WPS7851 Policy Research Working Paper 7851 Strategic Investment Funds Opportunities and Challenges Håvard Halland Michel Noël Silvana Tordo Jacob J. Kloper-Owens Finance and Markets Global Practice Group October 2016 Policy Research Working Paper 7851 Abstract Over the past 15 years, the number of government-spon- this paper outlines ways in which these challenges have been sored strategic investment funds has grown rapidly in addressed. The paper suggests that properly structured and countries at all income levels. This paper identifies some managed strategic investment funds can be effective vehicles of the challenges that these funds face in their endeavor to for crowding in private investors to priority investments, achieve economic policy objectives while also securing com- thus magnifying the impact of public capital. However, mercial financial returns—the so-called double bottom line. their success rests on the funds’ ability to balance policy Through the review of the objectives, investment strategies, and commercial objectives, source investment opportu- and operations of a sample of strategic investment funds, nities, and secure the right fund management capacity. This paper is a product of the Finance and Markets Global Practice Group. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at hhalland@worldbank.org, mnoel@worldbank.org, stordo@worldbank.org. The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. Produced by the Research Support Team Strategic Investment Funds Opportunities and Challenges Håvard Halland,* Michel Noël,** Silvana Tordo***1 with Jacob J. Kloper-Owens JEL classification codes: G23, G24, O16, Q54 Keywords: Strategic Investment Fund, (SIF), Sovereign Development Fund (SDF), Private Equity Fund, Venture Capital Fund, Co-investment Fund, Sovereign Wealth Fund (SWF), Strategic Investment, Infrastructure Investment, Private Equity, Financial Development, Blended Finance, Fiscal Policy, Public Finance, Public Investment, Domestic Investment, Climate Finance, Green Finance, Wealth Management, Project Evaluation, Public Private Partnerships, Double Bottom Line, Capital Stock.                                                              1 The authors, cited in alphabetical order, are grateful to Alexander S. Berg, Roberto de Beaufort Camargo, Kevin Carey, Richard Claudet, Ekaterina Gratcheva, Amadou Hott, Sunita Kikeri, Samuel Munzele Maimbo, Rolando Ossowski, Patrick Schena, and Fiona Stewart for highly insightful feedback on an earlier version of this paper, and to Jacob Owens for outstanding research support. * Finance & Markets Global Practice, World Bank Group. ** Finance & Markets Global Practice, World Bank Group. *** Energy & Extractives Global Practice, World Bank Group. Acronyms AREF Africa Renewable Energy Fund EMDEs emerging markets and developing economies ERR economic rate of return FONSIS Fonds Souverain d’Investissements Stratégiques GEEREF Global Energy Efficiency and Renewable Energy Fund GSIS Government Service Insurance System Fund, Philippines IFIs International Financial Institutions ISIF Ireland Strategic Investment Fund NTMA National Treasury Management Agency PBCE Europe 2020 Project Bond Initiative PE private equity PPP public-private partnership REAF Renewable Energy Asia Fund SBIC Small Business Investment Company SIF strategic investment fund SMEs small and medium enterprises SOEs state-owned enterprises SDF sovereign development fund SWF sovereign wealth fund VC venture capital 2    1. Introduction The past fifteen years have seen the rapid proliferation of strategic, government-sponsored investment funds that, in addition to generating returns for their investors, are tasked with catalyzing capital flows to priority sectors of national and regional economies. Their role goes far beyond the sole provision of public capital. Well managed strategic investment funds (SIFs) can create opportunities for attracting private investment, deepening domestic capital markets, and building the capacity of governments to act as professional long- term investors. At their best, SIFs bring highly specialized and sector-specific expertise to the structuring and financing of investment projects. Their presence as co-investors provides some degree of implicit political and regulatory risk insurance for private investors, particularly for infrastructure projects that are generally more exposed to sovereign risk. However, a review of the existing literature suggests that the establishment and operation of SIFs is not without challenges. Efficient operation of these funds requires a high level of fund management capacity, independence, and transparency. To be successful, SIFs need to balance policy and commercial objectives, source investment opportunities well, and secure the right staff. Although SIFs have been around for a few decades, they have until now not been the object of analysis in the literature. Section 2 proposes a definition and classification of SIFs based on their investment strategy. Section 3 identifies factors that may explain their recent proliferation, while Sections 4 to 7 focus on their structure, strategy, role, and operations. Section 8 identifies common challenges and proposes possible solutions based on the experience of a wide range of existing SIFs. Section 9 concludes. 2. What Is a Strategic Investment Fund? This paper defines SIFs as special purpose investment funds that exhibit all of the following four characteristics:  Are sponsored and/or fully or partly capitalized by a government, by several governments, or by government-owned global or regional finance institutions;  Invest to achieve financial as well as economic returns, in accordance with a double bottom- line objective;  Operate as expert investors on behalf of their sponsors; and  Provide long-term patient capital primarily as equity. But may also invest in quasi-equity or debt.2                                                              2   SIFs have yet to be analyzed in existing literature on investment funds. This paper is an attempt to defining what SIFs are and how they operate.  3    Annex 1 contains a non-exhaustive list of SIFs categorized according to of their geographical scope. SIFs come in different flavors. Their investments tend to focus on infrastructure projects and/or funds, but may also include investments in private equity (PE) and venture capital (VC) funds for small and medium enterprises (SMEs). A useful categorization of SIFs can be derived from research carried out by Clark and Monk (2015) on sovereign development funds (SDFs), which the authors define as publicly-sponsored commercial investment funds that combine financial performance objectives with development objectives. The authors suggest four operational and not mutually exclusive strategies for SDFs: (i) reinforcing, by reorganizing, professionalizing and innovating state holdings (companies, infrastructure, or other real assets) so as to drive commercialization and higher returns; (ii) crowding-in private capital, by acting as a cornerstone investor in key sectors or projects; (iii) catalytic, by seeding new industries, thereby diversifying the economy away from industries that are either no longer profitable or sustainable over the long-term; and (iv) financialization, by deepening local financial markets, thereby underwriting the development process through the growth of the capital market and the emergence of new financial intermediaries and investors focused on opportunities in the region. Each of these strategies is situated along a double spectrum, from strategic to commercial in terms of their investment objectives, and in tight or loose alignment with national endowments and advantages (figure 1).   Figure 1. Categorization of Strategic Development Funds Source: Clark and Monk 2015. Note: SOEs = state-owned enterprises. 4    Because SIFs are first and foremost commercially oriented investors focused on leveraging public investment by crowding in new sources of funding from the private sector (either domestic or foreign), by definition they populate the upper right quadrant in figure 1. Within this operating environment, SIFs could be categorized on the basis of their policy objectives as mainly catalytic, or reinforcing, or financializing. Figure 2 applies the proposed taxonomy to a subset of SIFs. The graph helps to visualize SIFs’ strategic positioning, and suggests that financialization and reinforcing are the most common strategies for the SIFs observed in this paper, particularly in Emerging Markets and Developing Economies (EMDEs). On the other hand, SIFs that focus on climate financing appear to play a catalytic role independently of the country of operation. Examples include the Africa Renewable Energy Fund (AREF), the Renewable Energy Asia Fund (REAF), and the Global Energy Efficiency and Renewable Energy Fund (GEEREF).   Figure 2. SIFs strategic positioning Source: Authors’ assessment based on SIFs’ mission statement and objectives. As with sovereign wealth funds (SWFs), SIFs’ sources of funding may include balance of payment surpluses, official foreign currency operations, the proceeds of privatization, pension reserves funds, fiscal surpluses, government (or government guaranteed) borrowing, and/or receipts resulting from commodity exports (IFSWF 2009). However, monetary authorities’ foreign reserves held for balance of payment 5    purposes, government employees’ pension funds, traditional public enterprise operations, and assets managed for the benefit of individuals are not sources of funding for SWFs and SIFs (IMF 2014). International, bilateral or multilateral financial institutions, domestic development banks, and some commercially focused development and climate finance institutions are not SIFs. Although these institutions may fulfill the four criteria proposed above, they differ from SIFs in their governance structure, and/or investment policy, deal sourcing, and staffing. In all these respects, they are more akin to government institutions than to SIFs, which – as discussed further in this paper – are nimbler structures that derive much of their modus operandi from the PE model. For example, the South Africa’s Public Investment Corporation (PIC) is a state-owned asset manager that invests on behalf of the Government Employees Pension Fund (89 percent), Unemployment Insurance Fund (6 percent), and other public funds. Its main investment objective is to achieve strong long-term capital returns above clients’ benchmark while contributing to the broader social and economic development of South Africa and the rest of Africa. The PIC lacks a formal double bottom line and, being a pension fund manager, is excluded from the IMF and IFSWF definition of SWF. By the same line of reasoning, pension funds are not SIFs even when applying responsible investment principles (such as CalPers). Public pension funds derive at least part of their resources from contributions made by employees, and their fiduciary responsibility is toward their contributors. Specifically, for a defined contribution scheme, the fiduciary obligation is to maximize the replacement value of pensions provided to its members at retirement. For this reason, pension funds’ investments are entirely commercial and cannot be subject to a “double bottom-line” objective. They can and do invest in SIFs on commercial terms (for example the South African Government Employee Pension Fund has invested in the Pan-African Infrastructure Development Fund). On the other hand, pension reserve funds are generally capitalized by budget transfers. Their objective is to hold precautionary savings for future government expenditures, which may include public pensions without having any contractual obligations to future pensioners (IMF, 2008). Pension reserve funds function very much like other long term government savings funds (Shields, 2013). Some pension reserve funds, such as the Australia’s Future Fund and the Ireland Strategic Investment Fund, have combined commercial and developmental objectives. These funds are SIFs. Others, such as the New Zealand Superannuation Fund, invest on purely commercial terms and are not SIFs. Government-owned investment funds that are fully capitalized by the government or a subnational entity to serve a politically defined purpose, and that do not seek private capital participation at the fund or at project level, are also not SIFs. These funds represent pools of public capital destined for public investment, often in infrastructure, that could in principle be implemented through the normal budget process. They are fiscal funds: essentially quasi-fiscal tools for governments. Like SIFs, fiscal funds provide increased 6    functionality to public investment, since managerial and professional capacity is centralized in a specialized body. Their single focus on policy objectives makes the attainment of these objectives more straightforward than for SIFs. But it also cuts them off from sources of private capital since profitability is a critical factor to attracting private investors. The largest government-owned fund of this kind is the Chinese Silk Road Fund, which recently announced its openness to external sources of capital but as yet appears to be fully state funded (Wall Street Journal 2015). SWFs may exhibit some of the characteristics of SIFs, particularly in respect of their domestic investment strategy when this involves double-bottom line objectives (for example, Malaysia’ Kazanah Nasional