An interview with Farrukh H. Khan, Senior Director, Business Development, Acumen
With over 25 years of senior management and board level experience, Farrukh is Senior Director of Business Development and part of the senior management team at Acumen. Previously, he was the Country Director of Acumen Pakistan. In his former life he was the founding partner and CEO of brokerage BMA Capital Management Limited that received several international awards under his leadership. He has previously served as the President of the Overseas Investors Chamber of Commerce & Industry, and as a director of Board of Investment, Pakistan. He currently also sits on the board of Pakistan International Airlines.
In this interview, BR Research picks Farrukh’s brains on global and local trends in impact investment, a concept that has failed to take off in Pakistan, as well as brief but important insights on how to kick off growth and investment in Pakistan. Below is the edited transcript.
BR Research: Why impact investing?
Farrukh H. Khan: The right place to start is 2001, Jacqueline Novogratz, the founder of Acumen, saw that traditional aid and charity wasn’t really solving the problems of poverty and was in many cases creating dependency, whereas traditional business capitalist models were not catering to the needs of the poor. So, she sought to find out if there is a third way and combine the better of the two approaches. Hence, the idea of patient capital and impact investment emerged.
We use philanthropic capital, which gives you the ability to take long-term bets on entrepreneurs and businesses working to meet the needs of the poor, at a price point that they can afford. Commercial capital looking for normal return will not have the risk appetite to make such investments.
Philanthropic capital is the only kind of capital that has a low-enough return expectation and a high-enough risk appetite to take these bets on business models that caters to the needs of the poor. So we back entrepreneurs who sustainably address the needs of low-income people earning $2-$5 per day.
This idea has grown since 2001 and has not only influenced the way philanthropy is being done but also how investing and business is being done, where the concept of impact is fast becoming the third dimension of investing.
BRR: The size of impact investment industry in Pakistan remains small. What is the reason behind it?
FHK: Since we started in 2001, India now has many impact funds, local and international; so does East Africa. In Pakistan we remain almost the only one. Now Karandaaz has come up but it is not focused on early-stage investments to my understanding.
The issue is on both sides. Donors still like to give traditional charity, which is indeed important. But just like in business if you only focus on firefighting and don’t invest strategically for the long term then the business will likely shut down. Similarly, in philanthropy, you must have a portfolio approach.
It’s OK for two individuals or firms to have different types of philanthropy in their portfolio, where one might have an 80-20 charity-to-impact-investing ratio and someone else might have 50-50. But you should not do 100 percent traditional charity. It’s really important to back long-term strategic initiatives that tackle the root causes of poverty.
On the other hand, people wanting to work on development issues, generally set up an NGO and look for donors. They don’t always think there might be better more effective ways to achieve their objectives in a sustainable manner.
We never say that charity is not important; it is hugely important. But one has to be thoughtful about the circumstances in which charity is the best way forward and in which circumstances one should explore other more effective ways such as impact investments. Resources are finite, which means you need to use every rupee effectively.
BRR: How patient is the patient capital?
FHK: We take a 10-12 years investment view, which means we are truly patient. We go with the expectation that we will be in this journey to help a company scale up before we can exit. We can be this patient because we invest philanthropy. Our partners don’t invest in us expecting a return. It’s like a social venture capital model. We turn every dollar donated to Acumen into capital and invest it in start-ups, in very early stage companies.
BRR: What have been the lessons so far?
FHK: One of the key things we have learnt is that you can’t do this work sitting out of London or New York. You have to be on the ground in the developing economies in which we work. We have had offices in Pakistan since about 2006. Being on the ground is very important because you have to understand the local context and the real work begins after investment.
We sit on a number of the boards of the companies we invest in; we work with them and provide them post-investment support, which is more than just financial support. We help them with proper corporate governance, introductions to other investors and organisations in our network. In short, we help them grow and scale up.
Another thing we have learnt is that over the last 17-18 years for every dollar that we have invested globally, on average $6 dollars have been catalysed by our companies as they have grown. From a philanthropic perspective, if you have given us one dollar to invest, it is getting leveraged almost six times. Those investments have impacted the lives of about 270 million people across the countries we operate in so far. We have invested more than $115 million in about 113 companies in 14 countries and catalysed a further $620 million of capital, as these companies have grown. We have shown that the model works and has a very high “capital efficiency of impact.”
Another important insight that we have learnt is that the opposite of poverty is not wealth; the opposite of poverty is dignity and choice.
BRR: How does one measure the impact?
FHK: Measuring of impact is a difficult thing, but it is important to do. Unless you are able to do that there is no point in doing this work. There are different ways of measuring impact and it is a field that is developing.
Impact has two broad aspects. The breadth of impact and the other is the depth. The former is the number of lives touched, which is an important number to see how many poor customers have been provided goods and services. The depth is the holy grail of impact, which tries to assess how exactly their lives changed for the better because of, for example, cheap solar lights.
We also have this unique Lean Data approach to impact measurement, inspired by a line in our manifesto that talks about listening to voices unheard. We leverage low-cost technology and the lean start-up experimentation principles to talk directly to low-income customers and gather high-quality actionable data. For the first time, our understanding of impact is coming from the bottom up. Working closely with our companies, we generate, analyse and use this data to improve their social performance and better serve their customers.
Before we make actual investments, we reach an agreement with the entrepreneur about the financial data and impact data that they will share with us periodically and also agree upon a theory of change.
