SDG-focused credit fund.

Case study

SDG-focused credit fund.

Despite the great level of attention and the best of intentions, the shortage in annual financing for developing countries to achieve the SDGs by 2030 has risen by USD 1.7 trillion in 2020, according to the OECD. This shortfall comes on top of the existing gap of USD 2.5 trillion annually.

We need to go from ‘billions to trillions’ to meet the SDGs and end poverty, protect our planet and livelihoods. This is only possible if institutional investors invest in the SDGs at scale. It would require a shift of only 3.7% of the USD 100 trillion of assets held globally by institutional investors to close this gap, according to the OECD.

New innovative SDG-focused credit fund

Fund manager ILX Management (ILX) has designed an innovative way to help bring about this shift. The ILX Fund I, launched in January 2022, co-invests with a broad range of leading multilateral development banks (MDBs) and other development finance institutions (DFIs) that have decades of experience in direct investments in line with the SDGs in emerging and frontier markets.

Cardano Development and the ILX team started exploring the investment thesis following the launch of the SDGs and adoption of the Paris Agreement in 2015. They conducted an extensive analysis of market data extracted from thousands of MDB and DFI private-sector loans.

Creates institutional capital flow towards the SDGs

It confirmed that investing in these so-called B-loans is a viable asset class: the loans’ default ratio is low, while the risk-adjusted returns are attractive, typically xxxx. Contrary to traditional blended finance, the ILX Fund doesn’t need concessional funding to lower the investment risks for more commercial investors.

To build the investment case, ILX received donor funding from KfW, on behalf of Germany’s Ministry for Cooperation and Development, the Dutch Ministry for Foreign Affairs, and the UK Foreign Commonwealth and Development Office.

Mobilising private finance at scale

The Amsterdam-based fund invests its capital at an equal share in private-sector loans arranged by MDBs and DFIs, such as the Asian Development Bank (ADB), African Development Bank (AfDB), European Bank for Reconstruction and Development (EBRD), IDB-Invest, International Finance Corporation (IFC) and Dutch development bank FMO. This means that investors have the same level of risk and return as the development banks they co-invest with.

Whether it is the EBRD, IFC or FMO, these institutions have a longstanding track record of investing in developing countries and maintaining the highest environmental, social and integrity standards. They also have programmes in place to support their portfolio companies with technical assistance and training.

ILX launched its first fund with the backing of APG, Europe’s largest pensions provider, which committed a total of USD 750 million on behalf of pension fund clients ABP and bpfBOUW. Following this first-close commitment, ILX is aiming for a total fund size of USD 1 billion for ILX Fund I. Partnerships such as the agreement with the EBRD to mobilise EUR 500 million of European pension fund capital should help to even surpass this target.

ILX should be able to easily launch follow-up funds because it can replicate its co-investing strategy providing investment opportunities at scale as long as it can select loans that match their requirements in terms of SDGs and the level of risk- adjusted returns.

Matchmaker between pension funds and development banks

There are a number of reasons why the ILX Fund is a good matchmaker between institutional investors and development banks. They are long-term investors; they operate in a semi-public market environment and it is their statutory mission to do more than simply generating financial returns.

Many pension funds, however, have always assumed that investing directly in companies in emerging markets is too risky, too illiquid and that the investments funds doing this are too small. Institutional investors have so much capital to invest that they need to invest at scale (minimum USD 50 million) otherwise it’s too costly for them.

Creates institutional capital flow towards the SDGs

Attractive risk-adjusted returns and diversification ILX takes all of these reservations off the table. It offers investors the desired diversification, attractive returns and the right scale.

The investment manager selects the best private-sector loans across regions, sectors and SDGs. It typically invests in middle-income countries from Asia to Latin America. Focus sectors are renewable energy and other key economic sectors such as sustainable infrastructure, manufacturing or agri-food. This diversification, which is what investors value most, distributes the risks across industries, geographies and SDGs, reducing the investment risk.

Catalytic effects

ILX’s investment strategy’s catalytic effects are twofold. By tapping into the billions of investment capital of institutional investors it mobilises investment capital at scale for the SDGs. It further strengthens the catalytic role of development banks because the co-investments free up their balance sheets for more lending. DFIs hold capital against the loans and equity investments that they make. When ILX brings in co-investments, the development banks no longer run the risk on that part of the loan. This reduces their balance sheet, freeing up capital to invest in new riskier projects and businesses in lower-income countries where their investments are most needed.

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