Berhad, and the Nigeria Infrastructure Fund owned by the Nigeria Investment Authority). However, unlike SIFs, SWFs’ international investments are usually guided by commercial principles only. On the other hand, SWFs with an exclusively domestic investment mandate may be considered SIFs if they exhibit the four characteristics listed in section 2. SIFs support the development of local economies through direct investment that aims to generate a high level of private sector participation. To achieve their objectives SIFs use different approaches: some domestically-focused SIFs are owned by both the public and the private sector while others are wholly owned by a government; some SIFs operate at global or regional scale, and may be funded by several governments. For example, the Philippine Investment Alliance for Infrastructure (PINAI) is a 10 year closed SIF, managed by a specialized private investment manager–Macquarie Infrastructure Management (Asia) Pty Limited–that invests exclusively domestically in a broad range of infrastructure projects. The PINAI was created in 2012 by the Government of the Philippines with assistance from the Asian Development Bank, and has a domestic and a foreign pension fund as the two largest shareholders. Senegal’s Fonds Souverain d’Investissements Strategiques (FONSIS) also invests only domestically. It was established in 2013 to act as catalyst for external investment to support the development of a strong local economy and job creation. However, its capital structure is much simpler than the PINAI: it is wholly owned by the Government of Senegal, and operates as a private equity firm on its behalf. As a result, its investment strategy is closely guided by the government’s national development plan. The European Fund for Strategic Investments (EFSI) is a regional SIF. It was established in 2015 and is funded through a €16 billion first-loss guarantee facility provided by the European Commission (EC) and by €5 billion capital provided by the European Investment Bank (EIB) – the European Union’s long-term public lending institution (NEU 2015). The fund is managed by the EIB and aims to generate additional investment of €60 billion by the EIB and by the European Investment Fund (EIF) and to unlock at least €315 billion in private 7    sector investment over a three-year period.3 Box 1 contains a summary description of PINAI, FONSIS, and EFSI. Box 1. Examples of SIF investment strategies: PINAI, FONSIS, and EFSI The Philippine Investment Alliance for Infrastructure (PINAI) is a $625 million 10-year closed-end private-equity- type fund. The fund is managed by an external, private sector manager, Macquarie Infrastructure and Real Assets (MIRA), and its policy objectives include (i) attracting top-tier international partners to infrastructure investment in the Philippines; (ii) fostering competition in domestic infrastructure finance; and (iii) establishing a secondary market for well-performing infrastructure assets. The Philippine government asked the Asian Development Bank (ADB) to develop financing solutions to help meet its infrastructure gap. ADB support for PINAI was built on previous legislative and fiscal reforms (for example, public- private partnership reforms, institutions, and feed-in-tariffs).   PINAI is an alliance of a small number of parties that combine domestic knowledge and international experience:  The Philippines’ Government Service Insurance System Fund (GSIS) is a large domestic social security fund intending to invest in domestic infrastructure, but with little or no experience in infrastructure investment. GSIS holds 64 percent of PINAI’s assets.  The Netherlands’ Algemene Pensioen Groep (APG) is Europe’s largest pension fund, and has significant experience in direct and indirect infrastructure investment. It holds 24 percent of PINAI’s assets.  The ADB provides guidance on the concept, design, and implementation of the new fund vehicle and holds 4 percent of PINAI’s assets.  MIRA is an experienced international fund manager holding 8 percent of PINAI’s assets. It manages PINAI and is responsible for all major investment, divestment, and management decisions within the fund’s overall mandate. PINAI aims to provide equity and quasi-equity (mezzanine debt) financing in core infrastructure assets exclusively in the Philippines. It seeks to invest in a portfolio of greenfield and brownfield projects across a broad range of infrastructure sectors (including power, transport, and telecommunications), and has a cap on greenfield exposure (Lewis 2013). Information on PINAI’s financial performance are not publicly available. However, GSIS was reported to have expressed an interest in doubling its investment in infrastructure projects in the Philippines to $800 million, on the count of their experience with very good returns and risk diversification offered by PINAI (interview with GSIS president Robert Vergara, The Philippine Star, February 7, 2016). PINAI’s financial performance will need to be judged at the end of the term of the 10-year closed-end fund.  Senegal’s Fonds Souverain d’Investissements Stratégiques (FONSIS) is a strategic investment fund focused on attracting private investment to Senegal by operating as a PE investor on behalf of the government. Established in 2013, it aims to invest in projects that stimulate economic growth and job creation in the framework of the national development plan—Plan Sénégal Emergent—while creating wealth for current and future generations. Its stated policy objectives include the support of strategic economic sectors, sustainable jobs, and small and medium enterprises, as well as the optimization and management of state-owned assets. FONSIS acts as a financial intermediary, which brings credibility; access to a network of international investors; and capacity to structure, negotiate, and transact deals. The fund has a minimum rate of return on its investments (hurdle rate) of 12 percent and a target multiplier of 1:12.4 Its investment criteria have been extensively disseminated in the                                                              3 http://www.eif.org/what_we_do/efsi/. 4 Multipliers are discussed in section 6. 8    national press, to build legitimacy and mitigate pressure to undertake projects that do not fit these criteria. FONSIS may —if necessary to attract external capital to high-priority projects—use an exceeding return margin above the hurdle rate to finance return enhancement or risk mitigation for external investors. Also exceptionally and subject to board approval, it may cross-subsidize one project (whose expected returns are below the hurdle rate but which has significant positive externalities) from a project with higher returns, so that the joint expected return remains above the hurdle rate. The European Fund for Strategic Investments (EFSI) started operation in 2015. The fund aims to help overcome the financing gap in Europe by mobilizing private finance for strategic investments, and acts as one of the three main pillars of the Investment Plan for Europe. With EFSI support, the European Investment Bank group provides funding for economically viable projects where it adds value, including projects with a higher risk profile than ordinary EIB activities. Further, EFSI aims to strengthen the European regulatory environment and support the investment environment throughout Europe. EFSI focuses on key sectors, including: 1) Strategic infrastructure, including digital, transport, and energy; 2) Education, research, development, and innovation; 3) Expansion of renewable energy and resource efficiency; and 4) Support for smaller businesses and midcap companies. Given its objective, EFSI’s main measure of success is the amount of external investment unlocked by its guarantees for investment in the fund’s defined priority sectors. EFSI aims for a 1:15 multiplier on its investments for the aggregate investments generated. As of April 2016, EFSI approved 249 transactions in 26 of the 28 EU countries. Source: Adapted from Inderst (2016a), Foce Consultora 2016; funds’ websites. SIFs may also act as venture capital (VC) funds. The first state-sponsored VC fund programs were created by the United States and United Kingdom governments to improve financing for fast-growing young firms and foment post-World War II productivity. In the 1960s these funds represented the bulk of venture capital raised in the United States (Lerner et al., 2012). Some of these programs are still functioning. For example, the Small Business Investment Company (SBIC) program, established in 1958, consists of federally guaranteed risk capital pools. State-sponsored VC programs are now seen in a growing number of EMDEs (EY, 2015). In Senegal, Teranga Capital is an equity impact investment fund launched in 2016. The fund targets promising domestic SMEs, with financing needs comprised between 75,000 and 300,000 euros. In addition to long-term finance in the form of minority equity participation, Teranga Capital provides management coaching to support the growth and consolidation of the SMEs in portfolio (sales and marketing, accounting, ESG benchmarks). FONSIS invested in Teranga Capital as limited partner alongside Investisseurs and Partenaires (general partner and fund manager), Sonatel, Askia Assurances, and two private professional investors. Another SIF, the African Agricultural Capital Fund (AACF), provides growth financing to Africa’s undercapitalized agriculture sector through SME investments in East Africa. The AACF was created in 2011 by USAID and other six investors. Managed by Pearl Capital Partners, the AACF aims to invest $25 million through equity investments to smallholder farmers with a target of around 9    15 percent annual compounded return. Successful venture capital industries have also been seeded by the governments of Israel and Brazil (box 2).   Box 2. Israel and Brazil Venture Capital Funds Israel’s Yozma program, established in 1993 with $100 million capital, initially sought to attract experienced international venture investors, who had to come up with $12 million of their own capital and work in partnership with an Israeli firm. Yozma would provide such investors $8 million in matching investments, with a capped upside to further attract private investors. Factors contributing to its success include that (i) its capital was spread across many small funds, (ii) it fostered relationships between local and international venture capitalists, and (iii) business incubators and tax incentives were established to complement the program (Yozma 2016; OECD 2003; Druid 2009). Since Yozma was established, Israel has gone from having no VC sector at all to having the highest VC penetration in the world as a share of gross domestic product (GDP), reaching 0.36 percent in 2012. 5 Brazil’s Inovar program combined the role of VC coinvestor with the provision of extensive capacity building. Inovar was launched in 2000 to teach entrepreneurs how to raise funds and to work with equity-holding partners. Limited partners needed to learn how to evaluate funds, and general partners how to select companies, manage funds, assess investment opportunities, and manage portfolio companies. A special organizational framework and tax incentives had to be put in place. In the beginning, Inovar’s sponsored venture capital funds needed to raise only 20 percent from private investors as market validation, with the rest provided by the government as loans with a capped return. The Inovar model has since been exported to other Latin American countries. In 2014 the program managed a $197 million venture capital portfolio (EMPEA 2016; Leamon and Lerner 2012). Source: Authors’ compilation, based on various sources.   SIFs may also be thematic investors. Particularly in clean-energy finance, several SIFs have been established with the objective of attracting private investment in wind, solar, and thermal energy infrastructure and energy efficiency. Some climate SIFs are funded by multilateral financial institutions, including Asia Climate Partners established by the ADB and the Global Energy Efficiency and Renewable Energy Fund (GEEREF), a hybrid fund with both private and public shareholding established by the EIB and several European governments (Box 3). Green SIFs are emerging at national level too. For example Norway recently announced its intention to establish a domestically focused renewable energy investment fund, Fornybar AS, and the Government of China is considering the establishment of a national green investment fund.   Box 3. Example of Green SIFs The Asia Climate Partners (ACP) is a $400 million joint initiative of the Asian Development Bank, the financial services group ORIX, and the asset manager Robeco. ACP makes PE investments in the environmental industries, resource efficiency, and renewable energy sectors in Asia. Besides PE, ACP provides additional form of capital such                                                              5 OECDiLibrary 2013; Ernst & Young puts it at 0.65 percent (EY 2015). 