If there is one thing the government’s ongoing demonetisation drive has amplified, it’s the yawning gap that exists in India between the privileged and the underserved. In that context, it seems appropriate that the country hosted its first convention on impact investing this week. Put together by the Impact Investors Council in partnership with the ministry of external affairs, the convention saw 175 limited partners and fund managers from the impact investing universe converge in New Delhi.
One of the highlights of the three-day convention was the release of high-level findings from research conducted by consulting firm McKinsey & Co. on the state of impact investing in India. The report itself will be released in January next year. But the sparse details available, gleaned from press statements and a brief conversation that I had with Vivek Pandit, McKinsey senior partner and head of its private equity practice in Asia, offer some interesting pointers to where the asset class is headed.
Before we get into the specifics, it is pertinent to note that this is probably the first time that a piece of research has drawn conclusions based only on pure impact investments. That, as defined by the Global Impact Investing Network, implies investments in businesses that have a dual mission to generate social and environmental impact, alongside financial returns. Such businesses typically address the needs of consumers at the base of the pyramid. Instead of assessing investments at a fund level, the study looked at deals in socially relevant sectors. The final list of 424 deals included only those investments where there was no ambiguity about the dual mission. Therefore, for instance, specialist impact investor Omidyar Network’s bet on online classifieds platform Quikr would not have made the cut. On the other hand, Sequoia Capital’s investment in Cuemath, a company that offers math tutoring services to low- and middle-income students, would have been included.
The 424 deals in which the study is grounded account for a total investment of $4.1 billion over a six-year period from 2010 to 2015. This is chiefly capital invested by venture capital and private equity funds. In isolation, $4.1 billion sounds like a decent sum of money. But let’s put it into context. Flipkart, the Bengaluru-based e-commerce company, has alone drawn more than $3 billion since it started up in 2007 and most of it has come in the last two years.
That said, $4.1 billion isn’t shabby for an asset class that is still relatively nascent in India. Last year was particularly good with investments touching the $1 billion mark for the first time (see chart).
Incidentally, the more than 60% spike in total investments from about $600 million in 2014 to $1 billion wasn’t driven by more deals. Rather, the growth, says Pandit, was on account of an increase in the average ticket size of deals—$14.3 million last year against $7.4 million the previous year. This was to a great extent driven by sectors such as cleantech and microfinance, which have lately seen renewed interest from investors.
The cleantech and financial inclusion sectors, in fact, account for the largest sectors in terms of deals closed and dollars drawn over the past six years. While investments in the cleantech sector stood at $2.2 billion, or 54% of the overall dollars invested, the financial inclusion sector, which includes microfinance, accounted for $1.5 billion, or 37%. In terms of volumes, however, financial inclusion pipped cleantech, accounting for 37% of deals closed. Sectors such as healthcare, education and agriculture, considered core impact investment sectors, are still comparatively small in terms of investment activity, though impact funds such as Lok Capital and Unitus Seed Fund have lately accelerated efforts to diversify their portfolios into these sectors.
The study also analysed financial returns from impact investments. It looked at about 50 exit deals and found that median returns in dollar terms stood at 10-12%, which is higher than the benchmark 7-10%. McKinsey declined to make available more information on exits. However, based on what has been reported in the media, impact investors have been fairly active with exits and returning capital to their investors or limited partners over the past couple of years. Much of the exit activity has been visible in the microfinance sector and this continues into the current year. In the nine months ended September this year, out of the top ten exits reported, three came from microfinance—Equitas Holdings, Ujjivan Financial Services and Janalakshmi Financial Services. Two, Equitas and Ujjivan, delivered liquidity to investors through initial public offerings, something of a rarity in India’s venture capital market.
There’s no doubt that impact investments have made significant strides over the past six years. Despite the gains, however, the sector continues to struggle with access to serious capital. This is true both for impact enterprises and startups as well as impact investors. Early-stage impact venture capital funds, in particular, still face massive challenges in raising capital adequate for their needs from limited partners. For the most part, corporate philanthropic foundations and development finance institutions remain the capital mainstay for impact funds. Unfortunately, by most accounts, while the impact sector has grown, the size of allocations from such limited partners have not grown at the same pace.
This doesn’t pose much of a problem for entities such as Omidyar Network, backed by eBay founder Pierre Omidyar’s personal resources, or the Bill and Melinda Gates Foundation, which draws capital from Microsoft founder Bill Gates’ personal resources. However, for independent investors such as Lok Capital, Aavishkaar, Elevar Equity and Unitus Seed Fund, raising successive funds hasn’t gotten any easier over the years. Until that changes, it will continue to be hard for impact investing to go mainstream and make the difference that it seeks to in narrowing the gap between the privileged and the underserved.
Snigdha Sengupta is a consulting writer with Mint. She contributes stories on venture capital and private equity.