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Geographic appropriateness can be thought of as the first and widest filter to move items to a deeper screening. Such an analysis starts by collecting a robust collection of data sets that capture basic investing requirements and specific investment thesis characteristics. A method of weighting the importance of the data sets should be implemented in order to determine a list of countries of interest and a heat map of their relevant qualities.

Data Sets

There are innumerable data points for each country, but a few key ones that both debt and equity investors should take a deeper look at. A straightforward method to understand the sourcing potential and investment suitability of countries is to create a country ranking system and heat map, based on desired investment-related characteristics. Standard investment characteristics to rank countries could include:

● Ease of starting a business

● Level of investor protection

● Level of contract enforcement

● Ability to mitigate insolvency

Many of these characteristics are implemented in analyses done by the World Bank's Doing Business project.4 The data here are very understandable and comparable across different topics using the World Bank's country ranking system.

For impact investing, additional metrics should be considered. One important metric is the Human Development Index (HDI), which ranks countries by submetrics of human development. The lower the HDI, the greater the need for impact investments. General sectors can also be targeted at the country ranking level. For instance, if healthcare is a focus of the impact investor, then an index such as one measuring maternal mortality could be integrated into the analysis. The goal of the analysis is to understand on which countries to focus active sourcing efforts.

To delve deeper into creating such a country ranking method, open the file Country_Ranking.xlsm from the website. This workbook contains multiple country ranking data sets and a method to synthesize the data into usable output. Ultimately, an ordered list of countries that exhibits the qualities an investor is seeking should be discernable from the analysis. To get there, though, the starting point is the underlying data.

In this analysis, there are six independent worksheets that contain data sets relevant to investors and some specifically to impact investors:

1. Inv protect: This data set focuses on investor protections. Many countries differ in their attitudes toward investors and the levels of disclosure, board of director liability, and the ability of shareholders to take legal action against companies. Most investors will want transparency, low legal liability for the assigned board director, and the ability to navigate negative situations through legal action. Countries are ranked by the composite level of investor protection for investments in the listed country, with 1 being the best and 189 being the worst.

2. Start business: The ease of starting a business can be indicative of how well a government facilitates the needs of entrepreneurs. This data set ranks countries based on four metrics: the number of procedures required to start a business, the time it takes to register a firm, the cost to register based on fees, and also equity required.

3. Contract enforcement: For both debt and equity investors, contracts transform conceptual and verbal agreements into a common understanding. More importantly, if one party deviates from that understanding, there should be a strong and efficient legal system to mitigate the situation. This data set ranks countries based on three metrics related to contract enforcement: the time it takes for dispute resolution, the cost of working through such a dispute, and the number of procedures required to achieve resolution.

4. Insolvency: Important for debt investors is the ability to lay claim to a company's assets if it becomes insolvent. Debt holders often invest with a priority over the company's assets and accept a lower return proposition than equity holders for such privilege. However, if the ability to recover value is diminished or difficult the reduced return may not be worth it. The insolvency data set looks at the time it takes to close a business, the cost of closing the business, whether the business is sold off in pieces or as a whole, and, very importantly, how much money a claimant recovers given insolvency.

5. HDI: If the prior four categories were the only data sets to include in this sourcing exercise, the top countries would primarily be developed economies that have less widespread need for impact investing.5 For an impact investor the developmental need is a priority and should be reflected in the analysis. To facilitate this, the Human Development Index (HDI), a statistic created by the United Nations Development Programme (UNDP), is used to rank countries. It scores countries based on life expectancy, education levels, and standard of living.

6. Maternal mortality: A sector-based investor may want to include his or her specialty in the analysis. In the example provided, a healthcare oriented investor can assess the development and need for maternal care in a region. Any other specialty can be similarly integrated depending on investor focus.

NOTES FROM THE FIELD

In 2005, while I was working for Citigroup, we were looking to fund investment in a certain Eastern European country. The investments would be mortgage related and required a high degree of certainty regarding contract enforceability and bankruptcy protection. As part of the deal team, we noticed that the laws were very loose in these regards. We engaged in local country due diligence and met with federal government officials who told us, “Don't worry, we will be changing those laws in the next few months.” After a lengthy plane ride home, we sat around a conference table the next day, and someone asked the best follow-up question, “If they can change the laws in just a few months in our favor, can't they change them just as quickly against us?” The investment was never made.

