How can SME funds optimise to attract more capital?

Small and medium sized enterprises (SMEs) in emerging markets are critical to driving economic growth, creating jobs and working toward the Sustainable Development Goals, contributing up to 60% of employment and 40% of national income.These SMEs face a significant financing gap, which is at risk of widening during the current Covid-19 crisis.Increasing access to finance can unleash SME’s potential to deliver financial and development returns. However, a lack of data on the risk, return and impact of investments has held back additional capital from flowing into SME segments in emerging markets.

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To establish realistic expectations for development outcomes and financial returns, and to encourage the flow of capital into SME segments, Shell Foundation and Omidyar Network commissioned a study of SME fund performance.

Five development finance institutions (DFIs) – CDC Group, GroFin, the International Finance Corporation, Obviam, and Triple Jump[1] – provided historic fund data related to financial and development performance.

Financial returns and development outcomes were analysed for 365 funds. The analysis revealed five key findings:

• SME funds typically demonstrate growth in the underlying businesses but lower risk-adjusted returns than other fund types, suggesting it will continue to be a challenge to attract commercial capital to this segment and development finance needs to play a crucial role
• SME fund returns appear to improve up to a 15-year time horizon, suggesting the typical 10-year closed-ended fund structure may not provide the time needed to maximize financial returns and impact in certain contexts
• Due to the longer horizon of value creation, the indicators of Total Value to Paid-In Ration (TVPI) and Distributed Value to Paid-In Ratio (DPI) are useful to compare fund types and have advantages over only considering Internal Rate of Return (IRR) as a return metric.
• Evidence of development impact is not tracked consistently across DFIs and fund types, making assessment of impact difficult. The number of jobs created is the most common impact indicator tracked by DFIs for their SME fund investments, but is insufficient as an indicator of development value
• Generalist funds show evidence of strong job creation outcomes relative to sector-specific funds, but have demonstrated lower returns on average

In response to these findings the report provides a series of considerations for investors, including a greater emphasis on:

• Monitoring development outcomes beyond jobs created,
• Monitoring performance and gathering and sharing improved data on the underlying portfolio of SMEs
• Seeking fund structures and terms that accommodate the longer horizon to value creation (e.g. alternatives to closed-end 10-year funds)
• Continuing to pursue generalist funds, which are well suited if jobs creation is the primary objective, but with the expectation of lower financial returns

Download the Report [pdf, 2mb]

[1] Triple Jump is a private fund managers that manages the Dutch Good Growth Fund mandate for the Dutch government