The widening role social impact funds have in the COVID-19 era

I had the pleasure of a timely conversation with Preeth Gowdar, director of the Palladium Group, who has more than 17 years of experience across impact investing, transaction advisory and strategy consulting.

He outlined his optimism over the broadening role that this investment sector can play amidt the pandemic uncertainty.

At Palladium Impact Capital (formerly Enclude), Preeth leads a diverse range of client engagements across the areas of capital raising, transaction and fund structuring, and strategy development. He advises entrepreneurs, fund managers, non-profit organizations and corporations with his focus sectors primarily spanning financial services, healthcare and agribusiness in developing countries.

Prior to joining Palladium Impact Capital, Preeth was among the earliest employees with Lok Capital, one of India’s first dedicated impact funds.

Vailakis: Preeth, thanks for agreeing to share your insights about the impact investing world at this time. What general shifts are you seeing in the fund allocation space right now? How are LPs reacting to the ‘new normal’ brought about by COVID-19 and market pressures?

Gowdar: There are two main parts of the international impact investor universe: (1) development finance institutions (International Finance Corporation (IFC), US Development Finance Corporation (DFC), etc.) — a category that comprises some of the larger investors, and (2) typical private sector limited partners — a category the comprises a higher volume of investors.

Currently, development finance agencies are acutely focused on providing near-term COVID-19 relief to their existing portfolio companies and others. Looking beyond this period of ‘relief’ investing, many in the space are wondering whether today’s events will trigger a major shift in longer term plans and how strong the pivot towards ‘resilience’ investing will be. As a result of the current crisis, investors may place heavy priority in the future on resilient food chains, fintech (‘no touch’ digital financial services and improved credit risk analysis) and healthcare (diagnostics and drugs), which have been exposed as lacking in many countries and essential.

Larger private sector investors are seeking to understand what the ‘new normal’ may mean for them and in the meantime have paused and are waiting to see where this period of uncertainty takes us. A number are likely now in the process of replanning their future allocation strategies.

There tends to be more volatility and bespoke behavior amongst the smaller private investors, i.e. small foundations and family offices. Their existing investment strategies may or may not directly align with the emerging class of ‘resilience’ strategies — some may pivot but others may stay close to their original impact theses. They are also quite varied in terms of their governance and operations and so there are vast differences in how quickly these investors can or will adjust to the new allocation environment.

Vailakis: As this is an alternative investing publication, many market players are reporting increased interest in distressed credit (although others argue that it’s early for actual purchases, it varies) and discounted secondary hedge fund and private equity fund stakes. Please share your thoughts about how these emerging trends intersect with the social impact investing sphere.

Gowdar: To date, there has been very little distressed activity in the world of social impact investing. Impact investors are almost entirely focused on building businesses and realizing positive outcomes from their capital.

However, in the current market where company and portfolio valuations are weakening, secondaries investing will become a strategy of increasing opportunity and importance. As investors shift towards infusing fresh capital into businesses (vs. paying out existing investors) or as they just pause overall, secondary transactions will reduce. As this translates into a reduction in exit liquidity, some limited life fund managers will be forced to extend a funds’ life or sell at a significant discount. This is a time when impact investors may realize the lack of secondary infrastructure we have in comparison to the private equity and commercial hedge fund markets and work to start building that infrastructure (e.g. a secondaries fund), which would make impact investing itself more resilient.

Vailakis: Technology and tech infrastructure (as we’re all much more tech dependent given shelter-in-place regimes), and select healthcare related investments are more popular now across the alternative investing allocator universe, as are individual co-investments in these sectors. You mentioned that you’re seeing parallel investment interest from the social impact LP community — please share what they are focusing on and any broader trend variations.

Gowdar: Tech and tech infrastructure have in recent years been very active areas of investing. Rapidly expanding mobile connectivity launched a wave of companies over the past decade and we expect this space will continue to thrive as underserved communities become increasingly connected. Looking to the future, we believe that using data to better serve the poor will spark a second wave of technology investing. More and more companies are using data to better understand, engage and serve individuals for whom little information exists. One of our colleagues recently proclaimed that eventually every company will become a data-driven company.

In terms of sectors, technology companies have been receiving investment across agribusiness, energy, financial services and healthcare. With the shift to ‘resilience’ investing, technology may take on a more central role. Within healthcare, there will be a bolstered interest in affordable diagnostic devices and pharmaceuticals. Technology that supports localized food chains will gain greater attention — connecting producers to local demand, supply chain tracing and small farm management systems all support a possibly accelerated shift to more localized and traceable food supply systems. And the fintech sector will now be even more empowered to expand their conversion to ‘contactless’ mobile and digital based systems.

Vailakis: Is the social impact industry seeing more allocations to larger managers with which LPs have existing relationships, as due diligence is easier?

Gowdar: As risk tolerance generally tightens up in the near and medium term, small fund managers that focus on earlier stage investing (and have shorter track records) may indeed face capital raising challenges.

However, if smaller managers are credibly able to create differentiated investment strategies around ‘resilience investing’, they may be able to overcome market challenges and attract significant amounts of impact funding purposed for rebuilding in the face of COVID-19. Nimbleness of fund managers may be a very useful advantage.

Vailakis: How does market sentiment differ during this downturn so far, when compared with the social impact fund challenges faced during the global financial crisis of 2008-2009?

Gowdar: In the last crisis, a large swathe of international impact investing fund managers struggled to raise capital. The fund managers were smaller, less proven and they were heavily tagged with emerging market or sector-specific risk. Many funds were single sector funds and financial services itself was a very common sector — this didn’t bode well in a crisis that began because of a financial services meltdown.

Impact investing has come a long way since then.

Many of our managers have multiple vintages behind them, diversified investment strategies and long relationships with their LPs. Combine that with the fact that impact investing is one of the most powerful tools in the world to help build our ‘new normal’; I am very optimistic about how the sector will fare in the days ahead.