BRR: Who does the impact assessment exercise? Because if it’s the investee company or Acumen or a company hired by either of the two, then there appears to be a conflict of interest problem.
FHK: We have an internal group that does it, which is our impact or Lean Data team. They are separate from the portfolio team; and they use third party people on the ground. The third party may be paid by the donor. It may be paid partly by the company, and partly by us. But we have never really had that problem because we are interested in finding out the true impact of our work, and use that information to help us invest better for the poor. Failures are as important to us as successes.
BRR: Are these impact results made public?
FHK: They are shared with the company, and the broad results are made public. For the first time last year, we did a sector report on off-grid energy. It was the first time anyone had researched and put forward sector wise impact matrices for off-grid energy sector. So even if your company has nothing to do with Acumen you could still compare your performance with sector standards.
BRR: A few years ago, impact investment was touted to grow to a $1 trillion asset class. Has it become a formal asset class, and what’s the quality of that growth?
FHK: It is very much a formal asset class. The most work as a sector body on this has been done by GIIN of which we are one of the founder members. According to GIIN, the size of the industry is over $200 billion.
My view is that a lot of it is probably reclassified assets rather than incremental flows. For instance, if some of IFC’s portfolio is reclassified as impact investment then a big number will come into that category overnight. I don’t think that much incremental capital has come in the sector, as opposed to large amounts of reclassification.
The second issue is the segment we invest in, which is early stage and focused on the poor. In that category, very little capital is available. Most of the capital is still focused on late stage investments where the business model is already proven, the cash cycle has become more certain, and that’s when this capital flows in to support expansion. But if no one is willing to support these entities at the early stage, then how will the late stage pipeline get developed? Such risk capital is very scarce and small.
The third thing is that a lot of impact capital goes to companies focusing on customers earning $10-20 per day. In a country like Pakistan that means these are companies that are catering to the lower middle class, whereas we at Acumen focus on the poorer segments.
BRR: What’s your portfolio size in Pakistan, ROI, and how many investments have you exited?
FHK: In Pakistan we have invested about $16 million in 16 companies so far. Our focus areas are education, health, agriculture and off grid energy.
In each of our investment we would like to make a profit, recognising that we might make profits in some and losses in other. On a portfolio basis, our target is to get a 1X return i.e. we should be able to get our capital back to reinvest it. We look at investments both from the lens of impact and return.
We have exited about $30 million worth of investments globally. In Pakistan we have exited about 4 investments. For instance, we exited Ansaar Management Company to very large low-cost housing companies from the UK. It’s a huge success story actually.
BRR: Do you ensure that post-exit those companies stay on track for catering to the needs of the poor?
FHK: Exit happens for two reasons. One of those is failure of business. If failure is not happening, then it means that we are not taking enough risks. Which is why we feel that 1X return is the right target for us because if we were making a lot of money on our portfolio then again it implicitly means that we are not taking enough risks.
If those companies are successful; then we exit through the sale of our shares which we are able to do only because someone else is interested in doing that business and sees value in it. Investors put money in only when they think that this company has the possibility of being a success.
Social entrepreneurs are concerned about the risks that perhaps a new shareholder will cause a mission drift. But after 10-12 years if you are able to show that your business model has become profitable working as a social enterprise, that it has steady cash flows, then at that stage a new investor in the company is not likely to force a change in the business model.
BRR: Let’s pivot to FDI given your background bringing investments in Pakistan. What’s your solution to dwindling investments and poor non-CPEC FDI?
FHK: There are a number of challenges that Pakistan is facing, and the government is working to tackle them. These are well known. However, I would like to share a couple of ideas. We have historically favoured foreign investors over local investors. If the local groups are investing, they will themselves pull in foreign investors as JV partners. The government cannot go and convince an MNC abroad to come and invest in Pakistan.
The other issue is that in Pakistan we don’t know what our “sunrise industries” are, where we can be genuinely competitive globally without any long-term subsidies or incentives. We need to research and identify such sectors. For example, some years back, the government had hired McKinsey consulting firm to identify three sectors that can have $1 billion of exports over a span of 3-4 years. Those sectors were identified but little further action was taken on that front.
BRR: What kind of action are you rooting for? Can you share some examples?
FHK: After we identify the sunrise industries, it is important that the infrastructure spending, policies, taxes, tariffs and everything else is aligned to support those industries. The whole supply chain has to work before industries can be successful. When Korea decided in the 60s that it wanted to become a world class player in automobile, steel, ship building and some other industries, then everything was aligned to make sure that those industries became successful.
Why did Kenya become such a force in horticulture? They did a lot of things and one critical thing that helped them to become successful in that sector was that they changed the flight schedule to Europe. This ensured that fresh flowers became available before the markets opened in the morning in Amsterdam.
Or take the case of India that has in recent times focused on the jewellery sector, for which they invested heavily in training people. If you want to do jewellery or horticulture, then you need workers who understand not the just the basics of that sector but also be able to create products that can compete internationally.
The point being that Pakistan has to fix all the nuts and bolts of the supply chain, taxation, policy lacunas and so forth to be successful and globally competitive in its chosen “sunrise industries
Whenever Pakistan’s economy takes off there are two things that hinder the growth. Because we have such high dependence on imports, we very soon have an FX crisis. And second, we immediately start running out of good HR at every level, whether it is in the stock market, pharmaceutical or any other sector. So we have to anticipate these challenges and plan the growth strategy accordingly.