Interviewee: Private Operations Department Head of ADB Ventures, Xiaowen Pu
CASVI: What kind of investment is considered as impact investments by ADB and what are the characteristics in practice?
Xiaowen (Sherwin) Pu: As for impact investments, we believe that, firstly, there should be an overall strategic roadmap to decide what the general direction is, how to define our goals, and whether the required resources are properly allocated. Secondly, these investments should be well managed.
If we want investment to generate impact, it must maintain its financial sustainability. Otherwise, the impact will not last. Apart from reaching the impact targets, we hope our investments will produce economic benefits in the long term. If companies want to raise funds from us, the prerequisite is that they need to have a sustainable business and financial model. We do not expect every portfolio company to become a unicorn, but they are anticipated to break even and generate returns for their investors. The biggest difference between ADB Ventures and other investors is that we are more patient. ADB Ventures’ fund life is 17 years, which means we can cover a full economic cycle. By opting for a patient capital approach, I believe we can avoid macroeconomic downside risks for financial returns.
In addition, I believe that impact investing is not about self-praising. It must be defined with certain features. For example, the impact performance of each investment should be evaluated objectively. There is an independent unit within ADB to help track and confirm the status of our impact targets. As a development financial institution, ADB does the evaluation systematically. When the investment is approved, we will set up targets and measurement standards, and actively track the progress of reaching these targets. We will disclose detailed information to the public to seek supervision. After exit, an independent review will be conducted to evaluate the performance of the investment. This approach applies not only to the impact investments, but also to our infrastructure projects, financial institutions projects, and others. We have such a target tracking system, the DMF (Design and Monitoring Framework) for every investment ADB made in the past. The official website of the Asian Development Bank discloses the DMF for every project.
CASVI: As a development financial institution, ADB has been paying attention to the Asian market and helping it achieve various development goals. Why would ADB come up with the idea to set up ADB Ventures (ADBV) this year (2020) to operate in a more systematic way of impact investing?
Xiaowen (Sherwin) Pu: ADB has always made its investments from an impact-driven angle. We have invested in tech-driven companies at different stages using different financial instruments, but we have not invested in tech-driven companies with a portfolio approach. ADB Ventures is not only a fund but also a platform established by ADB to support tech-driven start-ups systematically for the first time. We started to prepare for the establishment in the second half of 2018 and spent a whole year in 2019 to complete fundraising and the structuring process. On January 31 this year (2020), the ADB's board of directors reached a consensus to establish ADB Ventures. ADB Ventures Investment Fund 1 was successfully completed on April 14, with a total of USD60 million raised. So far, our first investment has not been made, but it is expected to be completed in early 2021.
Apart from the USD60 million Fund 1, we have also received about USD12 million as Technical Assistance funds from ADB and other investors, of which about USD5 million is used for pilot testing. The pilot testing is different from the proof-of-concept of a startup’s new product. We want to focus on companies that have already developed their commercial products. Our fund will help them expand regionally, meet with potential corporate clients, or extend their product range and value chains.
In addition, we cover the broad Asia-Pacific region. There are many low-income developing countries with different market needs. We believe that we need to continue developing innovative financial products to meet the challenge of lack of capital at the different life cycles of the startups. We are preparing to start the establishment of Fund 2, which will offer debt instruments to startups, at the end of this year.
CASVI: As a fund established by a development financial institution, will ADBV give priority to the impact investments, even if it might sacrifice some financial returns
Xiaowen (Sherwin) Pu: Definitely not. If a company cannot last for a long period, the impact is also unsustainable. We believe that it is not difficult to have economic benefits and the real challenge is how to accurately correlate economic benefits with the impact the company generates.
We are committed to the economic development of the region. Our aim is not only to make money when we invest or provide technical assistance but also to help the companies to go further.
We can still generate positive social and environmental impacts by investing in financially sustainable companies. It is not needed to sacrifice financial returns. On the contrary, financial sustainability is the prerequisite of impact. If a company is likely to bankrupt in the future and we continue to invest money in it, the company may still generate some impact within a limited timeline. But there may be no impact in the end. Financial wellbeing and sustainability is an important factor of our due diligence process. We hope that the company's business can continue to grow after our investment, so the impact will scale accordingly.
