ABC World Asia: Exploring the Asian Impact Investing Private Equity Market

Interviewee:

Managing Director

Tan Shao Ming

Q: Why did you participate in impact investing?

A: A friend and I initially discussed impact investing by chance and after further research, I realized that this was a very meaningful space with deep potential. I share a similar perspective with my organization – the world today is facing many serious challenges and society is beginning to show longer-term structural changes. It seems that we are witnessing signs of a tipping point for the earth and mankind almost every day. For example, climate change and public health issues in recent years have triggered public discontent; these challenges have also led to the global community taking proactive action. One of the trends is that the public has expectations and demands on companies to do good and to be socially responsible. Today some industries have begun to build a consensus that enterprises should shoulder social responsibilities and can no longer pursue shareholder value maximization blindly.

Large amounts of capital are required to address these pressing global problems. Impact investing is thus a channel that can drive traditional finance towards supporting social and environmental solutions for these problems. From a different perspective, the philanthropy space has also become more rigorous in demanding that recipients provide measurable metrics, in order to provide clarity on the returns from philanthropic gifts. Thus, impact investing has become a rising investing approach in recent years through its combination of financial returns and measurable social and environmental impact.

We see that the field of impact investing is more developed in Europe and the United States, compared to Asia. According to the 2020 GIIN report, about 60% of the world’s population is in Asia but we account for less than 20% of global impact capital. So, as an organization based in Asia, we want to try our best to promote impact investing in Asia and to narrow this gap.

The investors in ABC World Asia understand and commit to sustainability. Together, we hope to play a more active role in impact investing so that we can catalyze more companies to provide solutions for Asia’s complex social and environmental problems. We aim to combine compelling financial returns and measurable social and environmental impact. In this way, we can attract more traditional funds to consider impact investing and in turn contribute towards achieving the United Nations Sustainable Development Goals.

Q: What are the financial or impact expectations by LPs of the fund?

A: When we raise money, we set a return expectation for our investors. What we want to achieve is market rate return. Different investors may have their own considerations on return and impact. For example, Temasek Trust's main business is charitable trusts. Therefore, from a philanthropic standpoint, its goal is to do good and obtain returns. Other investors, such as Temasek itself or institutions such as Mapletree and Seatown Holdings, are seeking to balance business returns with positive impact.

Q: What are the unique opportunities and strategies of the Asia-Pacific impact investing market?

A: The Asian market can be more complex when compared to European and American markets. As Asia consists of many different countries, the legal structure, cultural context and challenges faced varies accordingly as well. In the European and American impact investing markets, there are already several clear sectors for growth. For example, environmental causes are very common and widely accepted in Europe. In Asia we see many impact investment projects falling into the area of social impact instead, which is comparatively less developed in Europe and the U.S. In Asia, we see more opportunities arising from more pressing needs.

We organize the sectors we invest in by geography and industries, and we look at the specific challenges each country faces, which vary widely based on context. For example, while China is addressing the challenges of an aging population or pollution, some relatively less developed countries in Asia are instead struggling with water shortages.

Therefore, the social and environmental issues faced by every country in Asia are not entirely the same, with different challenges arising at different levels. While we see many varied opportunities for impact investments, we are also keen to help foster a more disciplined and structured approach in this sector.

Another difference is scale. In mainland China, the size of enterprises is generally larger, while in some developing countries such as Cambodia, the size of enterprises is typically smaller. We need to think about how to make choices among the many companies in Asia.

Q: How does ABC World Asia develop its investment strategy?

We make impact investments in the form of private equity. Investors are mainly Temasek and its subsidiaries, with no individuals or families. We believe that private equity is a relatively resilient, risk-tolerant, long-term, and patient capital and at the same time, impact often takes time to manifest. So, private equity is an appropriate asset class for impact investing.

We focus on the pressing social and environmental challenges that Asia is facing and think about how to transform these problems into opportunities for growth and development. We have identified five areas of impact and seek investment opportunities in these themes: financial & digital inclusion, better healthcare & education, climate & water solutions, sustainable food & agriculture, and smart & livable cities.

Because different countries in Asia have different challenges, our focus is also adjusted accordingly. Generally speaking, there is no fixed asset allocation strategy for a certain region or area. And because we are still a relatively young impact private equity fund, we continual to review and evaluate strategies to invest more effectively. Geographically, we are focusing on China, India, and some of the larger countries in Southeast Asia such as Indonesia and Vietnam.

In the five investment themes that we have identified, we have evaluated over 200 projects. Our target investees have generally developed to a certain size. As a 10-year private equity fund, we bear an investment cycle of about 5 years, with a minimum investment threshold of USD10 million and an ideal investment of USD20 to USD30 million over the whole cycle of a single project. As growth capital, we position ourselves as a minority shareholder instead of a controlling shareholder.

In addition to the investment threshold, we apply our methodology to assess the impact which a potential target company can generate. At its core is a judgement of the company’s intention and corporate values, namely, whether the company intends to continue its business by pursuing its impact objectives. We want to find entrepreneurs who are passionate about impact development, who look forward to working with us to better leverage the impact of the business and to amplify that.

