How a mandate for impact in emerging markets helped the IFC outperform the S&P 500
By Hans Peter Lankes
This article was originally published on Impact Alpha.
Investors often meet skepticism when they say that they can make money while doing good. A new analysis of every equity investment International Finance Corporation has ever made validates this notion, especially when capital is scarce.
IFC, the private-sector arm of the World Bank Group, is one of the longest-standing equity investors in emerging markets — a market segment that it named and promoted — with a track record of investments dating back to 1961. Its mandate is to promote economic development, so it selects its equity investments, and manages its portfolio, with the aim of having a positive impact. IFC’s investments do not benefit from any explicit government guarantees. IFC typically invests alongside private investors on the same terms, so its equity returns can be compared to those of private investors — on a pre-tax, pre-fees basis.
Unlike private fund managers that must hit return targets and liquidate their portfolios over the fund’s life — typically five years — IFC is more patient, holding equities for longer, around eight years on average. This turns out to be key to making money in frontier markets, where macroeconomic trends and exchange rate fluctuations can reduce equity returns over shorter periods. The analysis shows that a one percent increase in cumulative annualized real GDP growth over the life of the average investment is associated with an additional 6.62 percentage points of excess return on that investment. Looking at all IFC equity investments since 1961, the portfolio outperformed the S&P 500 index over the same period by 15 percent. IFC’s patience contributed to this outperformance, with longer holding periods being associated with stronger performance at the investment level, even when controlling for sector and vintage years.
How did IFC achieve this outperformance? The analysis shows that its mandate for impact led IFC to find equity opportunities that other investors missed, by investing in markets that lacked access to capital, as its charter requires. IFC overweighted developing economies compared to market benchmarks, such as global foreign direct investments inflows. Among these economies, investments in countries with barriers restricting firms’ access to capital, such as limited banking system development, generated the highest average returns.
Providing capital to economies in which capital is scarce can be an especially lucrative way to make a difference. Imperfect integration of global capital markets appears to have left attractive opportunities in countries with less developed banking systems and capital controls, creating scope for both profit and social impact.
IFC’s equity portfolio may be the largest equity portfolio managed under an impact strategy, so these findings are significant. But they need to be supplemented by more research into the financial performance of a wide range of impact portfolios, which will only be possible with increased willingness to share performance information. This will help build confidence among investors — especially institutional investors concerned about their fiduciary duty — that they can invest for impact while meeting their financial performance targets. This analysis will hopefully motivate other impact investors to share their performance track record, and encourage more investors to invest for impact in emerging markets, where equity capital is needed most.
Hans Peter Lankes is Vice President of Economics and Private Sector Development at IFC.