Investors make an impact in Central America

Investors make an impact in Central America

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Ever since the term "impact investment" was coined at the Rockefeller Foundation in 2007, the number of private funds with a mandate to make a positive difference has skyrocketed around the world.

As those funds have built portfolios with roughly $114 billion in assets under management, Latin America and the Caribbean have received 12% of the total investments, trailing only Sub-Saharan Africa among emerging markets.

As part of a recent trend, impact investment funds are extending their reach in Latin America, supported by funding from local family offices and foundation, along with multilateral organizations and family offices and foundations in North America and Europe.

Larger markets like Brazil, Mexico, Colombia, Peru and Ecuador still account for the bulk of impact investments in Latin America, but Central America is becoming fertile ground for these funds. Investment inflows coming to Central America have surged in recent years, but impact funds based in the region have also begun to gain traction.

Private equity and debt financing are not the only avenues for impact investment, but they are regularly regarded as the primary way to improve living and environmental standards in underdeveloped regions. Publicly-traded companies, on the other hand, are often too big for impact investors to make meaningful change without voting rights.

Regardless of how they invest, impact funds all have similar goals in mind: improve living conditions and environmental standards by investing in employment programs, supply chains, sustainable environmental practices and ecofriendly consumer goods.

"We’re seeing a phenomenon towards agroforestry, sustainable agriculture, emerging technologies, biopesticides and natural organic products. These are all moving very rapidly," says Nathalie Prado, managing director of investments at EcoEnterprises Fund in Costa Rica.

Initially run by the Nature Conservancy from 1998 until 2010, the now-independent EcoEnterprises was one of the first impact investment funds to be based in Central America. Mostly focused on the Mesoamerica, EcoEnterprises raised $74 million for its third fund in May and is targeting a final close of $100 million, Prado says.

EcoEnterprises had previously targeted investments from $50,000 to $500,000 each for its first two funds, which raised $46 million combined. But now it is looking for investments that can go up to $6 million each, taking advantage of larger capital commitments, she says.

Piling in

EcoEnterprises' example has sent signals to other funds that they can get double-digit returns from impact investments in Central America, while also aiming to improve social and environmental conditions in the region.

Pomona Impact, launched in 2011, is raising $30 million for its new fund, looking to make investments for up to $1 million each, up from a previous limit of $250,000.

"There’s been a few funds outside the region. You don’t have the luxury of being attached to the companies. You have to be in the ecosystem to source very high-caliber deals," says Rich Ambrose, co-founder and managing partner at Pomona Impact.

Based in Guatemala, Pomona Impact operates exclusively in Central America and invests in the agricultural and the service sectors. It has funded a firm that makes transport pallets from banana waste products in Costa Rica, as well as the maker of the first organic sugar-free chewing gum in Central America, a US company that sells bracelets made by low-income women in Guatemala and a manufacturer of low-cost water filters with offices the region.

Pomona Impact has also helped its investment targets implement price discrimination models, allowing companies to sell products at higher prices to upscale consumers, usually around 25% of buyers, and thus subsidizing prices for the remaining buyers from lower income brackets.

Strategies such as these have allowed Pomona Impact to target internal rates of return from 18% to 22%, according to Ambrose.

The fund is now looking to make investments in educational technology and drone companies through its next fund, which it expects to close before end of June this year.

SME opportunities

PymeCapital grew out of the need to finance small and medium-sized enterprises, or SMEs, in Central America. Mostly active in Nicaragua and Bolivia, PymeCapital is building a $25 million fund, with an eye on making investments in El Salvador, Honduras, Dominican Republic, Peru and Paraguay, says Jorge del Castillo, a fund manager at the Managua-based investment firm.

PymeCapital has made most of its investments in agriculture, but it is now looking to get more involved in manufacturing, tourism and renewable energy projects, del Castillo says.

The large funding gap for SMEs, estimated to run around $24 billion in Guatemala, Honduras, El Salvador and Costa Rica, has become a major attraction for impact capital in Central America.

"Oikocredit, Deutsche Bank, Fundación Avina and Alterfin have done a lot of work in microfinance and are now looking to enter impact investing through SME funding," del Castillo says of PymeCapital’s partner investors.

Microfinance previously received the largest share of impact investments in Central America. This has since changed

"Today, about 70% of all microcredit clients in LAC are served by regulated institutions that have developed new delivery channels —such as ATMs, banking agents and mobile phones", says Alessandro Maffioli, the division chief of development effectiveness at the Inter-American Development Bank Invest (IDB Invest).

On the other hand, the growth of decentralized electricity and the introduction of new agro-industrial technologies have given impact investors the tools to solve other problems, such as organic waste, water scarcity, inadequate sanitation services, environmental degradation and rural electrification.

The widespread use of digital communications has also laid the foundation for the private equity and debt markets to develop in Central America, which has allowed for the greater involvement of impact investors, says Susana García-Robles, head of the multilateral investment fund and equity operations at the IDB Invest.

"Technology has made possible not only the interconnection between entrepreneurs but also that SMEs be born with this link to technology, need less money to prove their concepts and get traction, and they now have the possibility to scale to other similar regions," she says. 

Planting seeds

SMEs make up 90% of businesses and employ more than half the workers in Central America. The increase of debt financing for these businesses will likely help reduce economic inequality in the region, but the companies must grow and employ hundreds, if not thousands, to avoid a brain drain to other countries.

According to Ambrose from Pomona Impact, for Central America’s economies to move from primarily factor-driven economies to innovation-driven ones, they will have to create a more attractive ecosystem for venture capitalists.

"There are very few pure venture capital firms operating in the region. There is an angel investment development going on, but it is still the very early stage," he says.

For IDB Invest's García-Robles, the lack of venture capital expertise and adequate regulations for the sector pose challenges to development in Central America.

"The best approach for impact funds continues to be investing through mezzanine tools," she says.

Central America also lacks vibrant equity markets, which makes exiting an investment tricky, other sources say.

Angel investors

Despite the current landscape for venture capital funds, one Costa Rican firm has defied the norm since 2012. Started with funds from its founding partners Allan Boruchowicz and Adrián García, Carao Ventures has since tapped into a growing network of angel investors.

"We're looking for very promising entrepreneurs with startups that can have a high impact in the industry they are operating in, either regionally, locally or, ideally, globally," García says.

Carao Ventures does not identify as an impact investment firm, but it has provided seed capital to startups in fintech, biotech, education, big data and industrial technologies. The firm’s base in Costa Rica allows it to look for investments across Central America, with energy, health, education, biotech and hardware companies all in play, he says. LF