial crisis. But finance can be a force for good."

Impact investing is an investment framework and discipline that goes beyond ESG, and aims for a positive and measurable social and environmental impact, along with a financial return. While relatively nascent, the segment has seen tremendous growth.

The Global Impact Investing Network's 2020 report estimates the size of the market at US$715 billion from US$502 billion in 2019. In 2019, private debt attracted the highest capital allocation of 37 per cent, followed by publicly traded debt (24 per cent) and private equity (16 per cent).

In Singapore, while investors go the private equity route for impact investments, there are also a number of fund managers who have launched impact equity and fixed income funds, investing in public securities. These managers include BlackRock and Amundi.

In a still-evolving sector, there are few clear standards for impact measurement and management (IMM). But asset managers have gravitated towards the United Nations Sustainable Development Goals (UN SDGs) to set objectives, measure and report on impact. Earlier this year, Temasek Trust announced a collaboration with SDG Impact, the UN Development Programme's flagship initiative to establish global practice standards for SDG investments and provide tools to help investors identify areas of need and make targeted investments.

ABC World Asia, set up in 2019, has raised S$405 million from founding investors including Temasek Trust, Pavilion Capital, Mapletree Investments and Singapore Power.

To date, it has deployed S$98 million into five companies. Solar energy producer Sunseap is a portfolio holding. The others are Australian V2food producing plant-based meat; Chinese microfinance company CD Finance; Kim Dental in Vietnam and India- based agri-tech company Cropin.

Mr Heng's career as an investment professional has spanned some 25 years, of which around 14 were with Temasek, stewarding portfolios invested in three major clusters - real estate, financial services and consumer.

MR Heng says ABC World took pains to develop its impact assessment framework. This was done in 2019 before the onset of Covid-19, which enabled it to build a pipeline of potential investees before travel restrictions hit.

"Asia is full of challenges. We asked ourselves - what are the most pressing issues and what is the business opportunity set for private capital? (Developing a framework) is not rocket science, but it's hard work. At the end of the day, we want to make sure that the output of a business' products and services is linked to the target outcome, and we want the process to be evidence-based."

"Impact and profit are not mutually exclusive. A business needs to make a sustainable return so it can continue to serve people. You can have a business serving the bottom of the pyramid, but it likely will make very little money, not enough to cover the cost of capital and may be in business for only five years... The company has to have a business model that we think can be sustained."

ABC World's philosophy takes its cue from Temasek's vision to help build an "ABC World", comprising "Active Economy, Beautiful Society and Clean Earth".

It has identified five investment themes linked to a number of SDGs. These themes are: climate and water solutions; better healthcare and education; sustainable food and agriculture; financial and digital inclusion; smart and livable cities. While investments are evaluated through an impact lens, the fund is girded by a rigorous financial discipline with the aim of generating market-rate returns in keeping with the sectors it invests in.

ITS impact evaluation framework, developed with the Bridgespan Group, entails four steps. The first applies an impact screen to ensure potential investees meet the baseline impact criteria. Then, an impact thesis is articulated to ensure the company is aligned with the fund's impact objectives.

A scoring system is applied, which defines a minimum threshold for impact. Last is a set of impact KPIs (key performance indicators) or metrics which will be tracked through the holding period.

ESG criteria are woven into the process, but ESG alone is insufficient. The firm takes an active stance towards portfolio companies, leveraging its Temasek network, for example, to help portfolio companies grow and add value. Companies' ESG profiles should also improve in aspects such as diversity on the board and management.

A NUMBER of other factors matter in the due diligence. "We look at outcome alignment; is there a link between the business' products and services and the targeted outcome? What are the positive and negative externalities? When you use solar panels for electricity, for instance, that's positive. But you also manufacture the solar panel and the process may be negative. We look at materiality. If, for example, only 2 or 5 per cent of the business relates to a target impact or outcome, then it doesn't pass our test.

"We look at the entrepreneur's intention, because we don't want them to pivot away. During the due diligence process, we require impact monitoring and reporting. If they refuse to do this, it's a red flag."

An example is dental clinic Kim Dental which runs a network of 19 clinics in six cities in Vietnam. Oral diseases affect over 3.5 billion people globally and is rarely prioritised in national health policies of low and middle income countries, says ABC World in its inaugural impact report.

Kim Dental's mission relates to SDG 3 which aims for good health and well-being. The chain offers basic dental care at an affordable price to reach a wider base of patients. At the same time, it also offers higher value-add dental services for which it charges higher prices.

"Investing in Kim Dental is catalytic. We did a survey of customers. Fifty per cent visited the dentist for the first time, and from that you can see the market is so underserved. Yes, they don't serve the lowest rung of the population, but at the same time, the capital is catalytic in helping the general population who are actually in need of the services. So you are improving public health."

Another portfolio company, CD Finance, is a microfinance institution in China, operating in rural areas. It began in 1996 as a non-profit organisation offering microfinance, and was established as an independent organisation in 2008. Its mission relates to SDG 1 which aims to reduce poverty and SDG 8 to promote decent work and economic growth.

OVER 87 per cent of CD Finance clients are microenterprises. It has embarked on digital services, delivering loans through mobile phones. "Eighty per cent of CD Finance borrowers are women who are a much better credit risk, and 98 per cent of loans are for productive use such as buying a tractor or seeds. The loans do not over-burden the borrowers... Too many microfinance (organisations) are not in the right sub-sectors; they encourage rampant borrowing.

"We also look at non-performing loans and how the firm goes about to recover. When you do this well, the NPL is quite low, about 2 per cent. That's amazing; the loan tenor is not very long - two to six months, not more than a year."

"Microfinance is an industry where you do need a relatively high touch point - meaning loan officers going down to villages to understand the issues and (discern) who is a good credit. CD Finance has tens of thousands of people on the ground. Their model is a hybrid between the Internet and technology to bring down costs, and a high touch point to understand what is happening locally."

For now, one challenge is the general dearth of Asian research to help impact investors. "We work with various parties such as universities. Sometimes we initiate our own customer or industry surveys, and get expertise to help us to validate the results. As the industry evolves, things will get easier."

Mr Heng is optimistic about the outlook for impact investing and is confident about ABC's ability to raise capital. "We're at the beginning of our journey. We'll need another two or three years... My sense is that if we keep up this pace of deployment we will go to market for more capital and we welcome that. Many family offices and institutional investors have expressed interest. They want to look at how we assess impact and report it."