When the newly formed Global Impact Investment Network (GIIN) canvassed its 24 founding members in 2010, the world was reeling from a financial crisis that had exposed fundamental flaws in our capitalist system.
Over the ensuing decade, the impact movement has built up an irrevocable momentum, increasing dramatically in both scale and sophistication. Indeed, the GIIN’s numbers have swelled to over 300 investors, managing more than $303 billion of capital, with the full impact investment market estimated at $715 billion at the end of 2019, according to the GIIN. The diversity of participants has also evolved enormously.
The United Nations Sustainable Development Goals, adopted by member nations in 2015, meanwhile, have galvanised the industry, providing a common language and framework for thematic investment. Impact businesses themselves, many of which were just a flicker of an idea 10 years ago, have matured into viable and thriving enterprises in need of finance and knowhow to support their growth. And pervasive tech advances have continued to underpin innovative strategies and drive down costs, bringing ever more aspirational business models into the realms of reality.
“We firmly believe you can drive both financial and impact returns, and in fact that they have a collinear relationship – a company that maximises its impact performance should have better financial outcomes”
There has, in addition, been a growing acceptance that financial performance and positive impact can go hand in hand. The GIIN’s 10th annual survey, completed this year, found that while there was a wide variance in return expectations a decade ago, the industry has now consolidated around risk-adjusted market rate returns, with two thirds of investors seeing no trade off.
“It’s well established that impact investments should not be concessionary,” says Joanna Reiss, partner and co-lead of impact at Apollo, which has recently launched an impact strategy. “We firmly believe you can drive both financial and impact returns, and in fact that they have a collinear relationship – a company that maximises its impact performance should have better financial outcomes.”
A world on the brink
Of course, underlying demand for impact investment has also rocketed. Our natural environment is indisputably under threat, with temperatures rising and extreme weather events, from Australian bushfires to heavy rainfall, increasing in frequency and severity. Public sentiment has rallied around high profile environmental and social concerns, ranging from melting glaciers and water shortages, to racial inequality and the #MeToo movement, while a new generation is prioritising purpose over profit.
“The younger generation of investors are pushing their asset managers to provide them with products that deliver impact alongside returns. That’s a very powerful trend,” says Jean-Philippe de Schrevel, founder and managing partner at Bamboo Capital Partners. “Young people are also looking for jobs that are meaningful and young entrepreneurs are looking to make a difference. When I did my MBA at Wharton a little over 20 years ago, there was no mention of impact. Now, it is a serious component of the curriculum.”
And, of course, this culture with a conscience has grown up in a decade of austerity. Government spending has been tight and large donor-funded NGOs are restricted to emergency relief. It has become imperative for the private sector to step up.
Indeed, while there was a risk that covid-19 would dominate the international agenda to the exclusion of all else, global head of sustainability at Macquarie, Chris Leslie, believes the pandemic has actually shone a light on the way in which all global challenges must be faced going forward. “In a perverse way, covid gives us insight into the sort of global co-operation that is going to be necessary to deal with things like climate change,” he says.Meanwhile, the international pandemic, against which the GIIN’s latest survey was completed, has revealed the ongoing fragility of our economic system and levels of inequality that have become palpably unsustainable.
“If anything, investors will leave the covid crisis with a renewed sense of the importance of a business’s responsibility to employees and customers,” adds Michael Etzel, partner at impact consultancy Bridgespan Group. “That’s exactly the kind of non-financial considerations that impact investors have been championing for years.”
Why private debt makes sense for impact investment
While impact investment headlines tend to focus on the world of equity, private debt is actually the largest contributing asset class. It accounts for over a third of total AUM at 34 percent, according to the GIIN, followed by real assets at 22 percent and private equity at 19 percent.
Indeed, while early impact investment loan agreements were often virtually indistinguishable from commercial loan agreements, as impact investing has matured over the past decade, impact loan agreements have become increasingly focused on protecting and enhancing impact performance. At a minimum, this means including reporting covenants focused on borrower impact performance. But many impact investors are going further by modifying common contractual provisions to embed impact considerations, incorporating impact performance requirements into their loan agreements or both.
“Impact investment opportunities cover all asset classes, which reflects the varied financing needs of impactful companies as well as diversification opportunities for impact investors,” says Tania Carnegie, head of the impact ventures practice at KPMG. “While there is a lot of emphasis on private equity, private debt is one of the largest asset classes impact investors allocate capital to.”
Historically, that capital has primarily been targeted at microfinance opportunities, Carnegie adds. This was driven by the withdrawal of commercial banks in the wake of the financial crisis. But investors are increasingly taking a multi-sector approach.
