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Felix Hermes | Is emerging market private equity the most effective way to invest for impact?

Felix Hermes | Is emerging market private equity the most effective way to invest for impact?
12-06-23 / Felix Hermes

Felix Hermes | Is emerging market private equity the most effective way to invest for impact?

Impact investment, at its core, is the task of identifying a change the world needs and deciding how to make it happen. This job – my job – is therefore defined by a determined search for the most effective ways to put capital to work to build an equitable, sustainable future.

I believe emerging market private equity investment is in a unique position to bring about measurable change, at scale, and can deliver impact in ways other asset classes cannot.

Let me explain.

Deploying capital where it is needed most

When searching for ways to put capital to work to build an equitable and sustainable future, tackling climate change is a good starting point.

Climate change will affect poorer nations – and especially women and the very poorest within them – far more than developed economies. We have written extensively on this topic already.

A significant factor in this vulnerability is resilience, or lack thereof, to climate events. Insurance penetration in the markets we target is almost non-existent; a fraction of that of developed markets. That underinsurance leaves thousands of emerging and frontier communities significantly threatened by change. But it also represents significant opportunities in rapidly-growing markets like agri-insurance. This is not an area that many other asset classes can easily support.

Technology will be crucial to tackling climate change, and many of the most important innovations require growth capital to continue or accelerate their roll-out at scale. With respect to insurance, technology is essential to drive access, affordability and relevance of solutions; key pillars of inclusive product offerings. When deployed in emerging markets, the investment in some technologies can even result in a "leapfrogging" of infrastructure incumbent in developed nations. 

What's more, emerging market private equity can often deliver high levels of "scalability".

Accessing less mature markets means investment can result in material exposure to vast market potential with a comparatively smaller investment. Emerging markets (EM) are home to 80% of the world's population and are singularly driving global population growth. They have also consistently grown their share of global GDP over recent decades, with the widespread expansion of middle classes as a consequence. This amounts to an immense and unmet need for affordable, essential products and services, a need private equity can engage with. This is where impact and capital growth potential naturally coalesce.

Fine control

Private equity investors in emerging markets can actively steer their partners' companies towards these unmet needs, offering potential for both growth and impact. This forms a natural part of value creation, particularly in the areas of product offering, distribution and technology/scalability. 

Private asset classes in general benefit from closer control of the owned assets, and high levels of influence over matters of operation and governance. By holding larger ownership stakes, competing with fewer co-shareholders and using active ownership and engagement, private asset investors can create investment value and measure the positive change.

For EM private equity though, the significance of governance in value creation is elevated further. The influence of board composition, management and reporting relative to companies in developed markets can be hugely significant.  

Similarly, the introduction of environmental and social policies and responsibilities, where they are not yet implemented at the societal level, can be transformative in EM, rather than incremental as is often the case in developed markets.

Linked to this is the elevated role of local networks in EM private equity. Locating and accessing the best opportunities requires knowledge of local risks and key stakeholders. This support requires hard-to-source expertise and talent in very specialised markets.

It's important to note that all of these drivers of value and positive social influence require little to no use of financial engineering/leverage, which play a much lesser role in emerging markets.

In addition, private ownership allows for investors to ensure that any sale of an asset is to a party sharing the same intention to continue to build towards societal or environmental value. This can be established during the due diligence process, and indeed is specifically referenced in the Operating Principles for Impact Management (OPIM) framework.

Unparalleled potential

Taken together, these factors - in my view - give private equity in emerging markets unparalleled potential to be additive. The ability to influence companies, to drive capital growth by addressing underserved needs, and the opportunity to reach vast populations with comparatively small investments can combine to be highly effective in pursuing impact.

*Felix Hermes is the Head of Private Equity and Sustainable Infrastructure at Blue Orchard, a member of the Schroders Group.

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