Derek Newberry

Emerging Market Investment Hits the Mainstream: Green Sectors Are Up Next

The following article provides summary analysis of two events last week hosted by WRI-IFC and IFC-EMPEA. The conferences dealt with the issues of green investment in emerging economies and the broader growth of emerging economy investment, respectively.

wri logoSustainable SME finance is evolving from its status as an interesting trend to becoming a sizable sector in the future, but for now the investors involved in this area are a pioneering group, searching out stable returns in unknown territory. That was the gist of last week’s IFCWRI workshop on sustainable investment in emerging economy green sectors.empea logoNearly twenty fund managers with investments in companies all over the world and in a variety of high-growth industries including clean technology and organic agriculture met on May 8th to explore the opportunities and challenges in their work. These firms were generally divided between two dominant models, as revealed by a survey WRI conducted before the event. We found that firms operating in this sector are generally either local venture capital funds like Asia West that follow a traditional VC framework with a sector-specific focus or larger capital aggregators – U.S.-based hybrid-investment vehicles that use a variety of finance mechanisms to support their clients.

The challenges that were mentioned repeatedly in our funds survey were the same that arose in our event’s roundtables centering on building the deal flow of sustainable businesses and fundraising for new investment models.? Francisco Grajales, an Analyst for Econergy International went in-depth on the issue of finding good investments in this sector. He noted that one common solution to this problem among fund managers is to engage in intensive technical assistance with each investee. On the fundraising side, the Eurpoean Investment Bank’s Cyrille Arnould explained that as sustainable emerging economy investment is a relatively new phenomenon, firms in this sector are still struggling to build up a proven track record of returns to attract mainstream investors.

Despite the significant barriers, participants were convinced that sustainable SME finance would be seen more and more as a viable investment vehicle in the years to come. Cyrille compared the state of this type of investment to where the microfinance industry was three years ago – a great idea to blend social returns with profits that had few proven models for investors to follow. Lending credence to the optimistic tone of the workshop participants, we found in our research that several of the funds surveyed reported returns of around 25 percent, with the majority of the more established funds reporting successful exits.

Fund managers broadly acknowledged that several obstacles would have to be overcome for sustainable SME finance to scale up as a sector; firms will have to experiment with creative finance and exit strategies. There still needs to be a comprehensive effort to offer some minimally standardized formula for defining and quantifying the social and environmental impacts of these investments. Overall, it is clear that there is plenty of opportunity in the sector. With the increasing emphasis on sustainability in emerging economies and the growth of environmental sectors driven by small enterprise, there is little doubt that these funds will experience the same success as their counterparts in the US and Western Europe.

In contrast to the unofficial “uncharted territory” theme of the WRI-IFC workshop, it appears that the broader sector of emerging economy PE/VC has already proven itself to mainstream investors. At least this seemed to be the general consensus from the EMPEA Global Private Equity Conference last Thursday and Friday. EMPEA used the occasion to unveil the results from this year’s survey of emerging market investors, which showed that emerging market investment is being seen less as a risky venture and more as a dependable source of returns in the global financial community.

The survey highlights give a good idea of what to expect in the future: 63 percent of those surveyed agreed that five years from now, emerging market PE funds would deliver higher returns than “developed” markets; over half of the LPs said that returns from their emerging market investments were meeting or exceeding expectations; and nearly 80 percent projected that their emerging market commitments would grow over the next five years.

Several challenges were identified for emerging economy investments – many investors confirmed that funds must have a local presence in order to navigate the different bureaucracies and cultural tendencies of each country. Funds also have to be selective in their investments, working with companies that know how to operate in an “unstructured world,” as one participant commented.

By the end of the conference, it was generally clear that emerging markets had earned their status as sources of dependable and attractive investment opportunities. The next step is for the new generations of “green” entrepreneurs to soak up a greater share of the capital coming into these countries in the future.