Investing for Financial and Social Returns: An Interview with Omidyar Network’s Mike Kubzansky
Mike Kubzansky is a partner at philanthropic investment firm Omidyar Network, where he leads the firm’s Intellectual Capital team and is responsible for defining investment strategies and conducting market research and analysis. In this interview, Mike reflects on Omidyar’s recent research on strategies for impactful investing in emerging markets and highlights opportunities and challenges for investors looking to achieve both financial and social returns.
Omidyar Network’s recent report, Frontier Capital: Early Stage Investing for Financial Returns and Social Impact in Emerging Markets, which you co-authored, discusses approaches to financing early-stage companies that serve low- and lower-middle-income populations in emerging markets. What should institutional investors and fund managers take away from this report?
The first major takeaway is that investing in frontier markets is not only an opportunity to do some real social good, but also an attractive investment opportunity in and of itself. There is an enormous opportunity within the low- and lower-middle-income segments in emerging markets. For example, according to our calculations, this segment has around US$3 trillion in purchasing power, making it extremely attractive for venture capital investors looking for larger total addressable markets. In many cases, once a company has established itself in the middle-income market, the cost to move further down the market to attract additional consumers is minimal. This is especially true for businesses using a tech platform or another kind of mobile-based product. Furthermore, companies that target both the lower income segment and the aspiring middle class segment will be better positioned when those consumers move into the middle class and become more attractive middle class consumers. Finally, many frontier markets avoid the high valuations common in traditional venture capital, allowing investors to concentrate on the fundamentals of investable businesses.
The second main idea put forward by the report is that different profiles for impact cater to different risk appetites. There are three segments of the market that people should consider—replicate and adapt, frontier, and frontier plus—depending on the investor’s appetite for risk and their ability to take on different and new business models. The replicate and adapt segment, which has the lowest risk profile, uses models that have worked elsewhere and imports them to emerging markets—such as Rocket Internet, which is replicating the likes of Amazon and Zappos, or Quickr, a mobile-based classified platform that provides access to jobs and services to traditionally underserved markets throughout India.
The higher risk frontier profile refers to unproven business models that tend to be asset-light and target both the low- to lower-middle-income segment as well as more middle-income customers. Think MicroEnsure, which partners with telecom operators to sell over 15 million affordable insurance products in Africa and Asia, or Geekie, an adaptive learning platform providing access to education in Brazil. Both of these companies leverage technology to reach a broad audience, increasing their ability to scale quickly.
Finally, frontier plus, which has the highest risk profile, involves investing in unproven business models with more difficult operating circumstances. This segment is not for the faint of heart, but it is also where we see outsized social returns in industries like solar lighting, cookstoves and affordable housing. We have also seen several successful exits that have produced 5x or greater returns for investors. In fact, all three of these segments have seen attractive returns, but cater to different types of investors.
The report emphasizes that creative financing models are important for investing in businesses within the frontier segment, and especially in the frontier plus segment. Are certain types of institutional investors more receptive to these innovative models than others?
Development finance institutions (DFIs) are in the business of promoting the movement of capital into frontier and frontier plus segments. Investing in these segments is a natural extension of what DFIs have already done successfully in other sectors and what they need to continue to do to fulfill their mission. Their eventual goal is to de-risk frontier and frontier plus companies and make them commercially attractive. As such, DFIs have historically played an important role as catalysts in driving capital to these segments, and this is especially true for microfinance. DFIs, such as International Finance Corporation and Inter-American Development Bank, along with grant makers such as the Ford Foundation, led the way in proving out the microfinance model. Currently, microfinance sits in the replicate and adapt category, but 20 years ago nobody would have said that. A more current example is the solar industry, where DFIs are investing in non-financial return oriented projects, such as Lighting Africa, that help to build out the ecosystem.
Another great audience for these more innovative models is the high net worth segment, in which some investors have long-term patient capital horizons, interest in and understanding of market development and the flexibility to pursue alternatives to traditional fund structures. Their potential for longer-term investment horizons gives companies the opportunity to get their business models right and to scale. More and more high net worth individuals are engaging in impact investing and their increased interest is an opportunity to broaden their scope, both in terms of the businesses they invest in and innovative financing models.
In general, it is important to show that the frontier and frontier plus segments are investable markets and innovative models will help, not hinder, returns. For instance, the frontier plus segment is defined by markets where exits are difficult. Regions in the frontier plus segment do not have deep capital markets and exits via public markets may not be possible. Structuring investments as venture debt or exploring non-traditional exits can help facilitate returns in such an environment.
How do you see frontier capital evolving over the next ten years? What are the main challenges for the three frontier capital segments?
The replicate and adapt segment will always be appealing for emerging market equity investors. The real challenge is how to de-risk these more un-proven business models, particularly those within the frontier plus category, and move them into the replicate and adapt segment. Proving these segments also means being patient when innovative companies find themselves in markets like Brazil where the macroeconomic situation is going both up and down. For frontier plus, the next ten years will really be about building the segment, bringing in not just institutional investors, DFIs and high net worth individuals, but also grant money and donor money to help de-risk investment opportunities. I would love to come back in ten years and say, “You know, all this effort that's gone into the solar segment has moved solar technologies from frontier plus into the replicate and adapt situation, or at least a frontier situation.”
The report mentions its purpose is not to serve as the last word, but instead to spark important conversation on how investors should approach impact investing. Where would you like to see the conversation go and what questions would you like to explore next?
I think our next frontier, no pun intended, is this notion of segmentation and a more nuanced conversation around impact investing, which we tried to introduce with this paper. As of now there is this myth that impact investing is one-size fits all and that there will necessarily be trade-offs between financial returns and social impact. In reality, impact investing is a big tent with a lot of players, ranging from pension funds and university endowments to DFIs and high net worth individuals, and those investors have varying appetites for risk, returns and social impact. There are going to be a number of segments, including those we tried to illustrate with this report, where no trade-offs are required, and then there will be investments where trade-offs will be required. In this regard, we have started to discuss this notion of “impact classes” in addition to asset classes. Are there different kinds of impact that different investors want to see? Should there be some segmentation around that as well? These are important questions that Omidyar Network would like to explore.