UK asset manager M&G launched its first multi-sector private debt impact fund in 2018, for example, seeded by M&G Prudential, Big Society Capital and the Swedish Foundation for Strategic Environmental Research. “Impact criteria can be added as part of debt agreements for a range of opportunities,” Carnegie says.
Opportunity in crisis
It seems probable then, that the social and economic vulnerabilities exposed by the coronavirus, coupled with the likelihood of high levels of sustained unemployment and governments buckling under constrained budgets in the wake of unprecedented state support packages, could propel the world of impact investment to new levels.
“There was a widely held fear, early on, that covid could hinder progress in areas such as climate change as more companies and governments focused foremost on economics and cost, but we haven’t seen that bear out in reality,” says Reiss. “The pandemic has been a catalyst for the public and private sector alike to prioritise social and environmental progress.”
Meanwhile, Bridges Ventures co-CEO Michelle Giddens adds she has no doubt the events of this year will accelerate the rise of impact investing. “It has shone a spotlight on some of the key challenges that we need to address – inequality; under-investment in public health; the precariousness of the labour market and our unsustainable environmental impact. Crucially, it has highlighted that positive change can happen quickly and at scale – in terms of cross-sector collaborations, the role of government, the adoption of technology and consumer behaviour.
“We’ve seen what we can achieve through drastic, concerted action. We now need to apply the same urgency to huge challenges like climate change. There’s a clear imperative to invest in rebuilding our economy so that it’s more inclusive and more sustainable. By playing a part in that rebuild, the investment sector has an opportunity to show that it is a force for good.”
Impact investment is not immune to the aftershocks of the international lockdown nor the ramifications of second wave outbreaks Almost half of respondents to the GIIN’s 2020 survey expect their investments to underperform financially, with 80 percent predicting an increase in market risk.
Furthermore, large swathes of the nascent impact industry have limited experience of a downturn and fundraising has taken a short-term hit. “When the crisis broke, we immediately realised that institutional investors would back off for a while,” says Els Boerhof, partner at Goodwell Investments. “In the past six months, our fundraising efforts have been entirely focused on private investors and family offices.”
And yet, in many senses, impact investments are relatively uncorrelated with global market trends, focused, as they are, on themes of fundamental need and the provision of basic goods and services. “It is what we call the survival economy,” says Boerhof.
“Generally speaking, because most of our investments are responding to these big, long-term macro challenges, rather than short-term trends, the portfolio has shown good resilience,” adds Giddens.
Furthermore, it is worth bearing in mind, that the global financial crisis resulted in significant innovation – for example, lower cost models, which were a real boon for exclusivity. “So, while the operating environment remains challenging in some sectors,” says Giddens, “we also expect there to be some really interesting investment opportunities.”
Bridges is not alone in eyeing impact opportunity. In recent years, a host of mega managers have launched impact initiatives, bringing a renewed sense of legitimacy to the movement. “The entrance of large, global private equity firms such as Bain Capital’s Double Impact, TPG’s Rise Fund and Partners Group’s Life Fund, signals a notable shift,” says Etzel.
TPG’s Rise Fund closed its first impact investing fund in October 2017 at $2 billion and now manages $5 billion in impact investing assets, with investments focused on education, financial inclusion, healthcare and clean energy, among others.
“Larger firms bring institutional awareness to the fact that mission-driven companies can create environmental and social change while also building profitable businesses,” says Steve Ellis, co-managing partner of The Rise Fund.
“Larger funds have the capital, business building resources, and expertise to help growth-stage, and even larger companies scale”
The Rise Fund
“That awareness brings more institutional capital to bear, and demonstrates to major global capital allocators that impact investments need not be concessionary. Additionally, whereas smaller funds traditionally made small cheque, or venture-sized investments, larger funds have the capital, business building resources, and expertise to help growth-stage, and even larger companies scale.”
The reaction of native impact investors has been broadly positive, largely because it lends the area more visibility and will hopefully bring in new investors. “It provides yet more proof that, on the tail end of the responsible investment movement, impact investment is gaining traction,” says de Schrevel, who is also eyeing the big buyout houses as potential buyers of Bamboo’s portfolio companies.
“It proves there is a market,” adds Boerhof. “And it offers choice for those looking for capital which is always a good thing.”
However, there are undoubtedly also rumbling concerns about these big brand giants entering the space. Where many early-stage and mid-market impact specialists focus on made-for-purpose impact businesses, these behemoths of the buyout world, will inevitably be taking a different approach – creating or enhancing impact in large, existing businesses.
