Lok Capital rides on impact funding

Impact investment fund Lok Capital recently announced the first close of its third fund of $100 million. All the existing investors participated in this round of fund raising, but what came as a surprise was the participation of a US-based pension fund and interest from domestic investors to be part of impact funding.

While impact funding in India has been gradually getting popular, performance of portfolio firms by funds such as Lok Capital is attracting a diverse range of investors. According to data from Venture Intelligence, for year 2016 to date, impact investment has touched $73 million across 16 investments. For 2015, the total investment touched $104 million across 57 enterprises.

"During this fund raising, we received interest from domestic investors, too. This is an interesting trend since domestic investors are more worried about liquidity opportunity. While we do not have contribution from any domestic player in the first close, we will have a few participating in the final close," said Venky Natarajan, partner, Lok Capital.

Lok Capital announced the first close of Lok Fund III at $40.5 million. This, along with Lok Capital's Fund I and Fund II, will bring the total capital under-management to about $125 million. Existing limited partners - CDC Group Plc (the Development Finance Institution of the UK); Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden NV (Netherlands Development Finance Company) and Societe de Promotion et de Participation pour la Cooperation Economique (Proparco) - have participated in this funding round, while TIAA Global Asset Management has provided a new source of capital for Fund III.

Diversification

Lok Capital was founded in 2001 by Rajiv Lall, managing director and vice-chairman of Infrastructure Development Finance Company. Through the three funds that it has raised, the firm has shown that impact funding can be a profitable venture, though that has not been its driving focus.

"Operations of Lok Capital started from 2006 when the first fund was invested. Since then, we have learnt a lot and diversified too," added Natarajan. In 2006, Lok Capital focused solely into investing in the micro-finance sector. The first fund invested in 10 microfinance institutions (MFIs) of all hues.

By 2010, the entire fund corpus was invested and that was the time co- founder and partner Vishal Mehta and Natarajan thought of diversifying the fund exposure to other sectors to comply with the theme of inclusive growth. "I suppose this thought came at the right time like a 'blessing in disguise'. We had just managed to close the second fund and the AP micro-finance crisis hit the market," said Natarajan.

Of the 10 investments that Lok Capital made through the first fund, three were impacted by the microfinance crisis in Andhra Pradesh. The fund had to write off one of its investments, exit from another and the third had a small exposure to AP. The AP crisis saw investors losing around $1.6 billion (based on the exchange rate of 2010) in investments, according to a report by Intellecap.

Despite the write-offs, Lok Capital's gross internal rate of return (IRR) for the first fund was 15 per cent. The first fund, which had a corpus of $22 million, invested in firms such as Janalakshmi Financial Services, Asirvad Microfinance, Spandana, RuralShores, Ujjivan Financial Services, among others.

The second fund of $65 million focused more on healthcare, education and livelihood sectors was also much more cautious as it invested in just one MFI. However, Lok continued to invest in financial inclusion firms such as Vistaar Finance and IFMR Rural Channels. The IRR for the second fund was 28 per cent.

Growth focus

"Microfinance in our country has a very narrow definition. We are now looking at small business lenders - players like Vistaar and Veritas - those who are giving loans for business and a large part of that loan is secured with collaterals. We continue to be opportunistic about the fin-tech space," said Natarajan.

Of the $100 million that the fund intends to raise, 70 per cent has been earmarked for the financial sector - SME finance and fin-tech - and the rest will be invested in healthcare, agriculture and other sectors. The IRR for the third fund is expected to be around 20 per cent.

"We are also looking at the affordable housing segment. Additionally, we also want to increase our exposure to small finance banks this year," he added. Natarajan also shares that 90 per cent of the third fund will be used to invest in new enterprises.

Of the 24-25 investments the company fund has done, 50 per cent of these have been exited and money has been returned to shareholders. Natarajan says the focus for Lok Capital will be into businesses that are inclusive in nature and sectors that can give reasonable returns.

But, challenges remain. "The biggest challenge is to find companies with good quality entrepreneurs and business models. I also feel we have not seen much in impact funding. To build something inclusive, we have to cap our financial returns," said Natarajan.