10    as debt and credit enhancement from the ADB, climate finance facilities, and commercial debt from partner organizations. The Global Energy Efficiency and Renewable Energy Fund (GEEREF) is an international fund-of-funds, domiciled in Luxembourg, which deploys public sector funds to catalyze private sector investment in clean energy projects. GEEREF started in 2008 with €112 million from the European Union, Germany, and Norway, and has since been further capitalized with an additional €110 million from private investors. GEEREF’s investments aim to achieve a “triple bottom line”: provide access to sustainable energy, combat climate change, and deliver compelling financial returns. Its target is to catalyze investments sufficient to generate 1 gigawatt of clean energy capacity, thereby avoiding 2 million tons of carbon dioxide emissions and potentially supporting the energy needs of 3 million people. Source: GEEREF 2015.   3. The Emergence and Growth of Strategic Investment Funds Over the past 15 years, at least 26 SIFs have been established, and another 13 are planned (Figure 3).6 Examples of existing SIFs include Bahrain’s Mumtalakat (2006), Italy’s Strategic Investment Fund (2011), Kazakhstan’s Baiterek (2013), the Global Energy Efficiency and Renewable Energy Fund (2008), InfraCo Asia (2010), and the Africa Renewable Energy Fund (2014).   Figure 3. Growth in the Number of SIFs                                                              6   These numbers may be conservative. The lack of publicly available data on investment funds and their operations makes it difficult to assess which funds exhibit the characteristics for classification as “SIF” identified in section 2.   11    While there are undoubtedly many factors affecting the establishment of a SIF, the widening of the financing gap for long-term investment that followed the 2008 financial crisis is likely to be one of them. Indeed, 17 of the 26 SIFs presented in Annex 1 were established after 2008. SIFs like the InfraCo Africa and Indonesia Infrastructure Guarantee Fund were set up to crowd-in private sector financing to infrastructure. Others, such as the Macquarie Mexico Infrastructure Fund and PINAI, funded by a combination of public and private capital, aim to improve government capacity to efficiently invest in PPPs. PPPs have historically been used to engage private capital in infrastructure projects that are too complex or too expensive to be financed by public capital alone. Global PPP investment in infrastructure reached $1.2 trillion in 2015 (PPI database). Although SIFs may be responsible for a significant portion of this investment, the lack of publicly available information on investment deals makes it difficult to estimate their contribution. Governments have also established SIFs to support the domestic capital market. Particularly in emerging EMDEs, local financial markets may lack the range of financial products or intermediaries required to sustain economic development, or the density of financial intermediaries may be too low to ensure effective competition between providers. As a government-sponsored financial intermediary, a SIF may offer financial services and products that are not yet being commercially provided, either for the economy as a whole or for certain sectors. The Indonesia Infrastructure Guarantee Fund is an example of this type of SIF. In advanced economies and EMDEs alike, governments are increasingly preoccupied with enhancing the local private sector competitiveness, by nurturing the creation and growth of innovative SMEs. According to a recent OECD study, young SMEs are globally the primary source of net job creation. The disproportionate contribution of young firms to employment creation holds across all economies, sectors and years considered (Criscuolo et al., 2014). In countries with underdeveloped capital markets SMEs frequently lack access to financing. Nonetheless, promising results such as those obtained in Israel and Brazil (Box 2) could provide useful information for SIFs that invest as minority limited partners in hybrid PE and VC funds. Finally, the increasing number of SIFs may be indicative of a growing confidence among their sponsors in the capacity of these funds to address market failures and economic externalities.7 SIFs’ dual financial and economic objectives allow investments to be guided by market imperatives – measured in terms of financial rate of return – as well as higher order policy imperatives – measured in terms of the economic rate of return (ERR) or other parameters (see section 5). Externalities can cause the economic rate of return (ERR) to be                                                              7  An externality is a consequence of an economic activity that is experienced by unrelated third parties. An externality can be either positive or negative. Externalities associated with an investment project refer to the wider impact of such project on the economy and society.  12    higher or lower than the financial rate of return. For example, an infrastructure project might have positive economic externalities that are not fully captured by its financial return (Gelb et al., 2014). A power plant, while paying for itself, can also improve access to electricity for local industry, and therefore strengthen domestic productivity. If the power plant is a wind farm, carbon emissions associated with a given level of energy production will be lower, generating a benefit (positive externality) that goes beyond the investment project itself. Over the last few years, SIFs such as GEEREF, Asia Climate Partners, and EFSI have emerged to address urgent investment needs in climate finance. SIFs’ ability to crowd in private sector financing is of particular interest to climate finance given the large estimates of financing gap, and the limited resources available to the public sector. 4. SIFs’ Structure and Market Validation The structure of SIFs vary along a broad spectrum, from the private management of public capital, through hybrid funds, to fully state-owned direct investment funds. In general terms, the choice depends on the relative importance of market versus policy objectives of the SIF. Private management of public capital is seen when the government invests in a private fund, on terms that reflect policy priorities, or when a public entity shares risk as a limited partner in a public-private hybrid fund. In this model, investment decisions are made independently by the private sector general partner that manages the fund or by an independent investment committee that might or not have government representatives, while the overall investment policy is set by the fund’s board that is usually dominated by limited partners. The fund manager and general partner may be required to put up some share of the total capital. The PINAI is an example of this approach. In funds that are fully government owned and/or operated, market validation may come from limitation on the ownership share in each investment, limiting the SIFs’ investments to minority participation of a certain size. Except for hybrid funds, fund management is frequently provided by a government-owned fund management entity operating at arms-length from the government (see Annex 1). The degree to which private capital participates in the fund’s structure (generally) increases with the degree of market validation (figure 4). 13    Figure 4. SIF structure, market validation, and public capital multiplier Source: Authors’ compilation. Although attaining a high level of private funding is a priority for SIFs, it is worth mentioning that a higher multiplier may translate to less SIF control of policy objectives. In the fund-of-funds model, the public sponsor’s control over an investee fund’s investments may be limited to supervision of environmental, social, and governance (ESG) reporting, while direct investment funds like the FONSIS can be expected to have a higher degree of control of policy objectives. The Alberta Heritage Savings Trust Fund (AHSTF), while not a SIF, illustrates the importance of ensuring market validation of investment projects (Box 4). The AHSTF had a complex set of objectives, and a complex structure to go with it. The emphasis on public investment and the significant political influence on the fund’s governance and investment decisions contributed to its poor results, and the funding of uneconomic projects resulted in many loans being written off (Morton and McDonald, 2015). Box 4. The Alberta Heritage Savings Trust Fund (AHSTF) The AHSTF was established in 1976 by the province of Alberta, Canada, to: (i) save for the future; (ii) strengthen or diversify the economy; and (iii) improve the quality of life of Albertans. During the early 1980s, the fund made loans to other provincial governments in Canada. Later the fund's money was used for capital infrastructure projects. Investments included low-interest financing to state firms, financing to Alberta corporations to encourage diversification away from the oil sector, social investments such as parks, and hospitals, and investment in the Canadian stock market. 14    Four out of five investment divisions of the fund were particularly striking because they covered activities that are conventionally undertaken by the general budget. The checks and balances that were set up for these activities were less stringent than those normally applied to the general budget. Indeed, by transferring money to a fund with loosely defined objectives, the executive (through the cabinet) determined spending priorities in a very autonomous fashion. Although there were ex post considerations of these decisions, which could have led to refusal by the legislature to approve further transfers into the fund, these were rather weak and could not easily reverse a spending decision once it had been made (Bacon and Tordo, 2007). Since a baseline analysis was not undertaken, it is difficult to assess to what extent the fund was able to achieve its policy objectives. In 1995, the mandate of the fund was put to a provincial referendum, and its domestic development role ceased in 1997. Since then, it has been a pure savings fund, operating as a commercial investor with the sole objective of maximizing financial returns for its shareholders, the citizens of Alberta (Warrack and Keddie undated; Smith 1991). Other sovereign funds with a domestic investment mandate, such as Malaysia’s Khazanah Nasional Berhad and Singapore’s Temasek, appear to have done better with regard to their ability to ensure market validation and generate financial return while supporting their national economies. These funds’ initial capital consisted of a portfolio of SOEs and other assets destined for full or partial privatization. As such, they as acted as state-owned holding companies. Because these funds’ role was to privatize state assets, their management and investment decision making process have, since the start, been exposed to and validated by market forces. The funds have since expanded into foreign assets while maintaining their public policy objectives. For example, Khazanah’s foreign investments are to some extent driven by the purpose of strengthening sector and industry links that promise to benefit Malaysia’s economy and Malaysian companies. 5. SIFs’ Double Bottom Line In principle, the policy objectives of an investment should be expressed in terms of ERR estimated in accordance with one of several accepted methodologies (see Annex 2). Although externalities can be hard to identify and objectively quantify, the ERR provides a single estimate of the social and economic impact of an investment project. In practice, however, most SIFs use simpler, albeit less comprehensive measures. For example, the GEEREF measures its policy achievements in terms of the amount of clean power generated. The European Fund for Strategic Investment’s (EFSI) main policy success benchmark is the amount of external investment unlocked by its guarantees for investment in the fund’s defined priority sectors, with the aim to generate a 1:15 multiplier on its investments. The Ireland Strategic Investment Fund 15    (ISIF) measures its policy objectives against the triple criteria of additionality, no displacement, and no deadweight, as illustrated in Box 5.   Box 5. The Double Bottom Line of the Ireland Strategic Investment Fund ISIF started operations in December 2014 with a €7.6 billion capital from the National Pensions Reserve Fund (NPRF). The overarching purpose of the ISIF is to invest on a commercial basis in a manner designed to support economic activity and employment in the State (NTMA 2015a). The fund has a stated target of a 1:2.6 multiplier on its invested capital. The ISIF’s act of establishment lists the following investment criteria • The investment performance goal is to exceed the average cost of government debt. • No withdrawals shall be made from ISIF for budgetary purpose before 2025. Thereafter a dividend-type payment of up to 4 percent per annum may be paid to the exchequer. • Investments shall not have a negative impact on the net borrowing of the general government of the state for any year. ISIF measures the economic impact of its investment activity by applying the following three concepts: • Additionality: the additional economic benefits to the gross value added (GVA)/gross domestic product (GDP) that are likely to arise as a result of an investment over and above what would have taken place anyway. • Displacement: the reduction in the additionality generated by an investment when measured at the overall economy level due to a reduction in such benefits elsewhere in the economy. • Deadweight: occurring when the economic benefits created from an investment would have been achieved without such investment being made. The ISIF seeks to allocate the majority of its capital (80 percent of its portfolio over time) to priority sectors that are likely to have high potential economic and employment impact, while also ensuring that all investments satisfy the fund’s commercial return objectives. The remaining capital is invested in assets that provide short term gains, act as an accelerator of market activity or address instances of market dysfunction. Some of the sectors with the lowest levels of deadweight and displacement and highest levels of additionality would be those involved in exports, manufacturing, and internationally-traded services. Investment opportunities that lead to economic additionality and have low levels of displacement and deadweight are likely to result in a high economic impact at the overall economy level over the long-term. Economic additionality can come in many forms, including increased output (turnover), profits (operating surplus), employment, net exports, and capital expenditure. The supply of enabling infrastructure also creates additionality in the future, by facilitating future competitiveness of the economy. Similarly innovation and investment in research and development (R&D) have long-term additionality that may not be immediately evident but is necessary for long-term sustainable economic growth. Source: ISIF Investment Strategy: Executive Summary (NTMA 2015b). 