Impact investing meets smallholder agriculture
How do investment funds build social and environmental priorities into agricultural financing? Several investment funds showcased their strategies for investing in smallholder value chains at the Global Landscapes Forum in Paris last December. While continuing to seek financial returns, investors are supporting and measuring a broader set of environmental, social and commodity-based outcomes tied to supply chain sustainability.
Strategic decisions to boost production
Three factors have spurred investors to bolster smallholder production of forest and agricultural commodities while improving social and environmental outcomes, according to Bernard Giraud, president of Livelihoods Venture. The organization's new Fund for Family Farming is investing $141 million over the next 10 years targeting smallholder farmers in Africa, Asia and Latin America.
First, smallholder farmers — 450 million and counting globally — produce the majority of food that is from developing countries. Yet they often struggle with limited income from inefficient, low-yield farming practices.
Second, rapid deforestation and soil erosion from farming can degrade air and water quality. This also can cause public health and social justice concerns. Depleted resources then further reduce smallholder productivity and cause economic vulnerability.
Third, companies that buy commodities from smallholders grapple with volume and price volatility. They also face quality issues. These problems affect the social and environmental reputations of their brands. These trends are increasingly heightened by climate change impacts such as severe weather events and rising temperatures.
Investments in the triple bottom line
In response, new impact funds seek financial returns from the production of forest and agricultural goods. These returns can be boosted by environmental markets that pay for stewardship practices that have social and environmental benefits that promote the triple bottom line.
Early adopters such as Livelihoods Venture, Althelia Ecosphere, the World Bank’s BioCarbon Fund focused investments in forest carbon offset projects. The sole returns to investors are in the form of carbon offsets. These offsets have social and environmental co-benefits embedded in them or certified separately.
Carbon offset revenues are intended to help investors reach their expected returns. But carbon remains underdeveloped as a driver of demand. In addition, carbon is a limited proxy for driving performance across a broad, mainstream set of commodities and services.
Subsequently, Livelihoods Venture and the BioCarbon Fund have launched a next generation of funds that are more holistically focused on achieving returns from the broader landscape while cultivating more sustainable supply chains. These funds cover carbon, commodities, social benefits and other ecosystem services. This way, they more effectively can pay for conservation while also addressing the drivers of landscape conversion or degradation via a working-lands approach.
A new coalition of investors and project partners
In line with this more comprehensive approach, investor groups have diversified to include private investors, companies looking to reform their supply chains, and public development agencies. These agencies are motivated by sustainable development, ecosystem services and social benefits.
Spreading risk across a broader coalition of investors in a single fund helps to reduce the risk of these investments. This is particularly crucial for emerging markets.
Multinational companies such as Mars, Danone, Firmenich and Veolia have moved to the forefront of sustainable supply-chain investments. They have faced growing pressures for corporate sustainability and environmental stewardship. More fundamentally, they are anchored by the need to manage risks posed by development and climate change to agricultural yields, which drive their bottom line.
"What’s going to become of our palate — the scents and flavors we give to buyers — 50 years from now?" said Dominique Roques, head of naturals purchasing at Firmenich, the world’s largest privately owned perfume and flavor company. Firmenich sources 180 natural ingredients across 40 countries. "We rely 90 percent on smallholders. If Indian farmers don’t want to produce tuberose anymore, it could disappear from the palate. There are examples of where it has already disappeared."
At the forum, funds shared some financing strategies they use to invest in sustainable land use. They included landscape bonds promoted through the Global Canopy Programme’s Unlocking Forest Finance initiative, early-stage private equity investments by the Terra Bella Fund, and Credit Suisse’s environmental-performance-indexed facility.
Companies investing in Livelihoods Venture sign purchasing agreements with project developers to sustainably source raw and value-added products from smallholders. In exchange for upfront financing for a project, they receive commodities and carbon offsets in return.
Projects need to be able to absorb $10 million to $15 million to be of interest to investors. Rates of return vary widely from as low as 5 percent for impact-focused returns to the low 20 percent range for higher-risk projects. The extent to which these funds can support smallholder farmers ultimately depends on the level of aggregation and the scale of commercial returns possible through specific forest or agricultural commodities.
Smallholder value creation
"A major challenge is the need to change the mindsets of farmers from just harvesting something and getting the best price to understanding quality, which fundamentally starts with how farmers deal with soil," said Manoj Kumar, CEO of Naandi Foundation, which runs the Araku Valley project in India as part of the Livelihoods Venture portfolio. "Another challenge is for large numbers of farmers to go beyond producing raw materials at the bottom of the supply chain to the next step of processing, and becoming partners in value creation."
Transformation does not happen overnight. Projects require risk-tolerant, patient impact investors due to high upfront costs and delayed paybacks.
Clement Chenost, co-founder of the Moringa Fund, a public-private partnership that has raised almost $95 million to invest in agroforestry in Latin America and sub-Saharan Africa, said that blending public and private investors allows for longer investment horizons than would be possible with private investors alone.
Instead of the typical one to three years sought by risk-averse capital investors, these newer funds can offer individual investments lasting eight to 10 years — with the funds themselves lasting up to 20 years.
Measurements of success
The high costs of monitoring and evaluating project outcomes are a big barrier to investment in smallholder projects, which are often fragmented and diverse in constituency and implementation.
Third-party certification standards from the Verified Carbon Standard, Forest Stewardship Council and Rainforest Alliance have proliferated. However, there is no universal standard. Funds often develop their own impact metrics to satisfy investors’ demands for assurance that their investments have impact.
"The private sector tends to base its investments on a few quantifiable metrics as proxies for all things," Kumar said. "It is more concerned with, ‘Will it work or won’t it work? Let’s do it cheaper next time.’ Don’t crumble to the private sector. Stand up for what you are confident in."
Higher monitoring costs associated with more complex metrics could detract from funding used for project implementation. However, proper monitoring and evaluation are key to ensure that smallholder farmers and other project stakeholders achieve desired outcomes. Outcomes should not be imbalanced in favor of investors’ financial needs at the expense of smallholders.
Peter Holmgren, director general of the Center for International Forestry Research, said the key investments are really made by the local smallholder farmers who bear the greatest risk. "Making it easier for farmers to earn a living while leaving soil and forests intact is what will make a difference."
The evolution of funds to recognize various certifications beyond carbon or commodities in their project portfolios may aid in comprehensive impact evaluation. Participation of various investors interested in different aspects of the project could help defray certification costs for individual elements.
How scalable and accessible such investments are remains to be seen.