When developed countries experience a prolonged economic slow-down (such as the one toward which we are currently accelerating), it’s long been felt that investments in emerging markets can offer reduced volatility and opportunities for growth. Emerging market businesses are often more resilient to macroeconomic shocks and downturns, while middle class populations, who are more economically tied to the swings of financial markets, tend to be more intensely affected than low-income communities.

Despite these dynamics, international impact investing is far from protected from the coming downturn. During the financial crisis of 2007-2009, struggles in the U.S. and European economies did have an effect on the impact investing sector, choking the flow of capital into impact investment funds. This was a time when the microfinance sector was proving that businesses that serve low-income segments could successfully absorb venture capital and private equity funding, and the widespread success of Microfinance Investment Vehicles resulted in a new generation of multi-sector impact investing funds.

But as these emerging fund managers were seeking to raise capital during the hangover period following the recession, many funds were slow to get off the ground. Raising capital at the Limited Partner level was difficult, especially for those moving beyond the Development Finance Institutions (DFIs) to target private investors.

After a temporary deceleration, the impact investing sector bounced back with exuberance, spawning a diversity of fund managers over the past 10 years. But as the sector has grown, it’s become progressively interlinked with international capital markets, and now faces a heavier challenge from the next downturn.

Since 2010, fund managers have moved away from being anchored by DFIs. Impact investors are increasingly tied to allocations from institutional investors, family offices and philanthropic endowments that, together, remove a degree of separation from between the sector and the macroeconomic environment. We will see the effect of the recession more profoundly challenge the impact investing sector in the coming months and even years.

Fund managers and General Partners who are currently seeking to launch funds need to quickly adapt to the changing investment environment. Tactics exist to navigate what will be a more competitive fundraising environment where investors may reduce allocation sizes and risk tolerance across their portfolios. These reductions will likely happen with particular attention to illiquid strategies in emerging markets.

Needless to say, each fund manager’s situation requires a custom review of their fundraising strategy, and the following considerations may help.

• Recalibrate the fundraise target. Consider resetting your fund raise goals at the outset; it is never prudent to announce targets that are unlikely to be met. Developing more realistic ‘1st close target’ expectations going into a fundraise process may make for more realistic interactions that will earn you greater credibility. Investors will be more interested in committing to something that will have a greater likelihood of close.
  
  
• Reprioritize investor marketing efforts. Place a priority focus on DFIs and other public institutions that will arguably be less prone to tightening emerging market allocations. Double up on efforts to solicit commitments from existing investors.
  
  
• Understand whether opportunities lie in refining investment strategy. Depending on how long-term an outlook you’re open to taking, modifying investment strategies can be a useful tool to better align with changing investor preferences. Though each market comes with a great deal of nuance and it is difficult to generalize, bolstering allocation to “unsexy” sectors may be attractive. For example, consider increasing the focus on operating businesses serving core sectors and less on the technology models surrounding them. Investors will be seeking to trade scalability for stability. High growth or high leverage propositions will become more difficult to sell.
  
  Additionally, consider foraying into or bolstering the use of asset classes that may be more compatible with the future environment risk averse. For example, consider employing debt, which can take advantage of a lower interest rate environment or utilise instruments that have a running yield and, ideally, are also self-liquidating.
  
  
• Introduce risk-mitigation through the capital structure. Where possible, build in first-loss capital through a layered structure or build in partial guarantees.
  
  
• Ensure the investor distribution is expanded from the outset. If a placement agent has a network that aligns well with your strategy, they can greatly increase the efficiency with which you connect with relevant prospects. They can significantly expand the diversity and number of investors you engage with and will most certainly decrease the time it will take to reach those investors. In a fundraising environment with heightened competition, an appropriate partner can be key to success.

There is a great deal of uncertainty in today’s markets, but there is certainty in knowing that strong preparedness will be worth the investment.

Learn more about Palladium's capital advisory services or contact info@thepalladiumgroup.com.