Cause and effect investing

Do you want to see your money grow and also have the satisfaction of knowing that you have done your bit for society?

If the answer is yes, then you need to invest in social funds.

Social, or impact, funds are private equity-like funds that pool money from investors and put it to work in a ‘portfolio’ of ventures that meet the fund’s objectives. They aim to use your money to generate a measurable social impact while also earning a financial return.

But wait, isn’t charity all about not expecting any rewards? Why must I expect a return at all when I am doing good? “A return expectation brings in discipline and accountability to those using your money,” says Krishnamurthy Vijayan, Founder and Managing Director of Charioteer, a social fund that invests in businesses to create livelihood opportunities.

Social funds may invest directly in sectors such as microfinance, agriculture, healthcare, education and clean energy, which support a social cause. There could also be funds that help create employment, empower women or encourage small enterprises. The idea is to create enterprises that can support social causes in a sustainable manner.

Social funds are regulated investment vehicles, which now come under the ambit of the Securities and Exchange Board of India (SEBI).

They are registered as Category 1 (Social) Alternate Investment Funds. To invest in a SEBI registered social fund you need a minimum investment of ₹1 crore. But the money is usually collected in instalments spread over the initial two-three years.

Having invested in a set of ventures over their term, social funds typically plan to ‘exit’ or sell their stakes in these businesses after a specific period (say, six-eight years). The returns so generated are distributed to investors, after deducting fund expenses and fees.

Social funds typically have a 2 and 20 fee structure, like private equity funds. That is, you pay 2 per cent of the sum managed and also part with 20 per cent of any excess returns earned over a ‘hurdle rate’. The income from the fund investments will be ‘passed through’ the fund and you must pay tax on your share of income.

Unlike other investments, social funds provide both a financial return to investors and a social return through the impact the fund created on human lives. Returns are typically muted at about 10 per cent, compared with over 20 per cent in a regular private equity fund. Also, the lock-in period may be longer than 10 years, because such funds invest in very small ventures and stay invested until they are able to scale up.

While typical private equity funds sell out in 17 months, social funds stay invested for 50 months, says a report from the Department of Management Studies IIT-Madras.

Funds straddle a wide range — if some earn a high return by investing in microfinance, for others the primary objective is to do good and returns are incidental. The investments may take the form of either debt or equity. For instance, IFMR Investment Adviser Services plans to launch an overseas closed-end debt fund, which aims to offer low-cost loans for a five-year period to NBFCs in microfinance, says Nikhil Mardia, its Investment Manager.

While many funds have a broad mandate, such as helping the under-privileged, others may define their target areas. Khosla Impact, a social venture fund, has a goal of investing in technology-oriented social ventures. Incube fund focuses primarily on the health-care sector.

Social funds strike a chord with many high net-worth individuals who care about social issues in a certain geography or sector. They are happy to have just their capital returned. “Charity is not sustainable, but a successful business will deliver social impact on a sustainable basis,” says Subramaniam Iyer, an angel investor.

Social fund investors should look for three things — measurable social impact, muted returns, and sustainability of the ventures, says Krishnamurthy Vijayan.

‘Muted returns’ are essential because a very high return in a social fund may come at the expense of the beneficiary.

Before investing, you may want to check the funds’ criteria for selecting investee companies. “When choosing ventures to invest in, we look at the track record of the management for being socially equitable,” says Venky Natarajan of Lok Capital. Also, ask if the fund sets a bar on minimum wages, gender diversity, reasonable work hours and facilities, such as health insurance, for employees.

Given that you are looking for twin payoffs, you need to monitor the fund both for its financial and social results. Monitoring social impact isn’t easy even with funds providing periodic disclosures on social impact metrics, such as loan disbursal, number of patients treated or employment created.

But to truly monitor and quantify social outcomes, social audits must be done on an ongoing basis. The process involves checking company records, as well as conducting detailed interviews and surveys of beneficiaries to assess and certify impact results, says Latha Suresh, Director, Social Audit Network, India. You can realistically expect an audit report only once a year, she observes.

The social investing concept is still young and carries high risks. In addition to the risks faced by a private equity firm, policy changes may affect social funds focussed on sectors such as education, banking, healthcare and off-grid energy.

Social ventures may also lack the eco-system support that traditional ventures take for granted — working-capital loans from banks. This is getting better now, as organisations such as SIDBI are offering loans.

In some cases, the ventures may be run by non-governmental organisations or first-generation entrepreneurs who may not be market- or operations-savvy.

Lately, more senior founders have been entering this segment, easing some concerns, notes Manas Ratha, Director — Dasra Social-Impact and Portfolio, an organisation that connects social funds with companies.

If you are keen to give, it is also a problem if the social fund earns too high a return. During the microfinance boom, many companies started chasing profits, at the expense of beneficiaries.

This problem will ease as domestic investors — who understand the issues and are actively involved — participate more, says Thillai Rajan, Associate Professor, Department of Management Studies, IIT-Madras.