Frithjof Van Zyp
bfinance, the leading independent investment consultancy, has released fresh research on the rise of ‘impact’ private equity funds, showing the remarkable evolution of ‘impact’ private equity landscape while also revealing current ‘best practices’ and ‘red flags’ from recent asset manager research.
While the emergence, rapid growth and maturation of the ‘impact’ investment sector represents an extremely positive development for the investment industry, asset owners are now grappling with the challenging practical task of assessing and comparing these strategies. Momentum in ‘impact’ investment has been particularly strong in private equity but, amid concerns around ‘impact-washing’ and ‘SDG-washing’, it is crucial to set meaningful standards. Therefore, it is important to understand: what is an appropriate standard to which investors should hold ‘impact’ private equity managers accountable?
Frithjof Van zyp, Senior Director at bfinance says “Growing client interest in relatively nascent Impact private equity strategies has resulted in bfinance conducting multiple searches across this space over the last 12 months. Interestingly these searches have uncovered a wide spectrum of available strategies which can vary greatly by impact type and philosophy. This has helped bfinance develop practical assessment criteria at a firm, fund, and deal level as outlined in the paper.”
Strategies
Private equity strategies with an explicit mission to deliver impact are a relatively new and rapidly evolving breed, first appearing in the mid-2010s and now numbering well over a thousand. Investors can now enter this asset class with a reasonable expectation of non-concessionary returns alongside intentional, measurable impact, with target IRRs ranging from 10% to 25%.
While initial launches were more likely to have a venture capital or growth focus, more recent vintages have included a growing number of buyout funds—some of them over a billion US dollars in size. Dedicated impact fund-of-funds have also emerged, as have specialist secondaries funds and co-investment funds, not to mention custom separately managed accounts (SMAs). These developments are hallmarks of an increasingly mature asset class.
Managers’ approaches to impact vary greatly. Most focus on a multiple environmental and social impact themes, though significant minority of strategies (almost a third) focus solely on environment impact considerations—chiefly climate. Nearly a third of managers use a methodology relating to the UN Sustainable Development Goals. Fund of funds deliver a more ‘indirect’ and diversified impact profile than their direct fund counterparts, given that they are further from the underlying assets, but investors should not underestimate their potential contribution: the most credible FoFs are actively driving impact ‘best practice’ among underlying GPs, helping managers to strengthen impact processes and reporting standards.
Best practices and pitfalls
It is far from straightforward to assess the credibility of impact private equity strategies. Black-and-white requirements are problematic in an essentially immature sector. Idealised impact investing best practice does not yet translate into real life. Actual track records are short; KPIs are problematic; managers are often unable to demonstrate intentionality, additionality or a clear theory of change to the extent that one may wish. The investor must find a way of navigating a highly imperfect world.
Based on recent manager research, however, there are significant attributes that investors can now look out for when weighing up today’s impact private equity fund offerings. These ‘best practice signals’ and ‘potential red flags’—indicators that characterise stronger and weaker approaches—are presented in this report. They can be divided into three groups: those that relate to the deals, those that relate to the fund and those that relate to the asset management firm.
At the level of the deal investors can look for specific indicators with respect to sourcing, due diligence, measurement, management/stewardship and the approach to exit. At the level of the fund one can scrutinise the nature of impact targets, resourcing, fee arrangements and more. At firm level investors can look for key indicators of impact commitment and culture with policies, governance and senior management KPIs all under scrutiny.
None of these indicators represents a silver bullet but, together, they can help investors to form strong-yet-pragmatic expectations and gain the confidence needed to enter this asset class.
Anna Morrison, Senior Director Private Markets at bfinance, says: “In the last couple of years we have seen an exceptional increase in interest and demand for ‘impact’ strategies among our institutional investor client base. Although this is evident in many asset classes, including public equities and real assets, activity has been particularly strong in private equity. Yet when it comes to implementation, investors can find it extremely difficult to assess and compare strategies from an ‘impact’ perspective: it is a challenging subject, not least because managers’ practices are evolving. I’m excited to share this report since it gives some pragmatic insight on what we’re really seeing at the moment when scrutinising fund managers, in terms of the stronger versus the more problematic candidates.”
