Blended finance’s education problem

You may be forgiven for thinking that the private and public sectors are like cats and dogs. While they co-exist with one another, they typically do not like interacting with each other. Yet a growing trend in impact investing has seen a surge in private-public partnerships designed to solve the world’s most pressing challenges.

Blended finance impact investment vehicles targeting the United Nations Sustainable Development Goals (SDGs) are becoming more commonplace. However, they are not exactly a new phenomenon. Private equity funds have adopted blended structures for decades, but in impact investing, they take on a new guise.

These private-public partnerships typically combine an asset manager with a public sector entity, such as a non-governmental organisation (NGO), a development finance institution (DFI), and in some cases, governments themselves.

How blended finance works

The blended finance investment vehicle that they establish is split into different tranches. The first tranche is typically referred to as the “first loss”. This is where the public sector capital sits. If there is a loss in the portfolio – it takes the hit to protect private sector capital in the senior tranches. At first glance, this might seem counter-intuitive. But in reality, this is simply not the case.

Public sector entities donate capital to philanthropic causes. The difference with a blended finance investment vehicle is that it uses this capital to seed the first loss. This draws more capital to the cause that the public sector entity and the investment vehicle are both addressing, for example, access to clean energy. This is because this initial investment attracts and protects private sector investors in the senior tranches of the vehicle by taking any losses in the portfolio. This is vital as these investment vehicles tend to target niche or underdeveloped markets where risk is heightened.

In short, blended finance investment vehicles lure more capital to address the SDGs and do so because the private and public sector partners in such a unique way.

Despite this, few understand the full potential of blended finance.

There is no doubt that blended finance vehicles are growing more popular – Google Trends shows that searches for “blended finance” have increase four-fold in the last decade. Meanwhile, Convergence, the global network for blended finance, estimates that $152bn of blended finance has been mobilised for sustainable development to-date – up from $32bn in 2010.

Educating potential investors

Blended finance has an education problem. The private sector needs to be convinced that these vehicles can deliver a positive environmental and social impact on the ground, while delivering a risk-adjusted market return to fulfill their fiduciary requirements.

There are two ways to address this communications challenge.

The first is to showcase the strong environmental and social impact of blended finance vehicles. These vehicles must clearly and transparently communicate the impact framework they are using and the impact metrics of each investment in their portfolio. Collateral like an annual impact report – or a dedicated webpage – to showcase these metrics can prove to be vital to demonstrate the true impact and value of a blended finance fund to the naysayers and, more importantly, potential investors.

The second is to demonstrate a strong financial track record. Updates to inform the market about new fundraisings, investments and exits should be communicated regularly to a wide range of stakeholders, including the media, investors, and public sector partners. But aside from regular updates, blended finance vehicles should not be afraid to be creative. A filmed case study, for example, can bring a successful investment to life in a way that connects with its target audience in a more meaningful way than a standard press release.

Blended finance has the potential to make a significant, positive contribution to the world’s most pressing challenges and communications can play a vital role in ensuring that this potential is not overlooked.

By Lewis Hill, Account Director