Data Aggregation and Weighting

Once the data are loaded, it should be aggregated on a single sheet. The Data Agg sheet does just this by listing all potential countries with the relevant rank to the right. Note that there is a guide to the rankings in row 6, called Target. This is to keep track of whether a high or low number indicating a weak or strong rank is desirable. For instance, a country with a low score for contract enforcement means that it has a high standard of contract enforcement. This is desirable for most investors. However, a low HDI rank indicates a very developed economy and may not be the best country for an impact investor. Figure 2.1 shows the top part of the data aggregation.

Figure 2.1 Country rankings are aggregated and prepped for weighting.

Once the country data are aggregated, a weighting method can be applied to layer in the investment thesis preferences. Effectively, a weighted average score is needed. However, one needs to be cognizant of whether a high value or low value is desirable. In this example, for five of the six metrics it is desirable to have a lower score. To work with the weighting method of having a higher percentage influence a higher rank converting the low scores to a high score is necessary. Conversion can be done by subtracting the count of countries for each data set by the rank for all of the factors except HDI. With the correct ranking figures, a weighted average can be calculated by multiplying the weights by the ranks.6 Figure 2.2 provides an overview of the weighted calculations.

Figure 2.2 The aggregated data and a weighted value for each country are calculated.

Controlling the Analysis

The weights can be adjusted depending on an investor's investment thesis. A scenario selector system is ideal for setting up various weighted cases. Figure 2.3 exemplifies such a system, which will be used in other analyses throughout this book.

Figure 2.3 A scenario selector system allows the user to enter investor preferences and toggle between scenarios.

Results

Once a scenario is selected, the Data Agg sheet calculates the appropriate statistics based on the weights and the results can be summarized. The Summary sheet shows the top 25 countries that are produced from the combination of the weights selected. Additionally, a heat map of the relevant characteristics is displayed so a user can see what is driving the results. Figure 2.4 shows the top 15 results for a global equity impact investing scenario.

Figure 2.4 The selected countries are summarized, along with a heat map of the relevant statistics.

The most noticeable feature of Figure 2.4 is that there are some affluent geographies on the list, such as Singapore and Hong Kong. Even though the HDI is heavily weighted, there are still four other factors that favor developed countries. For this reason, it is necessary to take a closer look at the heat map that shows how the rankings were created. It is clear that there are trade-offs with each country that was selected. For instance, the first choice is Rwanda, a country that is very favorable because of a high development need based on HDI and acceptable scores on investment protection and contract enforcement. Insolvency and ease of starting a business are not very good, but the other factors still outweigh the low scores.

The trade-offs are evident when Singapore is examined. It has the lowest HDI score of the top 15 countries shown, but makes it to the top 15 because of very high scores for contract enforcement and investor protections. It also has high scores for the ease of starting a business and insolvency mitigation.

Investors can customize the weightings depending on the focus of their investment strategy. For instance, a debt investor may put more emphasis on insolvency protection and contract enforcement given the first lien position of debt on the assets of a company. Change the scenario selector on the sheet to Global Impact – Debt. When this is done, the results change and Ethiopia takes the top spot, primarily because of a more favorable insolvency mitigation score, which is important for debt investing.

Keep in mind that this is only a method to start building a framework for geographic suitability and that each country should be examined in detail. For instance, Ethiopia as the top choice for Global Impact – Debt has a high need for development and a good insolvency mitigation score, but compared to the mean investor protection score amongst the top 25 (6.256), its investor protection score of 1.6 is very low. Depending on the risk appetite of the investor, this combination may not be suitable. Individual analysis is always required. Also, the data sets chosen here are not exhaustive or completely indicative of a perfect investment environment. Local due diligence should always be undertaken to vet country risk.

Finally, impact investing does not have to only be done in emerging markets. There are many companies that are domiciled in developed countries that have focuses abroad or, as mentioned in Chapter 1 earlier, even in areas domestically that demonstrate need. However, investors in companies that are domiciled in developed markets and do business in emerging and frontier markets should still do a country risk analysis of the primary operational regions. Indirect risks can disrupt cash flow and quickly put stress on the viability of the company as a whole.