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When the world adopted the 2030 Sustainable Development Goals (SDGs), policymakers knew that aid alone would never meet the financing needs. They embraced the “billions to trillions” vision, believing that an abundance of commercially viable SDG-related investments was ready and waiting for trillions in profitable private investment—if only development finance institutions (DFIs) and others could clear away the obstacles that stand between the investments and private investors.
Reality looks different, however. Finding bankable projects, especially in low-income countries, is hard for commercial investors and hard for DFIs, essentially for the same reasons. The DFI view of risk, tolerance for risk, risk management approaches, and goals for risk-adjusted returns are not greatly different from those of commercial institutions.
The result is a critical gap in the architecture for development finance. Grantmakers fund non-financially sustainable activities that yield high-development-impact. And commercial impact investors, including DFIs, seek market returns along with impact. What is missing are investors that target investments at scale with sub-market risk-adjusted returns and high development impact.
We need a new public-private actor in between, one that has a very different risk tolerance and financial objective, and an emphasis first and foremost on development impact. In a new paper, we are proposing the Stretch Fund, to partner with DFIs. The Stretch Fund would “stretch” the capital of existing DFIs in two ways: by expanding the spectrum of investments in which DFIs can participate; and by taking on high-risk tranches to open up more DFI investment opportunities.
As a pooled investment vehicle, the Stretch Fund would combine capital from public and private investors that are like-minded in prioritizing development impact over returns, helping to mobilize private finance for development. Not only would it target capital market gaps, and have a strong results measurement framework built in, but the Stretch Fund would also be financially sustainable.
In the paper, Lee and Preston work through how such a structure, with this investment strategy, can preserve its capital at the portfolio level. Drawing on examples from similar entities, and interviews with professionals who have managed similar funds, the authors have constructed a financial model that combines financial sustainability with high risk tolerance and high development impact.
Watch this helpful video explainer to see what the Stretch Fund can do as part of a critical gear in the development finance machinery, and check out the paper here.
CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.