16    6. Public Capital Multipliers Publicly available data suggest that SIFs generate a wide range of public capital multipliers. Box 6 contains a brief description of the methodology used for calculating public capital multipliers and its application to a select number of SIFs for which data are publicly available. Although multipliers do not reflect the ability of SIFs to operate efficiently, or the wider social economic impacts of its investment, they do provide a useful indication of a fund’s ability to crowd in external capital. However, the following important caveats apply: 1. Definition. Multipliers may refer to different dimensions (for example, different ratios, financing instruments, definitions of public and private capital, definitions of commitments or investment, and so on). For example, the external capital may come from other government institutions, or multilateral development institutions, instead of the private sector. 2. Additionality. Private investment in a company/project may occur independently of public participation, particularly when the expected financial returns are attractive. In this case estimated multipliers would be overstated. 3. Projections. Multipliers may refer to expected rather than actual investment volumes. 4. Expectations. Multipliers can generate mechanistic or otherwise unrealistic expectations.   Box 6. The Public Capital Multiplier The concept of a public capital multiplier was first prominently used in the development of the Europe 2020 Project Bond Initiative (PBCE), adopted in 2012. It is defined as the ratio of total investment to public funds invested in a certain project. The multiplier can be calculated at the fund level and at the project investment level. The combination of the two levels results in the total or overall multiplier as follows:  Fund (or investment vehicle) multiplier = total size of fund or facility/public capital  Investment multiplier = total invested in projects/fund size  Total multiplier = total investment volume/public capital Information on multipliers is very limited. Whereas the public capital multiplier is an explicit measure of success for and an integral part of the public disclosure of funds created by the European Union/European Investment Bank, other SIFs do not report their multipliers. Table 5.1 below is therefore the result of estimates based on press releases and other publicly available data. 17    Table 5.1 Capital Multipliers of Selected Funds: Preliminary estimates Fund Year Capitalization Fund Multiplier Investment Multiplier Total Multiplier EFSI 2015 €21 billion 1x 6.7x 6.7x Marguerite 2010 €710 million 1x 11.8x 11.8x GEEREF 2008 €112 million 2x 35.8x ~71x ISIF 2014 €7.6 billion 1x 2.4x ~2.4 PAIDF 2007 $625 million 4.2 4 16.7x PINAI 2012 $625 million 25x Unknown ~25x MMIF 2008 $408 million 5x 10.3 51.7x FONSIS8 2016 €28 million 1x 9.6x 9.6x PBCE 2012 €230 million 3x ~6x ~19x Acronyms: EFSI = European Fund for Strategic Investments; GEEREF = Global Energy Efficiency and Renewable Energy Fund; ISIF = Ireland Strategic Investment Fund; PAIDF = Pan-African Infrastructure Development Fund; PINAI = Philippine Investment Alliance for Infrastructure; MMIF = Macquarie Mexico Infrastructure Fund; FONSIS = Fonds Souverain d’Investissements Stratégiques; PBCE = Europe 2020 Project Bond Initiative. Note: Multipliers in this table are World Bank estimates based on publicly available information on actual invested amounts, often referred to specific projects since detailed information at portfolio level is generally not available. Furthermore information on the public versus private share of capital invested at project level is also not publicly available. As a result, estimates shown in this table are indicative only. Funds that are wholly owned by a government have a fund level multiplier of 1. Source: Adapted from Inderst (2016b).   All other things being equal, the size of the multiplier appears to be linked to the fund’s structure. Intuitively, a SIF organized as a fund-of-funds should be able to achieve higher multipliers than a SIF that invests directly in specific projects alongside the private sector, although additionality is harder to establish at the fund-of-funds level. In a fund-of-funds structure such as GEEREF the effect of the multiplier takes place in three stages: (i) at fund level by coinvesting with other investors as a limited partner in a hybrid fund-of-funds, (ii) at the invested funds level through the fund-of-fund’s minority stakes in its invested funds, and (iii) at the individual project level through the invested funds’ minority equity or debt positions in individual companies or projects. In direct investment funds such as FONSIS, the multiplier effect occurs at the level of individual investment, in some cases through special purpose vehicles (SPVs). For example InfraCo Africa, Ghana CenPower, and the Kpone IPP gas project created Cenpower Generation Ltd and were able to mobilize $903 million in financing from both African (70 percent) and international (30 percent) investors.                                                              8 FONSIS has a targeted average multiplier of 10. Indeed in February 2015 FONSIS completed the financing of the €41.16 million, 30 megawatt solar energy plant and its transmission line project in Santhiou Mékhé, 100 km from Dakar, along with Meridiam, a Paris-based global investor and asset manager focused on public infrastructure projects. A third equity investor, Senergy SUARL, is a Senegalese company engaged in developing energy projects. The three are grouped in the company Senergy PV SA, which is responsible for developing the project. FONSIS provided a total €1.0 million contribution between equity and quasi-equity, for a 32 percent participation in the project company’s share capital. Proparco, the French Development Agency’s private sector arm, has provided €34.5 million in non-concessional debt financing. The project received a €3.5 million guarantee from the sovereign government, resulting in an investment multiplier of 9.6 for this project. 18    SIFs’ investment strategy also affects the size of their public capital multipliers. Intuitively, SIFs that operate like publicly sponsored VC funds may display lower multipliers than SIFs that invest in both equity and debt. This is because of the higher risk of equity investment, and the financial leverage. However, by participating in PE investments – either by co-investing with the private sector or by investing in a private sector managed VC fund – SIFs can enhance their capacity to make complex and risky assessments of young companies with no credit or operating record, as well as reduce investment risk. Multipliers can also be estimated for credit enhancement and blended finance in general (Brown and Jacobs 2011). 7. SIF Investment Strategy When policy imperatives prevail over commercial considerations, SIFs may find it difficult to attract private capital. Risk reduction and/or return enhancement mechanisms may help to overcome this challenge. For example, if public finance within the fund is used to increase the risk-adjusted rate of return for private investors, a SIF may leverage private funds that invest in relatively high-risk regions or projects, yet need finance with low risk premiums. Typical instruments are first-loss equity and capped return. First-loss equity means that the public sector investors take equity stakes in a SIF with a first loss position, thereby increasing the number of projects within the SIF that can fail before the private sector investors lose money. In a capped return arrangement, the government’s return on the capital investment is capped, allowing co- investors access to higher upsides on their investments. The European Fund for Southeast Europe (EFSE) is an example of first loss arrangement (Box 7).   Box 7. SIF with a First Loss Arrangement The European Fund for Southeast Europe (EFSE), based in Luxembourg, is a hybrid SIF with €756 million (US$1.1 billion) in commitments from donor agencies, international financial institutions, and private investors. The PPP approach enables the EFSE to mobilize funding from private institutional investors to top up international public donor funding for development finance. In addition, it provides a platform for the coordination of donor activities in its regions. This pooling of resources multiplies the impact of public funding. The EFSE operates as a market enabler, facilitator and risk taker as well as an innovator and incubator for new financial products. Donor or public capital constitutes the first loss tranche—the first tranche to be used in the event of losses. IFIs invest in the mezzanine tranche, private investors in the senior tranche. Because of its investment structure, the EFSE is able to provide access to long-term finance at market conditions to qualified investors. To undertake an investment, different sources of funds representing different risk tranches are pooled into a single source of financing for the EFSE. For the investment portfolio in each country, the proportion of the different risk tranches contributing to the total amount of pooled funds remains intact. Hence, donors and other investors hold a specific share of the pooled funds in the amount of their original nominal contribution to the EFSE. Source: Wang et al, 2013; EFSE website http://www.efse.lu/about-the-fund/mission/ 19    A SIF could also target impact investors or commercially oriented financial institutions who identify with the policy objective of the fund and often require a lower financial return than traditional investors (Box 7). For example, AREF received financing from the Sustainable Energy For Africa (SEFA), a fund administered by the African Development Bank, at a rate of return capped at 4 percent.   Box 7. Public Finance and Impact Investment Emerging and frontier economies hold significant promise for private investors and corporations that seek to diversify their portfolios and enter new high-growth markets. Yet, the high level of risk (real or perceived) is often a barrier to investment. Public and philanthropic funders can use their resources to shift the risk-return profile of investee projects or companies to create favorable conditions for private sector engagement. Such blending of public, philanthropic and private resources can in turn significantly scale up investment into areas that are critical for sustainable development, including infrastructure, climate change solutions, agriculture, health care and financial services (OECD, 2015). Impact investors have diverse financial return expectations. Some intentionally invest for concessional returns in order to maximize impact or to catalyze additional investment capital by accepting a riskier position in a deal. Others pursue market-competitive and market-beating returns, which are often linked to their fiduciary responsibility towards investors. According to a survey carried out in 2015 by the Global Impact Investing Network – a nonprofit organization dedicated to increasing the scale and effectiveness of impact investing – 25 percent of the respondent impact investors declared to pursue below market returns close to market rate, and 16 percent declared to pursue below market returns close to capital preservation.9 As outlined in Section 2, governments may finance their SIFs in different ways, including through equity investment and/or lending. In particular, a fund’s public sponsor may undertake on-lending to the fund at the interest rate that the sponsor is eligible for. Countries that have a strong credit rating or borrow from IFIs may be able to secure a margin between borrowing costs and expected risk-adjusted returns on their sovereign fund’s investments. A SIF capitalized with government borrowing will have the option of using the spread between the expected risk-adjusted return of the fund investments and the cost of borrowing to provide favorably priced credit or return enhancement to attract private investors, thereby increasing the multiplier.10 Also, by carefully structuring the price and time profile of its on-lending, the government can decouple its obligations to the original lender from the SIF’s repayment schedule, allowing the SIF to manage its investment independently of the original debt repayment schedule. In accordance with good public finance management principles, equity investments and/or on-lending to the fund need to be channeled through the ministry of finance (representing the ownership of the fund), be included as liabilities in government accounts, and receive parliamentary approval.                                                              