“There is unequivocally a need for aligned capital in the large company space,” says Rekha Unnithan, co-head of impact at Nuveen. “But what’s really important is making sure the capital that’s going into these companies is actually used to drive impact, not just observe it. Everyone knows that if you invest in a large enough business it is going to create jobs. New entrants must be held accountable.”
Giddens, meanwhile, adds that if all of these new entrants have their own approach to measuring and managing impact – so that they are effectively competing on the quality of their impact methodology, not the quantum of their impact – it could cause some confusion. It all boils down to the concept of impact washing, which undoubtedly has the potential to derail the growth of the industry.
“Accountability, authenticity and integrity are absolutely vital,” says Tania Carnegie, leader of the impact ventures practice at KPMG. “If LPs start to feel that the pursuit of impact isn’t quite as significant as they had been led to believe in due diligence, that could really undermine the asset class’s future.”
Other potential stumbling blocks in the years ahead include competitive intensity. “We are starting to see a lot of players going after the same kinds of deals which may cause pressure on valuations that cannot be substantiated with the fundamentals of the business,” Boerhof says. For Giddens, meanwhile, the key issue the industry faces is a lack of scale. “The main barrier to achieving scale, in our view, is that there is still not a generally accepted way to measure, manage and report on impact,” she says.
A blended approach
It is also important to remember that impact investment is not a silver bullet – not all solutions to the world’s problems will be solved through profit maximising investment. “In areas where this is not the case, we need to explore clever new ways of blending different kinds of capital, from investors and funders with different risk/return appetite,” says Giddens.
New finance tools are indeed emerging, using public money to de-risk and catalyse private sector interest. “If you tell a government that every dollar invested in a first loss tranche will trigger another three or four private sector dollars, that is a very efficient use of public money,” says de Schrevel. “And, of course, that first dollar may not be lost. It could be returned to the government and they get to do it all over again.”
Indeed, while impact investment may not be a panacea, there is a resounding bullishness about what can, and will, be achieved. Despite the covid crisis, just 16 percent of respondents to the GIIN’s survey expect their investments to underperform on impact – 18 percent expect them to outperform. Meanwhile, 57 percent are unlikely to waver from their capital commitments as a result of the pandemic and 15 percent expect to deploy additional funds.
“If you use the Sustainable Development Goals as a proxy for the social and environmental challenges we face globally, the UN says that it will cost up to $7 trillion a year to achieve those goals by 2030,” says Giddens. “Governments and philanthropy can’t hope to fund this alone. Private capital needs to play a part.”
The good news is there’s a growing realisation that by doing this – by helping more people to fulfil their potential and using our natural resources more sustainably – we can also unlock trillions of dollars of economic value. It’s been estimated that achieving the SDGs in just four areas – food and agriculture, cities, energy and materials, and health and wellbeing – could create $12 trillion of new market opportunities by 2030.
“Ultimately, we believe that all companies and all investments will need to account for their broader impact on people and the planet, not just their financial performance. So, to that extent, we think what people call impact investing today is actually just the future of all investing”
Indeed, there is a growing sense impact investment should no longer be viewed as a distinct asset class.
“Ultimately, we believe that all companies and all investments will need to account for their broader impact on people and the planet, not just their financial performance,” says Giddens. “So, to that extent, we think what people call impact investing today is actually just the future of all investing.”
Founding father of the impact movement and author of recently published Guide to the Impact Revolution, Sir Ronald Cohen, agrees. He believes the capitalist model that has served us for more than 200 years, lifting millions out of poverty, is no longer fit for purpose. Impact must be monetised and reflected in financial accounts, he claims, so that impact can be brought to the heart of the financial system, sitting side by side with profit.
Steve Ellis, co-managing partner of TPG’s Rise Fund, agrees: “We aim to expand the reach of commercial capital to help the next generation of entrepreneurs build profitable businesses that deliver positive and sustainable impact.
“We believe that a fundamental change, oriented to the belief that mission-driven businesses can also be profitable, will bring the weight of the capital markets marching towards impact companies and ultimately help close the funding gap to achieve the United Nations Sustainable Development Goals.”
And, in many ways, covid-19 provides the perfect opportunity for change. Just as people realised they had been foolish to invest in companies without properly measuring their profits in the wake of the 1929 crash, which ultimately led to GAAP and independent auditing, so the pandemic can pave the way towards, in Cohen’s words, a new form of “compassionate capitalism”.
“Erasing the boundaries between impact investing and investing is the real long-term opportunity,” says Etzel. “How can the private equity fund of the future afford not to take impact into consideration?”