Strategic Borderless Dealflow for Better Returns and Higher Impact
In the fourth article of our 2020 impact investment in Canada series, we dive deep into our third and final growth driver, geographic diversification of investments–or, as we like to call it, strategic borderless deal flow. Our research shows that only about half of Canadian impact funds pursue private market investments outside of Canada, representing a missed opportunity to increase returns, meet global impact targets, and diversify market volatility. We believe that investing abroad as well as domestically will improve overall fund performance by strategically capitalizing on macroeconomic differences between countries, by accessing impact opportunities where there is a shortage of capital due to the low risk appetite of local investors, and by harnessing economic growth and innovation occurring beyond Canada’s borders.
In economics, a fundamental theory is the law of comparative advantage, which postulates that countries will specialize in certain industries because their opportunity cost is relatively lower than in other regions. Specific industries or investment opportunities may be more favourable outside of Canada because the macroeconomic environment abroad is different; Interest rates or exchange rates may enable a business model to be more profitable in a foreign country. In a similar vein, indicators such as price inflation, risk premiums, unemployment, and GDP growth may mean that an investment opportunity makes more economic sense in a foreign market. As an example, infrastructure projects in Canada rarely offer high returns, but do so in fast growing economies of Sub-Saharan Africa.
Similarly, investor risk appetite varies by region, as does the degree to which institutional frameworks and policies favour investment. In some countries, innovation hubs for certain industries, such as Germany’s technology hub in Berlin, are strongly fuelled by foreign capital, due to local investor preference for lower risk thresholds. According to the Economist, savers in Europe tend to be less adventurous than in North America, preferring to leave their money in the bank, even when interest rates are negligible [1]. In addition to differing levels of investor risk appetite, government initiatives and policies also may foster an enabling environment, promoting private investment in industries where growth is of public benefit. This was exemplified in Germany when the government’s digital agenda supported rapid investment in IT security and high-speed Internet infrastructure across the country [2].
Finally, investing globally can also improve sector diversification by increasing exposure to industries that are underrepresented in Canada. The Canadian market is highly concentrated in the natural resources and financial services sectors, with the majority of growth and innovation in other industries occurring beyond our borders. According to the Royal Bank of Canada, more than 80% of R&D spending occurs in industries that represent less than 20% of Canada’s market, including Computing and Electronics, Healthcare and Automotive [3]. Sourcing deals outside of Canada can improve portfolio performance by both diversifying risk and by enabling access to high growth industries as well as impact opportunities abroad. A similar argument applies to diversifying investments across developed, emerging, and frontier markets, as different countries have different risk profiles and growth prospects depending on their level of development.
With the average Canadian allocating less than 10% of their assets outside of Canada [3], it is clear that there are inherent challenges to investing abroad, such as deal sourcing, monitoring investments, and building knowledgeability in a foreign market. While this can be a cumbersome task for larger financial institutions due to extensive bureaucratic processes and complex legacy technology, smaller, leaner asset managers with right-sized international teams are uniquely positioned to overcome these hurdles and to enable Canadian investors to establish a stronger presence in global private markets. As technology advancements are closing the communication gap and improving monitoring capabilities, remote oversight of investments has become feasible. Through leveraging technology, diverse market expertise and a global network to source deals strategically, a small international team has the agility to respond rapidly to new opportunities and enables new impact investors to operate across the global venture landscape
To learn more about what True North is doing to source impact deals globally, please contact Fund Manager Kai Chen (kai@truenorthimpact.com).