Investing in emerging markets requires a lot of local knowledge. Without the possibility of flying out for important field trips, conferences or due diligence, impact investors are looking at investing in their local offices, a network of external consultants and assessment technology.
Tom Brutton, Investment Executive at the Infrastructure and Climate Funds of CDC Group, the UK’s development finance institution, used to spend most of his time on a plane. Assessing investments across Africa and Asia required a lot of his time.
To assess an investment fund, he would normally have taken two or three months, travelling to the target countries involved and spending time with the management team, before pulling together a detailed report for the CDC’s investment committee.
But not only his approach to due diligence had to change in response to the global pandemic and lockdowns. The first thing he noticed, he says, was how his approach to his pipeline of deals had to change overnight. The number of investment proposals coming through shrank dramatically, while the normal idea generation that comes from conferences and industry gatherings was simply no longer there.
Brutton admits his initial instincts were about capital preservation, rather than new investment. Some colleagues even suggested putting a moratorium on new investments. Despite attending some virtual conferences there was a “pivot towards who we knew and what we knew.”
Due diligence in lockdown
How do you conduct extensive due diligence when you cannot visit the company? This was the biggest challenge, says Brutton. Pre-Covid there was a lot of focus on “observing team dynamics in action” and attempting to predict gaps in a management’s skills set. Not least, Brutton says, because the “ultimate nightmare” is a “manager break-up”.
Using Zoom and Teams was not enough. Brutton says he has an aversion to what he calls “choreographed presentations” by fund managers.
Growing use of local teams and consultants
To maintain high-quality standards, Brutton turned to CDC’s teams on the ground and local consultants.
Christina Leijonhufvud, the CEO of BlueMark, a leading provider of impact assessments for investors and companies, also sees a growing usage of third parties.
When Brutton was looking at a hydropower project in Nepal, he realized that CDC didn’t have a sufficient presence in Nepal to look at this potentially high-risk investment. He hired an Indian consultant to visit the project and give a detailed assessment.
Leijonhufvud also notices a growing use of “impact verification as a valuable tool for streamlining due diligence and separating the wheat from the chaff.”
Amer Khan, the Managing Director of Entelligent, the machine learning climate investment experts, observes that asset managers will be “looking to the growing array of technology-driven solutions that can help them with due diligence.”
“Rather than go to the investment committee for initial approval and then jump on a plane, we will concentrate more on front-loaded, tech-based interactions,” says Brutton.
Once the pandemic is truly over, Brutton expects travel to halve compared to pre-Covid levels, and that the CDC will continue to build up its offices on the ground.
He believes that his organisation’s approach to due diligence is now “actually a lot more robust”. There will still be some role for face-to-face contact, but this may be more around “sealing relationships when we are on the ground.”