Helping companies to generate and develop impact is our priority as a development financial institution. Entrepreneurs will focus on managing and growing their businesses. Assuming that the impact of every dollar is the same, and a company grows its business revenue from 100 RMB to 10,000 RMB, achieving a 100-fold growth, it means its impact may also multiply by 100 times.
CASVI: What is ADBV’s impact investment strategy?
Xiaowen (Sherwin) Pu: ADB Ventures Investment Fund 1 targets start-ups for the Series A round, focusing on four sectors: Cleantech, Inclusive Fintech, Agri-tech, and Health-tech. Our impact targets are that 80% of our investments generate climate impact, and 75% generate gender impact. The thresholds are quite high because most of the investments will achieve both targets at the same time.
Our primary focus markets are South Asia and Southeast Asia. Many of these markets have great potential and active ecosystems to support entrepreneurs.
Like Fund 1, Fund 2 is not very likely to focus on the Chinese market. The Chinese ecosystem is more developed and there is no shortage of public and private funds. We hope to allocate resources to more countries and regions in need as much as possible. However, in some cases, we will still consider investing in Chinese companies. In Fund 1, there is a company which we are quite optimistic about. Its technology has been applied not only in China but also in a large part of Southeast Asia. Its capability to scale commercially has been verified, which is quite important from the perspective of commercial returns. In addition, from the perspective of development, we also believe it is important for Chinese companies to go global and have an impact in other regions. Therefore, we will also look at Chinese projects, albeit from a different perspective.
CASVI: Who are the investors of Fund 1? What did you consider when raising funds for Fund 1?
Xiaowen (Sherwin) Pu: Our investors include the Ministry of Foreign Affairs Finland, Clean Technology Fund, Nordic Development Fund, and the Ministry of Economy and Finance Republic of Korea. We contacted many commercial organizations like large asset management companies during the period of fundraising for Fund 1, but later we chose to be more prudent. Therefore, we first considered investors with whom we were familiar, especially those with basic legal frameworks. That is to say, we actually took a shortcut during Fund 1. When it comes to Fund 2, the scale will be larger. With more preparation time, we might consider more commercial investors.
CASVI: Do investors of Fund 1 have specific expectations and requirements for financial returns and impact goals?
Xiaowen (Sherwin) Pu: Yes, they are quite clear that the money must generate financial returns. There is a 5% annual investment return target for our portfolio, which is not very high. In addition, we do not have carry or a very clear hurdle rate. However, achieving the 5% annual rate of return for the whole investment portfolio over 17 years requires quite a high return in each individual investment. As for impact, we have also set clear targets that 80% of the investment portfolio must have climate change impact and that 75% must have gender equality impact. The financial return must be in accordance with the impact targets required by investors.
In the future, as we create more impact investment products, I believe that the impact targets will definitely be higher, and we will adjust the financial return targets according to different products.
CASVI: Compared with non-impact investors, what is the value that ADB will create when investing in enterprises?
Xiaowen (Sherwin) Pu: What ADB cares about the most is additionality, and this applies to the investments made from ADB Ventures as well, which is the added value we can provide to companies.
The greatest added value we provide to startups is ADB’s extensive regional network, which can help the companies expand as they scale up. For example, it is easy to find experts from China, Indonesia, or from certain industries in many investment institutions. However, it is difficult to find experts who have a good understanding of more than 40 markets in Asia and the Pacific, and who also have both business connections and a public sector network. ADB is amongst the few investment institutions which have full support and trust from the local governments. I believe ADB’s unique value-added to each company is the most important factor beyond money invested.
CASVI: The 17-year investment cycle is long. Apart from using the DMF framework for tracking and evaluation, are there any other ways to control risk in terms of finance and impact?
Xiaowen (Sherwin) Pu: Risk management is divided into two parts: pre-investment analysis and post-investment management. We look at impact targets and financial returns for both stages. During the due diligence process, we do a detailed analysis to gain confidence that the investment can achieve both impacts and return targets.
After we invest in a company, we don’t expect the investment to be absolutely the same as our previous analysis. There might be various issues. Therefore, post-investment management is about helping the company solve problems as they occur, by constantly tracking and responding to them. If the company scales quickly and requires new investments, we can continue to do follow-on investments. Half of the funds from Fund 1 will not be invested immediately but will be used for follow-on rounds. Put it in other words, only when the first investment is successful, will we continue to provide funds and invest a larger amount. In this way, we can provide the company with long-term support while managing investment risks.