9 Survey results can be perused at https://thegiin.org/impact-investing/need-to-know/#s5. 10 A necessary assumption is that borrowing terms for the fund’s public sponsor are fully or partly passed through to the fund. 20    Like other financial institutions with government involvement, SIFs may have a comparative advantage over traditional financial institutions thanks to their privileged access to PPP investment opportunities, and a relationship of trust with public and private local investors. Clark and Monk (2015) suggest that this type of advantage may explain the remarkably high financial returns achieved by several SWFs with domestic investment mandate in spite of their social and economic objectives. Examples include Singapore’s Temasek (18 percent total shareholder return over 40 years), Malaysia’s Khazanah Nasional Berhad (10- year IRR of 13 percent), South Africa’s Public Investment Corporation (10-year IRR of 16 percent), and the Palestine Investment Fund (10-year IRR of 10.3 percent). These funds, the authors observe, have taken a role of wealth creators rather than wealth appreciators, acting like PE and VC investors by taking relatively large, direct stakes in projects and thereafter being actively involved in the operations of their investments. Furthermore, by being co-investors in PPP projects, SIFs allow governments to benefit if PPP projects turn out to be lucrative and provide comfort to the country’s stakeholders that their interests are protected, thus reducing the likelihood of PPP contract renegotiation in the future. 8. Common Challenges for SIFs Although SIFs are designed to achieve a wide range of policy objectives, some of which may be country and context specific, they face common challenges. This and other main challenges are discussed below. 8.1 Attracting Private Sector Investment Good governance. To attract private capital to a SIF or for co-investment, a SIF needs to be first and foremost a credible investor. For many investors, corporate governance has become one of the key factors in their investment decision‐making process. For example, 1Malaysia Development Berhad (1MDB), a SIF set up in 2009 to turn Kuala Lumpur into a financial hub, started to attract national attention in early 2015, when it missed payments for the $11bn (£7.1bn; €9.9bn) it owed to banks and bondholders. A series of probes and investigations exposed weak corporate governance. These findings crippled the SIF’s credibility and its ability to attract investors. From the perspective of a SIF, it is therefore very important to include solid corporate governance mechanisms in its establishing law, as well as in its bylaws and other policy and procedures documents —and to communicate these to investors. Sound corporate governance arrangements define clear mandates and objectives, provide incentives for the board and management of the SIF to pursue shareholders’ objectives, and facilitate the monitoring of performance by shareholders and owners. This is particularly important for SIFs and other state-sponsored institutions where clear policies and mechanisms are required to deal with complex mandates combining financial and public policy objectives (Gelb et al, 2013). Strong corporate governance —in particular, clear separation between the ownership role of the government and sponsors, the oversight role of the fund’s board and the investment and exit decisions role 21    of the fund manager— help to ensure efficiency and accountability. Transparent and timely reporting of accounting information, and strong external audit systems contribute to increase the market credibility of a SIF, particularly when the fund engages in PPPs (Corbacho and Ter-Minassian, 2013).11 SIF structure. Hybrid SIFs – i.e. SIFs that are funded by both public and private capital – provide a high degree of market validation, and are likely to generate a high overall multiplier. Since private sector participation occurs at the fund level, hybrid SIFs are likely to exhibit competitive financial returns. The PINAI, the AREF, and the REAF are examples of this model.12 However, an external manager may not have a natural incentive to achieve a high multiplier on SIF investments, since this is likely to result in more complex and time-consuming transactions that will not necessarily correspond to a higher return to the SIF’s own share of the capital in a project. Linking the external manager’s remuneration to the achievement of a multiplier benchmark may mitigate this risk. For fully state-owned and/or managed SIFs, limiting the SIFs’ investment to minority participation can provide the market validation of projects and enhance the integrity of investment decisions. In this way, due diligence by private sector co-investors can confirm the profitability of investee projects or companies (Gelb et al., 2013). Domiciliation. The jurisdiction in which the fund is domiciled may affect investors’ perception or assessment of the integrity of a fund’s activities, since such integrity is in part determined by regulatory quality, rule of law, and overall institutional quality of the country of domiciliation. Recognized international financial centers with strong legal, regulatory, and supervisory standards for fund operations may help to enhance investors’ confidence. International SIFs, such as AREF, GEEREF, or Asia Climate Partners, tend to be domiciled in known jurisdictions with attractive and cost efficient regulatory frameworks, such as Luxemburg, Mauritius, or Singapore. Tax optimization is also an important parameter in choices of domiciliation. SIFs that invest exclusively in the domestic market are normally domiciled in the country of operations, independently of their shareholding structure. This is likely related to the need to attract domestic institutional investors, as well as taxation and the home government’s considerations regarding its level of control of the fund. Where appropriate, dual registration could be considered, for example to provide some                                                              11  The objectives and mandate of the fund, the organization of the ownership function of the state, and the institutional arrangements that govern an SIF’s internal management bodies and processes are usually specified in a purpose- designed law, as well as in company law, financial sector regulations, and the fund statutes. The Santiago Principles for the Operations of SWFs (IWG 2008) and the existing literature on good corporate governance practice, including the OECD Principles of Corporate Governance (OECD 2004) and the OECD Guidelines on Corporate Governance of State-Owned Enterprises (OECD 2005), provide detailed frameworks for effective corporate governance (Gelb et al, 2013).  12 AREF and REAF report net IRR of 20 percent. PINAI does not report its IRR. However, in a recent interview, the Government Service Insurance System (GSIS), one of its shareholders, indicated its support for a second infrastructure SIF (http://www.manilatimes.net/gsis-calls-for-more-infra-investment/257275/). 22    degree of insulation against undue political interference in investment decisions – the biggest threat for any state-owned enterprise – and in the investment dispute resolution processes. 8.2 Sourcing Investable Projects Project preparation. In many EMDEs, the lack of capacity to transform investible projects into actual transactions is a hindrance to PPP finance even where capital may otherwise be available. Empirical evidence in Asia and Africa shows that project preparation facilities are not effective in transforming investible projects into actual transactions (Adam Smith International, 2016; ICA, 2014). To accelerate the generation of project pipelines and the preparation and closure of PPP transactions, several EMDE governments are establishing infrastructure PPP project venture funds. For example, FONSIS develops and structures strategic projects from initial sourcing, by identifying and working with financial and technical partners, through transaction close. The underlying model is for the fund to be responsible for managing all stages of the preparation of PPP transactions up to financial close. A PPP project venture fund may, after originating and structuring a project, be entitled to take an equity and/or mezzanine stake in the project’s special purpose vehicle (SPV), representing the government’s participation. The PPP venture fund would then have a direct incentive to generate viable and profitable projects. Such a fund can be set up either as a fully state-owned SIF, or as a public-private (or hybrid) SIF, or even set up as a sub-fund or fund compartment under an SIF. FONSIS is an example of a fully state-owned SIF that includes a PPP venture fund function. Including the venture financing function in a single fund (as opposed to a separate compartment) enables the government to capitalize on project preparation costs that the SIF converts into equity stakes or into a cost refund or a success fee, at financial close. Sourcing projects from national budgets. Since SIFs are partly or fully state-owned, they have an opportunity to align their investment strategy with the country of operations’ identified economic development priorities, subject to project viability. The close relationship with the government makes it easier for SIFs to source their projects from national infrastructure master plans, line ministries in each sector, PPP units, SOEs and public utilities, PPP studies performed by the government and development banks, other SIFs and SWFs, in addition to private developers (unsolicited proposals), commercial banks, and PE infrastructure venture funds. The FONSIS is an example of this model. Sourcing projects from national development plans and other government-related project pipelines must not inhibit the ability of the SIF to make fully independent viable investment decisions that enable the SIF to attract private capital. A SIF established as independent entity by an act of parliament may help to address this problem as is the case for FONSIS, Legal independence of the SIF may also address the challenge often faced by public investment units that are part of national treasuries to establish staff remuneration policies outside of public 23    sector pay scales, as is necessary to attract and retain highly skilled investment managers from the private sector. 8.3 Balancing Policy and Commercial Objectives Investment objectives. Successful achievement of the double bottom line objective requires that managers invest in projects that achieve competitive financial returns sufficient to attract investor across the risk spectrum, as well as economic policy objectives and associated economic returns. As discussed in section 6, when policy imperatives prevail over commercial considerations, SIFs may find it difficult to attract private capital even when they have good corporate governance. On the other hand, a fund that defines its policy objectives too loosely, focusing only on the maximization of returns, may end up making investments that would have taken place anyway, crowding out instead of crowding in private sector capital, resulting in a negative multiplier at the level of the overall economy. Performance metrics. The ERR is a comprehensive measure of the economic and social impacts of an investment project on the society as a whole, and has been widely used by the public sector and the donors community as part of their economic analyses (World Bank, 2013; World Bank, 2014).13 The tools of economic analysis of projects go beyond the estimation of the ERR, and can be used to answer broader questions about the impact of the project on the entity undertaking it, on society, and on various stakeholders. Economic analysis can also help to identify project risks and assess sustainability (Belli et al. 2001). However, none of the SIFs cited in this paper uses the ERR to assess investment opportunities, and none applies an explicit tradeoff between financial and economic objectives. In practice, SIFs use a simplified approach: they assess investment opportunities that satisfy a financial return benchmark, against an economic benchmark often expressed as proxy measure of the project’s economic and induced impacts, such as employment creation, the stimulation of new firms, the reduction in carbon emissions, and other proxy variables of their policy objectives. For example, the ISIF measures the social and economic contribution of the investment it undertakes by a variety of proxy variables, including employment, value addition at enterprise level, and underlying investee turnover (see box 5), and publishes its economic impact data every six months. SIFs often operate within a confined investment universe, i.e. invest only in certain sectors, themes, or asset classes predefined by their owners (for example, ISIF, AREF, GEEREF). A confined investment universe                                                              13 Economic analysis is more complex than financial analysis in that it uses economic measures of input and output instead of market prices, and includes nonmarket impacts (externalities or indirect effects) that are not part of financial analyses. Economic values are not observable in the market, therefore their estimate requires the analyst to make a range of specific assumptions. There is ample literature on the comparison of economic and financial analyses, their uses and respective limitations. See for example, Kholi, 1993 and EU, 2014. 