We adopt two approaches towards deal sourcing. The first is a top-down approach where we focus on areas or industries where we can make a real and substantial difference. For example, in regions where most companies rely on coal for electricity generation, we look for investments in new sources of energy. The other approach that we take is the bottom-up method where we start off by looking at a specific company. Among the companies we have contact with, some reached out to us proactively, and many are introduced by other investors or VCs.

Q: Compared to other PE investors, why ABC can attract entrepreneurs as an impact investor?

A: The biggest difference is that we are an impact private equity fund. Most other investment institutions do not consider impact in their evaluation. This difference can be a double-edged sword. To a large extent, whether entrepreneurs work well with us will ultimately depend on whether they share the same fundamental values with us. It can be a very attractive selling point for entrepreneurs if we can reach consensus on these values. To some enterprises, introducing an impact investor can help them receive certain validation, and can advance the company’s interests in the areas of customer engagement, employee retention etc. In addition, impact investing will bring some financial benefits to enterprises. For example, some banks and lenders are now willing to support impactful companies with relatively low-interest loans. This trend is still in the early stage of development, and when further extended can bring about a more comprehensive funding structure.

Q: How do investees view the relationship between financial growth & scale development and environmental & social improvements?

A: As we sift through projects, we try to find companies whose profitability is directly tied to their impact, such as new energy, solar, etc. When these enterprises expand their business, they can save energy, reduce emissions, and create profits. So, there is no trade-off between financial growth and environmental & social improvement. Such positive correlations exist in some industries. For example, in the field of inclusive finance, the focus of corporate growth is on providing universal access to financial services, rather than on the pursuit of high returns from a single customer. In the area of healthcare, companies popularize access to healthcare so that more people can enjoy it and then companies can reap the financial returns.

In addition, enterprises can no longer blindly pursue the goal of maximizing shareholder value. We are seeing the trend where consumers will buy the company's products or services because they recognize and align with the corporate values of a company. Therefore, when companies compete, a company with dual objectives can have an advantage over other traditional enterprises – thus, to be equipped with dual objectives is helpful for companies in brand building.

Q: How does the fund plan to do impact measurement and management?

A: The measure and management of impact is our core competency. We not only assess the quality of impact but also try to quantify social and environmental benefits of our investments through evidence-based research.

Our approach evaluates impact against the five dimensions of the Impact Management Project (IMP) framework – including "who", "what", "how much", "contribution", and "risk”. For example, “Who” is the customer base, “what” is the impact we generate, and “how much” is the depth and breadth of the impact. All of these dimensions can generally be quantitatively measured. “Contribution” is what we contribute to the organization or domain, and “risk” is whether there is a risk to hinder the company from achieving impact. We use the theory of change when assessing a company.

Among these five dimensions, some can be quantified by numbers, while others require our subjective assessment. For example, the quantitative measurement of   “contribution” depends on the circumstances. In some industries, it is easier to measure the contribution because we can clearly monitor the increase in the number of customers after investing in a company, or we can conclude that the company would not be able to expand its activities without our capital injection. In infrastructure industries, such as new energy and solar, it is also easier to quantify the “contribution”, which is specially demonstrated by linking the amount of capital that we inject into companies to the number of solar panels we can install to the reduction in carbon emissions.

The measurement of risk (of impact) is linked to financial risk to some extent. For example, new policies by regulators could have some impact on companies. In addition, the company's growth direction could be counted as a part of the risk, such as whether the company will persist in providing its original products and services to customers with corresponding needs rather than blindly pursue financial benefits. The rest of the general risks which can affect the company's business can also affect the company’s impact, such as competitors and access to capital.

In terms of the impact management process, we work with the investees to set impact goals and metrics. We track them throughout the investment cycle to ensure that companies do not deviate from their original goals. These metrics are as closely related to the core businesses as possible and are not new to the companies, examples will be operational data including number of customers, type of customers, and so on. This is possible because when we select companies to invest in, we usually require that the impact of their core business be aligned with their financial returns, minimizing trade-offs.

We publish portfolio impact reports on a regular basis. We initially chose to adopt the IMP framework because we invest across a wide range of sectors and the impact cannot be measured with a single metric. Therefore, we adopted this framework to measure impact as well as to assess the quality of impact.

Q: How is the investment exit considered? How do you avoid the original direction being diverged because of new entrant shareholders?

A: As a private equity fund, our modes of exit can include transfer of shares, sale of shares to other investors, or an IPO. There is minimal trade-off between an investment exit and our impact consideration. As much as possible, we want to enable companies to continue delivering impact without being affected by the entry of new shareholders. Therefore, we do prefer buyers with a sustainability and impact focus. This is an issue that we continue to study and assess.

Q: Are there any concerns about the development of impact investing in Asia and in China?

A: There are many opportunities in the Asian market. Impact investing is still in its infancy in Asia, and the challenge is create the awareness amongst more companies that there are investors who care about impact.

Overall, the development of impact investing in China is very rapid. Of course, from the definition of impact investing itself to the design and structural level, everyone may have a different interpretation. For example, ESG investing also includes the concept of impact to a certain degree. In addition, green finance, especially green bonds, is doing very well in China. I have also seen other impact investment institutions thrive. Therefore, I am anticipating that impact investing will continue to grow rapidly in China.