There might be happy stories and sad stories in an investment. “Happy stories” refer to a combination of positive impact and good financial return. I believe that only a few companies may have “happy stories” in the end. It is what we have anticipated before all the investments. That is to say, we rely on a few “happy stories” to achieve the impact targets and return our funds. “Sad stories” are inevitable because things do not always develop as expected. The important thing is to continuously make changes while monitoring and tracking our investments, so we can work towards having several successful investments that can generate financial returns and achieve impact targets in the end.
CASVI: What kind of management mechanism does ADBV adopt to evaluate the impact?
Xiaowen (Sherwin) Pu: Every year, we start by setting an impact target and actively track progress as we close each investment and monitor every portfolio company. There are two reasons. First, we let our investors know that their money is invested where they planned. Second, if there are changes due to the market or other reasons, we can also make timely adjustments.
As mentioned earlier, there is a DMF (Design and Monitoring Framework) in place to help track all portfolio companies. Each investment must have an impact entailed in the DMF and it will be evaluated by a third party. It also helps companies to track and monitor their own companies. In the DMF we have outcome and output indicators, and we actively track and monitor them. When an investment is initiated, we set targets in the DMF. When evaluating individual investments, we analyze their potential in each category and their contribution to the entire portfolio. As long as the goals are consistent, the impact of the portfolio is basically the sum of all individual investments. However, some adjustments may be required to avoid double-counting for the same problem statements, and we will continue to fine-tune the system.
ADB Ventures currently does not use external standards to measure the impact. In the future, it is still difficult to say whether we will adopt IFC's nine principles completely or partially, follow our own framework principles, or even produce new principles by collaborating with other firms and organizations.
CASVI: Do you have any special concerns about the development of impact investing in the Asian market and what do you think will be the challenges?
Xiaowen (Sherwin) Pu: I think it’s important that we apply consistent impact measurement standards. The inconsistency in different markets mainly results from the lack of official institutions to help align standards and monitor results. For example, if a fund sets its impact target as No.4, 7, 12, or 16 of the Sustainable Development Goals (SDGs), even with specific quantitative indicators, it is still difficult for funders to confirm whether it is true. Because there are no credible institutions to provide independent evaluations. We noticed that some institutions are providing such services, but not for free.
It may take some time to establish credible third-party institutions. Before that, some experienced founders believe that they can do impact measurement. However, for other investors, the biggest risk is that one or two frauds may ruin the entire impact investing market, which will be very troublesome. After all, impact investment institutions still need to consider reputation risk.
CASVI: ADB Venture’s theme of gender equality investment is very interesting. How do you achieve this goal through investment?
Xiaowen (Sherwin) Pu: We think about the improvement of gender equality from different perspectives. For example, if 30% of the employees in an investee company are women, with our support, they can eventually reach 50%. The 20% improvement reflects the real change in gender equality. Another example is that we also work on encouraging women to start their own businesses by investing in female entrepreneurs. In the fintech space, we invest with a focus on serving female borrowers, who have limited access to finance otherwise.
We take different approaches, but the goal is the same. We hope to promote the employment rate of women in the entire country or region and increase women’s contribution to GDP.
This is part of our impact targets that we incorporate into our investment strategy.
CASVI: What is your expectation of the Chinese impact investing market in the next few years? Will the entry of private capital promote growth in this field?
Xiaowen (Sherwin) Pu: I think there will be a lot of development and progress in the impact investment space, with more awareness in the region. However, there are still few institutional impact investors. With the acceptance and understanding of impact investing, how to grow the industry with different products is a question worth considering. In addition, there should be credible third-party institutions to evaluate the impact and monitor projects in a proper and not laissez-fairway, and to introduce impact measurement frameworks that can really promote the diversified development of this field.
How fast the impact investing sector can grow may depend on three aspects. First, the external driving force (whether it comes from the government or private capital); second, the performance of third-party service agencies, especially independent evaluation agencies; third, the potential risks. The Chinese impact investing market will witness great development in the next few years. However, once we see a bad investment case with very low financial returns in the market, it will severely impact the reputational risk of the domestic impact investing market and also harm our ability to hit our impact targets. This is why we believe it is essential to collaborate with third-party institutions to continually evaluate the performance of investments and ensure they can produce the needed impacts. Though at this point, it is still too early to know which organizations will play the leading third-party role in impact monitoring.