24    would, in principle, include sectors and themes that are expected to contribute the most to the achievement of the SIF’s policy objectives (i.e. sectors that are expected to exhibit high ERRs). Beyond its simplicity, this approach has multiple advantages: it allows a SIF to tailor its organization (staffing and business processes) around few and well defined areas of expertise, and it facilitates the identification of meaningful and easy-to-understand proxy variables of economic impact. The use of proxy variables as substitutes for the ERR, although a common practice among SIFs, provides only a partial assessment of a project’s socio-economic impacts, and may be more open to selection bias than a more comprehensive economic analysis. Using the single measure of the ERR, albeit not perfect, may also facilitate the assessment of the relative desirability of projects with the same IRR and cash profile. For example, given the same IRR and cash profile, it would be difficult to choose whether to invest in a project that generates exports or in one that reduces greenhouse gas (GHG) emissions. By estimating the ERR when possible and appropriate, a SIF could more easily compare alternatives with wide ranging expected outcomes, and optimize the economic impact of its investment portfolio. This is particularly important when the number of investable projects is greater than the resources available to the SIF. Other indicators that capture unquantifiable impacts should also be considered. Economic analysis is an integral part of the investment decision-making process in public sector organizations and for IFIs. The experience of these organizations could offer useful guidance to SIFs in designing ways to measure their dual bottom-line while preserving their private sector vocation. 8.4 Securing the Right Staff Human capital. The role of human capital as a key factor to explain firms’ performance has been highlighted by researchers working on developing a resource-based theory of competitive advantage (Acedo, Barroso, & Galan, 2006; Barney, 1991; Barney, Wright, & Ketchen, 2001; Coff, 1999). The theory argues that the heterogeneous distribution of valuable resources among firms—such as human capital— explains performance differences. Researchers generally concur that the knowledge embedded in human capital is the most universally valuable and hard to imitate resource (Coff, 1997; Grant, 1991, 1996; Kogut & Zander, 1992). High returns and risk diversifications have traditionally been the main focus of PE, venture capital, and the investment industry at large. A vast number of research papers have been published on the growing importance of human capital in the economic world, but very few are specific to the investment industry. While it is undeniable that an investment fund’s performance is driven by many external factors –such as favorable markets, and stable or growing economic environment – in an increasingly globalized economy the underlying internal driver of success is the quality of an organization’s human capital. 25    Critical skills. The staff of the best investment companies, at all levels, share common characteristics: a) knowledge and skills about generating value; ability to read and interpret trends within the target markets, i.e. financial awareness; b) ability to quickly implement the right investment approach, i.e. commercial awareness; and c) access to extensive networks of contacts and the ability to interact with a wide array of people and interests, i.e. people skills (Warner, 2006). For some EMDEs, the establishment and operation of SIFs have been greatly helped by the increasing availability of highly qualified investment professionals both domestically and among their diaspora. For example, Nigeria and Senegal have been able to staff their respective funds with diaspora members that have extensive international experience in the financial sector. Cross-fertilization. Since SIFs are generally established to crowd in private investors, co-financing with the private sector can provide at the same time market validation and additional expertise to enhance the quality of investment decisions and fast track its staff’s learning curve. This model works best when there is a general alignment of interest among investment partners (Gelb, 2013). The combination of private and public sources of funding in a SIF’s capital structure – hybrid SIFs – help to keep the limited and general partners’ interest aligned, and may also be well suited to address issues related to limited partners’ inadequate human capital. However, even as limited partner, a SIF needs to acquire and retain an adequate level of capacity for project selection and assessment, and for the oversight of the general partner’s activities. Staff remuneration policy. A SIF’s ability to establish staff remuneration policies outside of the public sector pay scale is also critical to attract and retain highly skilled investment managers. This may require special legislation. For example, FONSIS benefits from legislation that sets it apart from other state-owned enterprises, and allows it to operate as an independent PE firm on behalf of the government. The fund offers salaries and benefits that are relatively competitive to attract and retain highly specialized staff from the private financial sector; applicants’ experience and education are screened by a professional recruitment firm and candidates go through financial aptitude tests as part of the selection process. In lower or medium income countries where it might be politically challenging to pay high salaries, donors could provide technical assistance facilities to contribute to paying the specialist staff required to successfully run SIFs. 9. Conclusion The number of government-sponsored SIFs has grown rapidly over the last 15 years, opening new opportunities to crowd in private capital to infrastructure PPP projects/funds and SMEs funds. SIFs are designed to achieve a wide range of policy objectives, some of which may be country and context specific. Some SIFs invest only domestically and are owned by both the public and the private sector, whereas others 26    are wholly owned by a government. Some SIFs operate at the global or regional level, and may be funded by several governments. Notwithstanding their diversity, all SIFs aim to crowd in private capital. This is achieved at the fund level by engaging as a limited partner in hybrid funds, or by investing in other funds, or at the project level through co-investment and/or the use of various return-enhancing and de-risking instruments. Investing with the private sector allows the public sector to generate a multiplier effect, which can range from 1:12 for a typical SIF’s direct investment to 1:70 for a hybrid fund-of-funds. The size of a SIF’s capital multipliers does not reflect its ability to operate efficiently, or the wider social economic impacts of its investment. But it does provide a measure of market validation, which is a critical success factor. SIFs sources of funding my include balance of payment surpluses, official foreign currency operations, the proceeds of privatization, pension reserves funds, receipts resulting from commodity exports, but also contributions from IFIs, and private sector actors. Partners that have a high credit rating or borrow from IFIs can on-lend to a SIF at low cost. In this case the SIF can, when necessary and justified by policy objectives, take advantage of the margin between low-cost loans and the expected risk-adjusted returns on its investments to enhance returns for private investors or de-risk their investments. SIFs face common challenges. Whatever their country of operations or area of investment, they all need to reconcile (and appropriately measure) policy and commercial objectives by achieving attractive returns on investment while delivering meaningful social and economic impact. Based on publicly available information on the objectives, strategies, and operations of a sample of SIFs, this paper has identified some of the challenges that are implicit in SIFs’ dual objective, and has outlined ways in which SIFs have addressed them. When policy imperatives prevail over commercial considerations, SIFs may find it difficult to attract private capital even when they apply good corporate governance principles, and are domiciled in a country with good regulatory quality, rule of law, and overall institutional quality. Sourcing investable projects may also be difficult, particularly where lack of capacity and information asymmetry hinder the preparation of a well- documented pipeline of bankable projects. Sourcing projects from the national budget may provide the opportunity to align the SIF strategy to the development priorities of the country of operations. SIF’s close relationship with the government makes it easier for these funds to source their projects from the national development plan and other government-related project pipelines must not hinder the ability of the SIF to make fully independent viable investment decisions. To be able to operate as expert investors, SIFs need to secure and retain professional staff with knowledge and skills about generating value, the ability to read and interpret market trends and quickly act on them, 27    and access to an extensive networks of contacts. Co-investing with experienced private sector investors can provide the SIF with both market validation and additional expertise, to enhance the quality of investment decisions and fast track its staff’s learning curve. A SIF’s ability to establish staff remuneration policies outside of the public sector pay scale is also critical to attach and retain highly skilled investment managers. Notwithstanding their growing number and relevance to policy-making, SIFs have in the existing literature not been the object of in-depth analysis. 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Strategic Investment Funds and Sovereign Wealth Funds Investing Domestically with a Development Objective Table A1.1 Strategic Investment Funds (SIFs) Size  Country  Name  Year  Financing Source  Objective  Sectors  Domicile  ($b)  To create a thriving economy diversified from  Financial Services; Telecommunication,  oil and gas, focused on securing sustainable  Technology, and Media; General  returns and generating wealth for future  Services; Industrial Manufacturing and  Bahrain  Mumtalakat  2006  $11.10  Oil Revenues  generations. Key sectors include infrastructure,  Services; Logistics and Transport;  Bahrain  financial services, telecommunications, real  Construction; Private Education; Real  estate, transportation, and aluminum  Estate and Tourism; and Consumer and  production.  Healthcare  Bpifrance provides assistance and financial  Merger between Caisse  Advanced materials, aeronautics,  support to small and medium‐sized enterprises,  32.578  des Depots, the former  automotive components, biotech,  facilitating access to banks and equity capital  France  BPifrance   2013  b euros  SWF, the Strategic  contract research, oil and gas  France  investors, in particular during the high‐risk  in 2015  Investment Fund, and  engineering, online video services,  phases: Start‐up, Innovation, Development,  OSEO.   surgical equipment and cards  International, Buy out.   Insurance, Wood, Mines, Services,  Materials, Telecommunications,  To support the growth of small‐ and medium‐ Hydrocarbons, General trades, Industry,  Gabonese  sized local enterprises through direct  Transportation, Property and Hotel  Strategic  investment; increase the capture of revenue  Industry, Automobile Industry, Banking  Investment  from the country’s natural resources; diversify    Fund, Fond  10% of oil revenue goes  government revenues and mitigate risk; and  While no targets have been set to  Gabon  Gabonais d’  2012  $0.14  to fund, 50% from excess  Gabon  broadly support the government’s strategic  specific asset classes, 80‐85% of ISIF’s  Investissem budget  economic policy objectives. Aims to develop  funds will be allocated to sectors with  ents  industries capable of generating enough  the highest economic impact, and 15‐ Stratégiques  revenue to replace oil revenues and reduce  20% will be allocated to projects with  (FGIS)  Gabon's dependence on hydrocarbon sector.   