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This article first appeared in Personal Wealth, The Edge Malaysia Weekly on August 12, 2019 - August 18, 2019

Private equity (PE) impact investors should look at small and medium enterprises (SMEs) in Southeast Asia as these companies are ready to embrace sustainability practices and are able to have a direct impact on society, according to Jupiter Impact Partners Pte Ltd.

The impact investing landscape in Southeast Asia is currently dominated by development financial institutions (DFI) such as the International Finance Corporation (IFC) and Asian Development Bank. Although they also invest in the SME segment, they tend to invest in less-developed markets, fewer sectors and have bigger deal sizes. At the other end are angel investors and venture capital funds that invest in start-ups.

“The other investors are taking a sector-based approach by looking at the microfinance or technology sectors. They are looking for the next unicorn. A lot of funding is skewed towards those sectors and big deal sizes. So, that leaves a funding gap for SMEs [companies with sales of between US$5 million and US$40 million],” Han Wan Hoon, head of research at the Singapore-based impact investing PE firm, tells Personal Wealth.

Han and co-founder Yap Kian Woon recently spoke at an event organised by Malayan Banking Bhd and Bursa Malaysia called “The evolution of ESG investing”.

A 2018 report by the Global Impact Investing Network had similar findings. From 2007 to 2017, impact capital deployed by DFIs stood at US$11.2 billion, compared with US$904 million by private impact investors (PII). The average deal size by PIIs in the eight major markets in Southeast Asia was US$6.9 million while that of most DFI deals was more than US$100 million.

There is a concentration of investments in a few sectors such as financial services and energy. Agriculture and micro-SMEs are two areas with high potential in the region. 

“We looked at the whole industry and found pockets of small funds [typically with assets under management of less than US$30 million] that started as non-governmental organisations before becoming impact funds. Then, you have the very big PE firms such as KKR and TPG Capital, which cover the globe and may not have a local team. We are right in the middle, targeting mid-sized impact investing deals of between US$10 million and US$20 million, in a few sectors,” says Yap.

Jupiter Impact Partners focuses on four areas — agribusiness and food, circular economy and water, climate change mitigation, and healthcare and education. Its investments in the last two areas are targeted at companies that make their services affordable and accessible. Interestingly, many start-ups are emerging in these four sectors.

“Investing in start-ups may sound more interesting, but the failure rate is very high. It is not organic growth because they do not have a core business yet. We like companies that have been around for some time,” says Yap.

“An example of a deal in our pipeline is a vertically integrated poultry farm-to-table business in Vietnam. The CEO can run the business successfully because he had worked in the industry as a senior professional for multinational corporations for many years before starting his own business. He can identify market trends and gaps.”

The farmer also knew about the demand for traceability in the meat industry, so consumers can be assured of the quality of their food, says Han. “He knew about the need to reduce [the use of] growth hormones and antibiotics [so he decided to change the way he was doing things]. We like these companies that have deep knowledge of their core business and are adapting to the new economy, which give them a higher chance of success.”

These SMEs want to change because they realise consumers are demanding sustainable practices. The impact of climate change is also felt by all parties in the form of unpredictable weather changes, for instance.

Han — who has more than 20 years of investing experience, having worked at a brokerage, asset management and hedge fund management company — points out that this investment thesis could not have worked five years ago due to a lack of awareness among consumers.

Meanwhile, some may say SMEs in Asia have traditional business models and are averse to change. That may have been true in the past, but the new generation of entrepreneurs is different, says Yap, who has a background in venture capital and PE.

“A sufficient number of businesses have been built in the region. So now, we have a batch of entrepreneurs in their late thirties to fifties. They have been trained by multinational corporations, are knowledgeable and are educated. We are looking for such people — professionals turned entrepreneurs,” he adds.

“We prefer to partner them than family-owned businesses that are usually controlled by one person. Typically, this group of people come together to do something different. They are more open and transparent. Based on a lot of the deals that we look at, SMEs are not necessarily the creator of technology but they know how to tweak and apply the technology.”

Yap and Han believe that SMEs can play a huge part in impact investing because they are able to create more jobs than a typical start-up. “SME businesses are expanding and are able to hire more people. So, the dollar per impact is higher. They accounted for about 70% of the jobs created and contributed almost 50% to GDP in Singapore [in 2018], for example,” says Han.


Investment themes driven by demand

Of the five areas the firm targets, agribusiness and food is the one they believe has the most potential, followed by circular economy and climate change mitigation.

The number of SMEs in the agribusiness and food industry is huge. It includes food producers, agriculture technology providers, farm management tool providers and those processing and distributing food.

One of the SMEs the firm is interested in is a Malaysian organic farm that applies circular economy principles by using black soldier flies to manage industrial food waste. The flies become feed for chickens, replacing commercial grain-based feed, which has been blamed for causing deforestation globally.

“There is also a company that produces custom-made fertilisers that do not dissolve in water immediately and are, therefore, wasted. Instead, they can be slowly released, which reduces wastage and boosts the growth of crops,” says Yap.

“There are people who are establishing smart farms by using the Internet of Things. Another category of companies are those creating food substitutes such as Beyond Meat in the US. But there are not many of these in Malaysia.”

A major driver of innovation in this sector is food security. This is especially true in Singapore, where the government has been pushing for solutions that can reduce the country’s reliance on food imports.

“The government is giving a lot of subsidies, incentives and land allocation to incentivise people to get into agriculture, such as indoor farming in a controlled environment. [By doing so,] you can reduce the carbon footprint from importing food and shorten the time from farm to table. I think that is also a big business,” says Han.

Some of the companies in these areas are bound to grow. Han cites aquaculture farms in Singapore as an example. “They are small now and have no scale, so the profitability is not there. But the Singapore government is encouraging [their growth] and land is scarce. This will accelerate the consolidation of those companies. It is all about timing,” she says.

Climate change mitigation solutions include companies that create micro-grids, which allow for distribution of energy independent of the main power grid. It is often used by renewable energy producers.

Some companies in this area create efficient power management systems. “One company fixed the chiller in an air-conditioning system so that it consumes 30% to 40% less energy than a typical system,” says Yap.

For some of the focus areas, the investable universe is big enough, they say. But deals are harder to find in the education and healthcare space. “It is true that it is harder to find commercially high-return opportunities in those two sectors, which also provide accessibility and affordability,” says Yap.


New fund to capture opportunities

Jupiter Impact Partners was founded earlier this year. Co-founder and managing partner Melissa Kang was previously ESG officer of Morgan Stanley’s global impact fund and principal investment officer and regional lead for East Asia-Pacific at IFC.

The PE firm is currently raising money for its first fund, which it aims to close by year end. Han and Yap say the firm already has a pipeline of investors and about US$400 million worth of deals, the majority of which are in Southeast Asia. A few of the companies are in China, but they have business models that can be replicated in the region.

The top-quartile PE firms in Southeast Asia deliver a net internal rate of return (IRR) of about 15%, according to Yap, and Jupiter Impact Partners aims to achieve a similar return.

By looking at the historical data of IFC, Yap and Han are confident the firm’s investments will generate good returns. According to reports by IFC and the Organisation for Economic Cooperation and Development, IFC’s private equity investments saw returns of 14% to 23% from 2000 to 2011.  

“A lot of these development funds actually provide very good returns. It is just about having the right timing and opportunities,” says Yap.

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