In recent years, the burden on governments and nongovernmental organizations to create or serve as a catalyst for social change has begun to shift toward ultrawealthy private investors.
Charitably inclined individuals and families increasingly understand that today’s complex global challenges require more than traditional philanthropy, according to Christina Alfonso, chief executive of Madeira Global, an investment advisory firm in New York that specializes in impact investing.
Today, many high-net-worth philanthropists are engaging in impact investing, an approach that aims to generate both financial return and measurable, positive social or environmental change by supporting for-profit enterprises that create sustainable, innovative products and services.
Examples include microfinance, whereby a lender provides small loans to promising startup enterprises, often in developing economies; and a web-based education treatment solution for autism assessment, training and data tracking.
Impact investments can be structured as debt, equity or a combination of the two, and can earn returns ranging from below- to above-market rates.
The size of the current impact investment market is between $30 billion and $50 billion, based on various estimates, Alfonso said.
Donors who are interested in impact investing often are not sure how to think about creating a strategy for impact or how to identify investment opportunities, Alfonso said in a telephone interview.
This prompted her and her partner Alexandra Cart to open Madeira Global in 2012 to help clients navigate the myriad options in order to create a planned type of investment.
The firm’s clients typically are in the $200 million-plus net worth range, Alfonso said. “The reason for that is we’re seeing that as a first go, impact investors are allocating from 1% to 5% of their overall asset base to impact.
“If you use those numbers, $5 million is the cutoff where anything less than $5 million is typically going to a fund to allow you the exposure as well as the diversity. Anything above $5 million is where the client is most interested in identifying specific investment opportunities that meet their financial expectations and social objectives.”
Those most interested in social venture capital generally fall in the under-40 age group, she said. “Many of the next-gens are serving as both social entrepreneurs and impact investors.”
But whether philanthropists are investing or giving their money away, “the common thread is efficient capital deployment,” she said.
Madeira Global is a hybrid structure: an LLC, which provides advisory services, and Madeira Global Foundation, a Delaware-based 501(c)(3) entity. The two entities share a mission, to support for-profit social businesses.
The foundation, Alfonso said, serves some clients as a platform to transition from tradition charitable giving to performance-driven grantmaking.
Allocating Capital, Mitigating Risks
Madeira Global offers clients a four-step process for allocating capital to impact investments.
Advisors first create an actionable investment mandate based on a client’s objectives, risk profile, and financial and social return expectations. These factors determine the scope, size and type of investments within the mandate.
Next, with the client-specific mandate parameters in hand, advisors filter deal flow from a global pipeline, assess the suitability of filtered investment opportunities and, with a green light from the client, perform a rigorous due diligence on selected investments.
Then comes capital deployment. Whether this will be in the form of debt, equity or a grant will depend on the clients comfort and risk profile.
Alfonso said the Madeira Global Foundation allows support to come through the allocation of performance-driven grants as a way of bridging the gap between traditional philanthropists and impact investors.
Early- and growth-stage social businesses require financial and strategic advisory assistance as they strive to address global challenges through sustainable solutions. Grant capital gives social entrepreneurs the opportunity to test for proof of concept as they set a solid framework for their business and create a strategic plan for future growth and scale.
“It’s important to ensure you’re identifying the right targets,” Alfonso said. “Then, the second part of the equation is, how do we structure this appropriately?”
The fourth step of the capital allocation process involves active management of the investment and ongoing reporting on social and financial performance.
Alfonso noted that various risks attend impact investment, and she said Madeira Global was upfront with clients about these challenges.
Those considering overseas investments expose themselves to currency risk as well as political and economic risk. Liquidity is another concern. Many equity investments are considered early stage, and the lockup while waiting for an exit can be eight to 10 years.
Fees can be onerous. These include transaction costs per deal size, cap intro fees and the cost of robust due diligence.
There are also the costs involved in managing the investments on a local level. And perhaps not surprisingly, insurance products are starting to appear in the impact investment space, tacking on another fee.
Metrics to capture social progress are a work in progress, “but we’re getting there,” Alfonso said.
“Impact investing is challenged by an inefficient market, disproportionately high costs relative to the risk and opacity and complexity,” she said.
“We address those challenges by identifying an impact mission and objective, so having a clear focus and angle, increasing transparency and then reducing those transaction costs.
In terms of risks, it is important to list and assess them, and then account for them in planning and deployment, Alfonso said.
If called for, Madeira Global creates hedging strategies, applies diversification, reduces correlation across the portfolio, designs customized metrics if necessary for particular investments in a client’s portfolio, and regularly monitors and actively manages the investment.
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