short term benefits such as employment  projects or accelerating normalization of  capital markets  The dual mandate of the ISIF—investment  Equity: 13% (2.1% EM, 10.9% small and  return and Irish economic impact—represents  mid cap)  a new “double bottom line” approach to  Financial Asses: 65.7% (cash 45.5%,  investing, and will require all transactions to  bonds rest)  generate both risk‐adjusted commercial returns  Infrastructure: 4.6%  Ireland  A share of assets of the  and an economic impact in Ireland. Following  PE: 5.9%  Strategic  National Pensions Reserve  Ireland  2014  $8.36  recent restructuring, ISIF increased its exposure  Commodities: 3.3%  Ireland  Investment  Fund (NPRF) became  to corporate bonds, as well as downsizing its    Fund (ISIF)  assets of the ISIF  allocation to alternative assets. However, all its  Infrastructure: transport, education,  investments target opportunities in Ireland to  tech, development, wind, etc.  promote the Irish economy, create jobs and    attract foreign investments. Can invest directly  Natural Resources: energy, agriculture,  into infrastructure and PE.  waste, and water  CDP Equity invests in companies of major  national interest, with the aim of creating value  for its shareholders via growth in size, the  improvement of operating efficiency, and the  aggregation and enhancement of the  100% PE:  competitive position on national and  Research, Innovation, and High‐Tech  90% gov CDP (bank  international markets of the companies  14.45%, Defense and Security 2.89%,  CDP Equity  4.9b  owned by Ministry of  Italy  2011  invested in. CDP Equity is an institutional  Financial Industry 6.94%,  Italy  SPA  euros  Econ and Finance), 10%  operator which acquires mainly minority  Industrial/Manufacturing/Mechanics  Fintecna  holdings in companies of “significant national  30.64%, Infrastructure 16.18%; Made in  interest” which are balanced economically,  Italy 29% ‐‐‐‐ (2013)  financially and equity‐wise and which have  adequate profitability and development  prospects that are suitable for generating value  for investors.  Mission: to promote sustainable economic  development of Kazakhstan through funding  and support of priority sectors of the economy  for implementation of public policy and State  programs, finding solutions for socially‐ oriented tasks and reaching goals set by  Infra, transport, financial, energy,  Strategy 2050.  telecom, SME, etc.      Vision by 2023: the main financial agent of the  Clear double bottom line  Kazakhstan  Baiterek  2013  12.7  Holding Company  Kazakh government that supports  Kazakhstan  measurements, such as jobs created,  diversification, modernization, and sustainable  enterprises created, subsidies, projects  development of the economy and provides  financed, and housing brought into  solutions for socially‐oriented tasks of the  operation.  state.    Main goals/objectives: 1) provision of full range  of financing instruments, 2) support SMEs, 3)  support new modern economic sectors and  innovation development of the economy, 4)  34    support export activities of national companies,  and 5) support and promotion of affordable  housing  Diverse sectors, but specifically targeting  To promote economic growth and make  clean energy and tech.    strategic investments on behalf of the    government, contributing to nation‐building;  22% in media and communications, 17%  and to nurture the development of selected  in healthcare, 15% in power, 14% in  Government shares of  Khazanah  strategic industries in Malaysia with the aim of  financial services, and 11% in property.  privatized national  Malaysia  Nasional  1993  34.9  pursuing the nation’s long‐term economic    Malaysia  agencies. Issues Islamic  Bhd  interests. Invests in PE via direct investments  Known to have 10.6% in Real Estate,  bonds.  and fund commitments. Overall, it has a flexible  8.7% in infrastructure, and the  mandate that allows it to have a wide range of  remaining in equities and PE. 55% in  strategies, including growth and early stage  domestic market, 12% Singapore, 7%  start‐up vehicles.   China, 6% Indonesia, and 7% Turkey in  2015  Fonadin promotes the participation of public,  private and social infrastructure development  by providing non‐refundable and refundable  financial products. It is an instrument designed  Infrastructure; equity, debt, and  to assist in the fulfilment of infrastructure  mezzanine.  El Fondo  programs by creating the necessary conditions    Nacional de  Government budget and  to promote national and international private  Industries: Aviation/Aerospace, Bridges,  Mexico  Infraestruct 2008  $14.26  existing infrastructure  sector investment in infrastructure in Mexico.  Education Facilities, Energy,  Mexico  ura  project returns.    Healthcare/Medical Facilities, Railway,  (FONADIN)  Uses PPPs as main conduit of policy. Provides  Roads, Sea Ports, Telecom,  support, financing, and know‐how for the  Transportation, Tunnels, Utilities, Waste  planning, design, construction, and final  Management, Water  transfer of projects developed by the private  sector.  Also invests into funds, and acts as a  fund‐of‐funds.  Macquarie  Infrastructure assets located in Mexico in which  Infrastructure: roads and rail, airports  Mexico  Fonadin ‐ 81m, Macquarie  the fund would have significant influence over  and ports, water and wastewater,  Mexico  Infrastructur 2010  $408.00  ‐ 59m, and seven pension  Mexico  management, operations and strategic  energy and utilities as well as social and  e Fund  funds ‐ 268m  direction.  communications infrastructure.  (MMIF)  Mobilize national and international tourism  Moroccan  investment. By attracting investors and  Fund for  2/3 gov. budget and 1/3  partners, structuring and executing investment  Morocco  Tourism  2011  $1.80  from Hassan II Fund  transactions, and supporting and managing  Tourism  Morocco  Developmen (owned by State)  investments within its portfolio, it will  t (FMDT)  consolidate the financing of the Moroccan  tourism sector.  National  To invest in projects that contribute to the  Infrastructure: power generation,  Excess earnings from  Nigeria  Infrastructur 2011  $0.54  development of essential infrastructure in  distribution and transmission  Nigeria  crude oil exports  e, one of  Nigeria. The NIF is 40% of NSIA (40% * 1.35  infrastructure, healthcare infrastructure,  35    three funds  billion)  real estate, agriculture, transport  of Nigeria  Selects projects/sectors through national  infrastructure, water resources  Sovereign  priority and potential for nationwide economic  infrastructure, etc.  Investment  development impact, potential for attractive  Authority  commercial and social returns, conducive  regulatory environment, and ability to unlock  private sector participation.  To strengthen the local economy through  strategic investments, while maximizing long‐ 36.8% in public equities (75% domestic);  run returns for the fund’s ultimate  6.8% in Fixed Income; 37.2% in PE (IT,  shareholder—the people of Palestine. Aims to  Palestine  microfinance, agriculture, tourism,  West Bank  do this by encouraging growth in the private  Investment  2003  $0.76  State Budget  healthcare, educational services, and  Palestine  and Gaza  sector of Palestine by investing in socially  Fund PLC  small renewable energy); unknown % of  responsible projects in vital economic sectors in  Private Debt, Real Estate, Infra, Natural  the West Bank and Gaza Strip. Specifically, it  Resources  looks to promote job creation as a means to  spur economic growth.  To mobilize private sector capital for  infrastructure development.  It seeks to invest  Philippine  in a portfolio of greenfield and brownfield  Investment  Macquarie 50m, ADB  projects across key sectors, including: PPPs,  Infrastructure: wind, gas, transportation,  Philippines  Alliance for  2012  $0.63  25m, APG 150m, GSIS  Philippines  water and waste, road and rail, mass transit,  thermal, solar, water  Infrastructur 400m  ports and airports, power generation and  e (PINAI)  transmission, renewable energy, gas  distribution, and telecommunications.   To make equity investments in strategic sectors  within the Russian economy on a commercial  basis by coinvesting with large international  Russian  investors in an effort to attract long‐term direct  Infrastructure, Retail, Energy, Logistics,  Russian  Direct  2011  $13.00  Oil Revenues  investment capital. Every transaction is  Airports, IT, Telecom, Textiles, Railways,  Russia  Federation  Investment  mandated to be co‐invested with an  Mining, Agriculture, Transport  Fund (RDIF)  international investor. Predominately investing  into Russia, with up to 20% allowed to be  deployed outside of Russia.  To invest in projects to stimulate economic  Fonds  Agriculture, fish, infrastructure, logistics,  growth and job creation, primarily to boost  Souverain  industrial hubs, energy, social housing,  investments, act as a co‐investor in SMEs and  d’Investisse mines, services (IT, health, education,  Senegal  2012  $0.76  State Budget  flagship projects in strategic sectors, and well‐ Senegal  ments  tourism).  structured projects to attract investors,  Stratégiques    effectively manage state‐owned assets, create  (FONSIS)  20% of assets to VC to fund SMEs.  wealth and sustainable jobs.   36    The SCIC is tasked for monitoring and investing  its capital based on market mechanisms. In  Vietnam  addition, the SCIC is responsible for promoting  State Capital  strategies to support market development, jobs  Infrastructure, Finance, Transportation,  Vietnam  Investment  2005  $1.00  Government budget  and economic growth in Vietnam. The SCIC was  Vietnam  and Healthcare  Corporation  also created to reduce government ownership  (SCIC)  in domestic companies. Aims to facilitate  corporate restructuring and promote SOE  reforms.   Source: Authors’ compilation. Note: ADB = Asian Development Bank; APG = Algemene Pensioen Groep; CDP = Cassa Depositi e Prestiti Group; EAP = East Asia and Pacific; ECA = Europe and Central Asia; GSIS = Government Service Insurance System; IBRD = International Bank for Reconstruction and Development; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa; PPP = public-private partnership; SOE = state-owned enterprise; SSA = Sub-Saharan Africa; SWF = sovereign wealth fund. — Not available. 37    Table A1.2 Strategic Investment Funds (SIFs): Multinational Region  Name  Year  Size  Financing Source  Objective  Sectors  Domicile  ($b)  AFRICA  The Emerging  2002  0.5977  PIDG Trust 388.1, KfW  Provides long‐term loans to private sector  Energy, infra, etc.  United  Africa  106.6, FMO 53, SBSA 25,  infrastructure projects in sub‐Saharan Africa.   Kingdom  Infrastructure  Standard Charter 25  Clearly measures impact in projects, amount  Fund  invested, jobs created, construction jobs  created, benefits reached.  AFRICA  InfraCo Africa  2005  0.126  Austria ADA, Netherlands  InfraCo Africa seeks to alleviate poverty by  Infrastructure: energy, transport, water  Mauritius  DGIS, Switzerland SECO, and  mobilizing investment into sub‐Saharan  UK DFID £5.9m. Funneled  infrastructure projects to catalyze economic  through PIDG Trust.  development. Targeting initial stages of  project development require relatively little  finance but higher risks can deter private  sector investors, so InfraCo Africa bridges  the concept, early‐stage development, and  advanced development gaps before  construction begins. The Company may  invest in support of commercially viable  infrastructure projects where, in the  opinion of the Board, there exists  demonstrable evidence of Additionality to  do so.  AFRICA  Pan‐African  2007  0.63  625m total: SA Gov  Invest in infrastructure projects in the  Infrastructure: Energy, Transport, ICT,  Mauritius  Infrastructure  Employees Pension Fund  Energy, transport, ICT, water and sanitation  Water, and Sanitation  Development  250m, Barclays/ABSA 125m,  sectors. The PAIDF will focus on very large  Fund (PAIDF)  Development Bank of  scale investments where it can make equity  Southern Africa 100m, Old  investments of US$ 25–120 million  Mutual 50m, AfDB 50m,  Standard Bank 15m, Liberty  Life 15m, Metropolitan  Asset Managers 10m, Social  Security and National  Insurance Trust 10m  38    GLOBAL  GEEREF ‐ Green  2008  0.222  Private 110m, EU Germany  Global Energy Efficiency and Renewable  Green infrastructure, renewable energy  Luxembourg  Energy Efficiency  euros  and Norway 112  Energy Fund (GEEREF) provides global risk  and clean power, and resource  and Renewable  capital through private investment for  efficiency; SMEs  Energy Fund  energy efficiency and renewable energy  projects in emerging markets and developing  countries. GEEREF focuses on Africa, Asia  and Latin America. It supports a broad mix of  energy efficiency and renewable energy  projects and technologies, such as small  hydropower, biomass, wind and solar power  projects. GEEREF was structured to catalyze  private sector investments into funds and  underlying projects by leveraging the public  sector seed contributions:    EIF (European Investment Fund) has assisted  sponsors in setting up and launching  GEEREF. EIF and EIB will select the  investment opportunities, monitor the  investments and raise funding.  ASIA  Renewable Energy  2009  86m  GEEREF 12.5m euros, BIO  REAF seeks to make equity investments of  Renewable Energy: primarily wind, small  United  Asia Fund (REAF)  euros  6m euros, OPIC, Bio, CDC,  EUR 5‐15 million into development stage  hydro, biomass, solar and methane  Kingdom  Calvert, DEG, and FMO. First  renewable energy projects and project  recovery  close of 50.7m, second close  developers deploying operationally and  of 51.9m close. OPIC also  economically mature technologies, and  put in 62m, and ADB put in  consolidate these investments into  $20m.   operating portfolios and generate good  returns through successful exits, primarily in  India, Philippines, Sri Lanka, and SE Asia.  Typically in economically mature  technologies with proven and successful  track record, namely small and medium  sized hydro, wind, solar photo voltaic,  geothermal, and biomass.   ASIA  InfraCo Asia  2010  0.085  DFID 60.8, DFAT 14.3, and  Create viable infrastructure investment  Energy and Power, Water and Waste  United  SECO 10.  opportunities that balance the interests of  Management, Transport, Agriculture;  Kingdom  host governments, local communities and  storage and logistics, telecomm, oil  domestic and international private sector  chain, min and upstream oil and gas,  investors. For projects that satisfy the three‐ urban infrastructure  fold criteria of being additional,  commercially viable and having  development impact, Infraco Asia directly  contributes development capital and  arranges project debt and equity capital  from third parties, as well as other InfraCo  affiliate programs.    39    EUCA  Marguerite Fund  2010  0.71€  710€ total: 100€ each from  Make capital‐intensive infrastructure  Transport, Energy, Mature Renewable  Luxembourg  (2020 European  EIB, CDP France, CDP Italy,  investments and will target attractive long‐ Fund for Energy,  Istituto de Credito Official  term and stable risk‐adjusted returns. Make  Climate Change,  Spain, KfW Germany, PKO  capital‐intensive infrastructure investments  and  Bank Poland; 80€ from  and will target attractive long‐term and  Infrastructure)  European Commission, and  stable risk‐adjusted returns. Green field 65%,  then total of 30€ from Bank  Brownfield 35%.   of Valletta in Malta and  Caixa Geral de Depositos in  Portugal  EAP  Asia Climate  2014  0.44  ADB, ORIX, Robeco.  Asia Climate Partners is a fund managed by  Broad spectrum of investment  Hong Kong  Partners  ADB, Robeco, and ORIX Corporation and  opportunities across three sector  SAR, China  supported by UK Government, to make  groupings: i) Renewable Energy, ii)  equity investments across a variety of  Resource Efficiency, and iii)  environmentally supportive, low‐carbon  Environmental Industries. Focus  transactions throughout Asia and the Pacific.  countries are China and India.  The fund’s objective is to invest in privately  held companies that are benefiting from the  macroeconomic and environmental  dynamics in emerging Asia, have a positive  impact on the environment and society, and  have the potential to generate a  commercially attractive annual return to  investors. Particular focus on China, India,  and SE Asia.  AFRICA  Africa Renewable  2014  0.2  GEEREF, AfDB (25m),  Renewable energy fund focused on sub‐ Grid‐connected development stage  Kenya  Energy Fund  Sustainable Energy Fund for  Saharan Africa, with 10‐30m size  renewable energy projects, including  (AREF)  Africa SEFA (25.5m), Global  investments.  Types of Financing: equity  small hydro, wind, geothermal, solar and  Environment Facility (10m),  project finance (30‐50% of project w/ market  biomass projects  SEFA Project Support Facility  rate returns after fees, carried interest, and  (4.5), West African  taxes), technical assistance/grants through  Development bank,  Project Support Facility, debt mezzanine.  ECOWAS Bank for  Investment and  Development, The  Netherland Development  Finance Company, Calver  Investments, CDC Group,  BIO, OeEB, Wallace Global  Fund, Sonen Capital,  Berkeley Energy, EIB  40    EUCA  EFSI ‐ European  2015  23.1  16b from EU, 5b from EIB:  Overcome current European investment gap  Diverse: strategic infrastructure,  Luxembourg  Fund for Strategic  21 b euro EFSI  by mobilizing private finance for strategic  education and R&D, renewable energy  Investment  investments, as one of the three pillars of  and resource efficiency, and SME  the Investment Plan for Europe. With EFSI  support  support, the EIB Group will provide funding    for economically viable projects where it  Sectors: Energy 29%, RDI 23%, Transport  adds value, including projects with a higher  13%, Digital 13%, SME 9%, enviro and  risk profile than ordinary EIB activities.   resource efficiency 9%, social infra 4%.  Source: Authors’ compilation. Note: ADB = Asian Development Bank; EAP = East Asia and Pacific; EFSI = European Fund for Strategic Investments; EIB = European Investment Bank; EU = European Union; ECA = Europe and Central America; GEEREF = Global Energy Efficiency and Renewable Energy Fund; IDB = Inter-American Development Bank; PPP = public-private partnership. 41    Table A1.3 Strategic Investment Funds (SIFs): Planned Size  Country  Name  Year  Financing Source  Objective  Sectors  ($b)  Bangladesh  Infrastructure Fund  Planned  $1.50  Foreign exchange reserves  To develop infrastructure and boost economic growth.  Infrastructure  Cameroon  SIF  Planned    ‐       ‐       ‐     unknown  Côte d'Ivoire  SIF  Planned    ‐       ‐       ‐     unknown  Egypt, Arab  50% from Arab investment  Rep.  SIF  Planned    ‐     funds  Infrastructure Fund.  Infrastructure  GIIF ‐ Ghana  90% of GIIF transactions must meet the GIIF hurdle rate and be fully  Infrastructure  commercially viable; 10% must be projects with high social impact and still  Ghana  Investment Fund  2016  $0.25  Budget  have positive IRR. Hurdle rate not yet determined.   Infrastructure  To primarily invest equity for the long term in companies that derive value  from development and operation of infrastructure assets/projects in India.  India Infrastructure  The resulting portfolio is expected to comprise greenfield, brownfield, and  India  Fund  2016  $3.00  Budget  operational assets/projects in core infrastructure subsectors.  Infrastructure  Local and international  sources, including Nigeria’s  SWF and domestic pension  Nigeria  Infrastructure Fund  2016  $25.00  funds  To invest in transport and energy sectors in Kenya.  Infrastructure  Norway  Fornybar AS  Planned    ‐       ‐     Clean Energy Fund  Green Finance  Green Strategic  South Africa  Investment Fund  2016    ‐     Budget  To catalyze investments in clean technology and low‐carbon infrastructure.  Green Finance  To mobilize private sector/institutional funding to coinvest in Thailand’s  Thailand Future  infrastructure. Pools investment in PPP projects as well as in government‐ Thailand  Fund  2016  $3.00  Budget  funded infrastructure assets.  Infrastructure  Tunisia  Planned SIF  Planned    ‐       ‐       ‐     unknown  Pakistan  Pakistan  Infrastructure Fund  Planned    ‐       ‐     Meet infrastructure Financing Gap  Infrastructure  Asia Climate  Finance Facility  $100 from ADB, $500 Germany  To leverage public and private sector investment in climate change mitigation  Climate Mitigation  Asia  (ACliFF)  Planned  $0.60  Private Sector  and adaptation in support of the goals of the COP21 Paris Agreement.  and Adaptation  Source: Authors’ compilation. Note: HC = hydrocarbon; IRR = internal rate of return; PPP = public-private partnership; SIF = strategic investment fund; SWF = sovereign wealth fund. — Not available. 42    Annex 2. Estimating the Economic Rate of Return and Policy Efficiency of Investments A project’s economic rate of return (ERR) may be estimated using cost-benefit analysis. Project benefits are defined in terms of their wider economic impact on a given country. For example, positive impacts include the promotion of growth, eradication of poverty, reduction of income inequality, and abatement of carbon emissions. Project costs are defined relative to their opportunity cost, that is, the benefit foregone by not using the same resources for the best available alternative investment. Discounted project benefits and costs are valued using shadow prices, which are defined as the increase in welfare resulting from a marginal change in the availability of goods and services or factors of production. A variety of approaches may be followed to estimate shadow prices in the economic analysis of projects, depending on the data available. At the most advanced level, shadow prices may be estimated using a dynamic macroeconomic optimization model of the economy. For example, a dynamic computable general equilibrium (DCGE) model is based on earlier classes of dynamic input-output models and linear programming turnpike models. DCGE models maximize output over time, subject to input-output production and resource constraints. The dual solution of the model generates a set of shadow prices for each product and resource for every year over the simulation horizon.14 Alternatively, shadow prices may be estimated individually, using methodologies that adjust observed market prices to reflect economic opportunity costs. In most cases, the analysis is conducted in domestic currency at the domestic price level. To this end, the border prices of exports and imports in foreign currency are converted into their domestic currency equivalent, using a shadow exchange rate that reflects the opportunity cost of foreign exchange to the country. The shadow exchange rate may differ from the market exchange rate due to a fixed exchange rate regime, import tariffs, quantitative import restrictions, as well as export taxes and subsidies. In turn, the shadow prices of outputs and inputs in domestic currency may differ from their market prices due to additional distortions generated by government and private sector market participants. These include distortionary domestic taxes and subsidies (such as sales taxes) or the presence of noncompetitive market structures (such as monopolies or oligopolies). They also include externalities that are not (or only partially) internalized by the market, such as greenhouse gas (GHG) emissions. Estimating the shadow prices of nontradable goods and services can be challenging. The valuation of nontradable material inputs is a multistep process that includes assessing market distortions, estimating upper and lower bounds for the shadow price of goods, and estimating the opportunity cost of goods based on demand and supply elasticities. For example, in the absence of a price for a given piece of land, putting a value on the land’s alternative use may require imputing a price based on the net present value of land rental prices. Also, amid widespread unemployment, the valuation of the shadow wage rate requires an estimation of the reservation wage, and different shadow wages need to be estimated for different skills, times, and locations. In preparation for the 21st session of the UN Framework on Climate Change (UNFCC) Conference of the Parties in Paris in December 2015 (COP21), considerable attention was devoted to the ERR analysis of                                                              14 In optimization theory, the solution to the dual problem yields the marginal contribution of each resource constraint to the objective function of the model, which is the shadow price of the corresponding resource. climate mitigation and adaptation projects. Since prices on existing partial carbon markets may equal the social cost of carbon only by coincidence, how one country chooses among various GHG-emitting projects may diverge from the maximization of world welfare. In particular, if the market price of carbon is lower than its shadow cost—but the switching price of carbon (that is, the price at which the country finds two alternative projects to be of equal value) lies between them—the country will choose the high-carbon project while the world would be better off if the country chose the low-carbon one, thus generating a financing gap. On the other hand, if the switching price does not lie between the market price and the shadow cost of carbon, then country preferences and world preferences coincide. At the same time, considerable attention has been devoted to estimating the shadow discount rate under conditions of uncertainty, including environmental uncertainty. Under the assumption that the marginal net benefit of a project is smaller when the recipients of those benefits are richer, in a growing economy, future benefits are valued less than present benefits. This is because it is believed that recipients will be richer in the future, as development proceeds. Estimates of the elasticity of the marginal utility of consumption generally range between 1 and 2. As a result, estimates of the shadow discount rate generally range between 1 and twice the expected rate of growth of per capita consumption. In theory, uncertainty about future consumption growth implies rising uncertainty about the future marginal utility of consumption. This in turn implies that the shadow discount rate should decline over time. The occurrence of shocks (such as natural disasters) has an ambiguous effect on the long-term, risk-adjusted discount rate because it reduces the risk-free rate, and potentially increases the risk premium. This may yield an increasing term structure of risk-adjusted discount rates if the asset’s beta is larger than two times the relative risk aversion.15 Such a structure would prompt more investment in projects with benefits in the distant future, if the investment project opportunity set contains enough projects with a small beta. This in turn would favor investments in climate adaptation and, more generally, in projects that meet standards of resilience to natural disasters. After the ERR for a project has been calculated, the policy efficiency of investment can be estimated as the ratio of ERR to total public capital invested. Source: Dang and Mourougane 2014; Tan and others 2001; Gollier 2015; Hamilton and Stöver 2015; and Squire and van der Tak 1975.                                                              15 The term “beta” is a measure of the volatility (or systematic risk) of a security in comparison to the market as a whole. 44